Christiana Romer has an important column in Sunday's New York Times on the stimulus. You will recall that as chair of the Council of Economic advisers, she played a big part in designing the stimulus, and forecasting its effects. She also is one of the preeminent academics who have done empirical work evaluating the effects of stimulus programs. You expect a thoughtful essay.
She explains how cause-and-effect empirical work in economics is hard
To understand what’s wrong with that reasoning, think of someone who’s been in a terrible accident and has massive internal bleeding. After lifesaving surgery, the patient still feels rotten. But we shouldn’t conclude from this lingering pain that the surgery was useless — because without it, the patient would have died.This is really good compared to the usual "of course it worked you blockhead" sort of argument from stimulus sympathizers (you know who, and "blockhead" is being polite).
Without knowing where the economy was headed in the absence of the stimulus, it’s impossible to judge what it contributed just from what happened afterward. That’s why empirical economists rely on other approaches.
Of course I might have used the image of doctors bleeding the patient, applying poultices or voodoo, and then claiming great power when the patient heals on his own, but the principle is the same.
A growing literature examines the effects of such tax cuts and increases in government spending over history and across countries, and the overwhelming conclusion is that fiscal stimulus raises employment and output in the near term.Wow, that's strong. .
..states that received more money [for random reasons] fared substantially better. This is the strongest direct evidence that the Recovery Act contributed to employment growth. Based on the estimated size of the effect, the studies suggest that the act created more than three million jobs.This does not follow at all. I don't think anyone disagrees with the proposition that if the government takes money from residents of state A and splashes them on state B, the economy of state B improves. But this totally evades the whole issue: what about state A? This is the entirety of the stimulus debate: The government can transfer resources, but not get resources to fall from the sky. (Whether it taxes or borrows form the residents of state A, it's still transferring resources.) Stimulus is supposed to raise aggregate demand, not transfer demand from state A to state B. Yes, if the government builds a military base in the desert, GDP in that desert goes up. From this, stimulus raising the whole country does not follow.
The web version cites the studies. I've read about half of them, and they are careful not to jump to this conclusion. (This is about cross-state studies. There is another industry of time-series studies, trying to see if times when the US overall has stimulated it did any good. That's another issue, which Romer doesn't talk about, so I will also put off for another day.)
She goes on,
In addition to its near-term jobs effects, the Recovery Act may also be having more lasting benefits. It’s too early to measure the value of the roads, bridges...Fine, but that's not the issue either, and never was. Sure, if there is a positive rate of return investment, make it, and a recession is a good time to do it. But the argument for Keynesian stimulus is that spending money helps the economy at that moment, whether or not it does any long run good. Paul Krugman is admirably honest by advocating we fake an alien invasion so we can build useless defenses. (I'm not sure why he's not for building useless ships and submarines, but that's for another day.) Whether that works is the issue, not whether the money turned out not to have been totally wasted.
She discusses some faults of the stimulus, finishing with
Finally, there’s little question that policy makers — myself included — should have worked harder to earn the public’s support for the act.Well, I might say, now is a good time to start. The question for our time is whether stimulus was a great tool rediscovered or a grand failure waiting the ash heap of history. If its central architect, and a noted scholar, has to stoop to such illogical arguments to summarize our experience, I'd say earning support is unlikely.
I wonder whether Dr. Romer took the ill patient - doctor analogy from Mankiw's "Crisis Economics"... Her article actually reminds me in part of Mankiw's. Anyway, always enjoy reading your posts Dr. Cochrane!
ReplyDeleteAll the best!
"Wow, that's strong. What are these studies..."
ReplyDeleteyou could look at her 31 page paper that she wrote and linked to. I'm pretty sure she'd break a NYT word-count limit otherwise.
"I don't think anyone disagrees with the proposition that if the government takes money from residents of state A and splashes them on state B, the economy of state B improves. But this totally evades the whole issue: what about state A? This is the entirety of the stimulus debate: The government can transfer resources, but not get resources to fall from the sky. It's supposed to raise aggregate demand, not transfer demand from state A to state B. Yes, if the government builds a military base in the desert, GDP in that desert goes up. From this, stimulus raising the whole country does not follow."
That logic doesn't apply to deficit spending, only if you were to tax one place to spend somewhere else. You're not transferring resources by deficit spending, merely putting idle resources to work. There's plenty of savings around with few good things for businesses to invest in, there's plenty of cement workers in Pennsylvania who could use higher hours, there's unemployed construction workers who wouldn't mind working a road project, teachers who'd like to teach and schools who need more, etc. It's not transferring output from one place to another, it's creating output in one place that would otherwise sit idle.
"Fine, but that's not the issue either, and never was."
sure it is, it just may not specifically be yours. Many think that it may be short-term gain for long-term loss (via paying interest on the debt); this was to state that there's plenty of long-term gains to be made too.
It is all a chimera, The short term gains are quite small and even problematic, while the debt is very large and serves as a very big drag on growth. This stuff defies the evidence and it defies basic logic. If it was possible just to prime the pump with borrowed money then we need never have another economic slowdown, but of course that is hogwash.
DeleteActions of government only hurt and delay recovery. As they also distort markets and give those business which need restructuring an artificial life preserver.
"Wow . . . . What are these studies? Alas, she doesn't give us authors or titles (NYT edits these out, I presume, as references are unimportant for such obvious truths), though the few such studies I have read are careful not to jump to this conclusion."
ReplyDeleteWow indeed. Readers can simply click on the link you yourself provide for Christina Romers' piece in which there are sixteen links to various studies and articles. Let us know after you've read them if you want to rethink your post.
http://elsa.berkeley.edu/~cromer/Written%20Version%20of%20Effects%20of%20Fiscal%20Policy.pdf
http://www.stanford.edu/~waw/papers/State_Fiscal_Relief__AEJ_Policy.pdf
http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-23-2012-RecoveryAct.pdf
http://macroadvisers.blogspot.com/2010/02/ma-on-fiscal-stimulus-definitive-answer.html
http://www.stanford.edu/~waw/papers/State_Fiscal_Relief__AEJ_Policy.pdf
http://www.frbsf.org/publications/economics/papers/2010/wp10-17bk.pdf
http://web.econ.ohio-state.edu/dupor/arra38_jul12.pdf
http://www.treasury.gov/resource-center/economic-policy/Documents/20120323InfrastructureReport.pdf
http://www.foreignpolicy.com/articles/2012/08/13/think_again_obamas_new_deal
http://www.recovery.gov/Accountability/Pages/GAOFindings.aspx
http://www.columbia.edu/~vw2112/testimony_JEC_vonWachter_29April2010.pdf
http://www.economy.com/mark-zandi/documents/economic_stimulus_house_plan_012109.pdf
http://www-personal.umich.edu/~shapiro/papers/aejep2012.pdf
http://topics.nytimes.com/top/reference/timestopics/people/r/franklin_delano_roosevelt/index.html?inline=nyt-per
http://topics.nytimes.com/top/reference/timestopics/subjects/g/great_depression_1930s/index.html?inline=nyt-classifier
http://www.newyorkfed.org/research/economists/eggertsson/Great_Exp_AER.pdf
Thanks. I read the print version -- how old fashioned -- without links. Back soon on the studies
DeleteBut what if the spending on state A is deficit financed, not supported by taxes? Are we then back to arguing about whether Ricardian equivalence means that fiscals stimulus never works in a world of rational expectations? I seem to remember a dustup a while ago involving you, Bob Lucas, Simon Wren-Lewis, and Paul Krugman about Ricardian equivalence and income smoothing, but I don't have the time to reread that whole exchange.
ReplyDeleteOne could also refer to the widely cited review of the literature by Valerie Ramey in the JEL in 2011, 49(3). Of course she is a supporter of Gov. Romney, so I don't think the blockhead smear applies to her, does it? In addition, the work of Bob Hall (also not a liberal) suggests relatively large multipliers from government spending (link for example here: http://www.stanford.edu/~rehall/Daedalus%20Fiscal%20Stimulus%20Published.pdf)
ReplyDeleteI would appreciate your take on this. Clearly there is an abundance of prominent, careful, peer-reviewed research finding multipliers larger than 1. The IMF just made an about-face on this issue as well. Where do they all go wrong?
Ramey's work shows a multiplier less than one.
DeleteWhy does stimulus fail?
ReplyDeleteBecause it is stimulus, here one day, gone the next. This is what happens when you pair micro-economists with politicians - neither of them has any interest in the long term.
Instead of stimulus, focus on contracts. Friedman is correct - people make their spending AND investment decisions not on their current income but on their future anticipated income.
The federal government influences future anticipated income and long term economic growth by selling long term liabilities. Those liabilities can be debt (guaranteed) or equity (non-guaranteed). Both are claims against future tax revenue, and the present value of all future tax revenue is infinite.
"But this totally evades the whole issue: what about state A? This is the entirety of the stimulus debate: The government can transfer resources, but not get resources to fall from the sky. (Whether it taxes or borrows form the residents of state A, it's still transferring resources.)"
ReplyDeleteJohn,
There is nothing stopping the residents of state B from buying goods in state A - so what is your point? It is almost as if you look at one transfer mechanism (government) and say after that point the flow of money stops. If you are going to make a small government or antistimulus argument, at least make one that makes sense.
Stimulus is ineffective because it is just that, stimulus - here one day, gone the next.
Reducing government expenditures is good because the federal government creates a demand without adding to supply. Reducing federal expenditures is good because the federal government takes productive resources and puts them to a non-productive use.
people disproportionately spend and invest in their own states
DeleteLAL,
DeleteNot true. Individual persons typically shop for goods at a local market or store. But that store gets most of its goods from out of state.
Likewise, while typically the largest investment an individual has is his / her home & family, a lot of people have investment / retirement plans that spread investment money all over the US and indeed the world.
Hello,
DeleteI agree it is not a 0 or 1 phenomenon...but even you point out it is still disproportionate.
Anyway, services are a much larger sector of the economy.
I claim that most money spent will be to local wages, so even if there is a small bias it will multiply. I don't pay the wages of the grocery clerk in another state as directly as I pay for the wages of the clerk in my own. my potentially tiny bias together with the clerk's potentially tiny bias will multiply through and keep a 'disproportionate' amount of wealth in my own state.
As for investing...I am thinking of studies which are easy to find
http://web.ku.edu/~finpko/myssi/FIN938/Zhu_local_EA.pdf
What is important is that this phenomenon is not explained in any macro keynsian or rational expectations model very easily.
I don't need no one or everyone, I need the ratio to be unequal.
LAL,
Delete"My potentially tiny bias together with the clerk's potentially tiny bias will multiply through and keep a 'disproportionate' amount of wealth in my own state."
Be careful calling money (a medium of exchange) wealth. The two are not the same. Wealth is better measured as a flow (GDP). Wealth is not a bank full of federal reserve notes. What you do with those FRN's is more important than how many you have.
Suppose there are two states A and B, the federal government taxes residents in A and gives the money to residents in B. At the same time the residents in A recognizing that the money in their pockets is easily taken by the government decide to spend their money more quickly. The residents in state B thinking that the government is going to help them build "wealth" spend their money more slowly.
GDP (State A) = Money (State A) * Velocity (State A)
GDP (State B) = Money (State B) * Velocity (State B)
Money in state A decreases, but velocity in state A increases by more. Money in state B increases, but velocity in state B decreases more.
Which state has more "wealth"?
This is an overly simplistic example, but I think the point remains valid. Money in a bank is not wealth.
Frank.
Deletevelocity of money is one thing not to calculate or predict.
NGDP: PY = MV.
The increase in M will lead to inflation, so Y not actually increase, but only P. Want to improve the best judgment is to increase V, want to do this, the best way to let the economy adjusts.
liquidate labor, liquidate
stocks, liquidate the Farmers, liquidate realestat .... and liquidate bad assets
"The increase in M will lead to inflation."
DeleteUm, no.
Recognizing that all money begins as a debt:
Debt * Velocity = Real GDP * (1 + Inflation Rate)
DV = RGDP * (1 + IR)
DV is a measure of financial transactions that occur in the purchase of goods.
DV = Income * (1 - Liquidity Preference) + Change In Total Debt w/ Respect to Time
DV = I * (1 - LP) + dD/dt
Income is interest payments + income from sale of goods
DV = (Interest Rate * Debt + PY) * (1 - LP) + dD/dt
DV = (Interest Rate * Debt + DV) * (1 - LP) + dD/dt
DV = ((Real Interest Rate + Inflation Rate) * Debt + DV)) * (1 - LP) + dD/dt
DV = ((RIR + IR) * D + DV))*(1 - LP) + dD/dt
0 = D * (RIR + IR) * (1 - LP) - DV * LP + dD/dt
D = exp(f(t))
dD/dt = f'(t) * exp (f(t))
0 = (RIR + IR) * (1 - LP) - V * LP + f'(t)
V = [ (RIR + IR) * (1 - LP) ] + f'(t)
Letting productivity PR = Real GDP / Debt
PR = RGDP / D = V / (1 + IR)
PR = [ [ (RIR + IR) * (1 - LP) ] + f'(t) ] / (1 + IR)
Letting productivity be an exogenous variable and solving for the inflation rate:
IR * PR - IR * (1 - LP) = -PR + RIR * (1 - LP) + f'(t)
IR * (PR + LP - 1) = RIR * (1 - LP) + f'(t) - PR
Inflation Rate = [ RIR * (1 - LP) + f'(t) - PR ] / [ PR + LP - 1 ]
And so the inflation rate will rise with increased credit demand ( f'(t) ) unless it is offset with higher liquidity preference or higher productivity. That does not mean that it will rise.
More recent Ramey article. From the abstract: "Using a variety of
ReplyDeleteidentification methods and samples, I find that in most cases private spending falls significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity."
See:
http://econ.ucsd.edu/~vramey/research/NBER_Fiscal.pdf
The paper is irrelevant for the discussion of the recovery act. She ends her data in 2008. Most advocates of stimulus don't argue that multipliers are "normally" bigger than 1. The advocates of stimulus argue that multipliers are bigger than 1 when monetary policy is at the Zero-Lower-Bound.
DeleteHer new paper does not address the scenario of the recovery act at all, the scenario which Christy Romer addresses and which Prof. Cochrane finds questionable. Auberach and Gorodnichenko show clearly, for example, that the multiplier is time-varying. Thus, I believe her latest paper is not necessarily making any new contribution to the literature on the effect of the recovery act.
If this last stimulus was so large that it had a definite multiplier of more than one, then why are we all still broke?
Deletequestion on the CHODOROW-REICH, FEIVESON, LISCOW, WOOLSTON paper:
ReplyDeletethey correctly recognize that current arra spending in medicaid is correlated with the error in change in current employment.
so they instrument on 2007 medicaid spending but then also include lagged change in employment as a control, doesn't that just move the problem around? ... same correlation
Yes, but will she win a Nobel for pioneering and championing the "jobs created or saved" metric that will revolutionize economic research and enhance public policy?
ReplyDeleteJohn, here is a question. Suppose the part of stimulus that was government projects ( since it was about 40% tax cuts ) had a small negative NPV in terms of the merits of those projects. However, it mitigated at least for some people the problem of long-term unemployment. There is research that shows long-term unemployment to be a permanent drag on human capital and economy in the long run. So the true impact of the stimulus = NPV of projects + NPV of higher human capital. You are basically placing zero weight on the NPV of human capital part. Why so ?
ReplyDeleteLet's stick to the issue at hand -- does stimulus raise output and employment, of the whole economy. Sure, maybe the projects aren't worthless. Maybe digging ditches and filling them up gives people needed exercise. Maybe working on a government project helps human capital. That's not the economic question at hand here.
DeleteThe economic argument for Keynesian stimulus is that borrowing (or taxing, the "balanced budget multiplier) from A and spending the money raises output and employment EVEN IF the spending is totally useless. AKA defenses for alien invasions. Digging ditches and filling them up again.
If you want to go with "well, sure, Keynesian stimulus is useless for raising employment and output, but the 'stimulus' bill was useful because of all these other reasons" we will have advanced the debate substantially.
I think there are two debates.
DeleteDebate #1:
Which theoretical model is better, Keynesian or non-Keynesian/ Personally, I don't think anybody in the world outside of a very narrow circle of economists is interested in this debate, because it is too technical. I might be wrong
Debate #2:
Was economic stimulus bill as designed by Obama administration, useful on net, or not? Should it have been even bigger? I think that's the one that we are interested in, as the readers of this blog, Krugman's blog, etc.
I think I know where you are on Debate #1, but not on Debate #2
We're getting somewhere. This post and debate is about #1. Which is the crucial question. You have to settle this before we talk about debate #2. Does borrowing money and blowing it, even on something inherently useless, help the economy? That is the central question dividing all of us on #2.
DeleteIf we could agree to "no" on #1, then we can proceed to "well, did the actual stimulus bill help for other reasons?" and debate #2 intelligently. There are whole books on that -- John Taylor's for example.
But this post, and Christina Romer's article, are exactly about #1. And it IS the crucial question to understand. Trillions of dollars of spending and debt depend on the answer.
What I don't understand is why many opponents of stimulus seem to argue that the answer to #1 is time-invariant. There seems to be an abundance of studies arguing for a time-varying multiplier, depending for example on exchange rate regime and the response of monetary policy (particularly if the ZLB applies). This also seems to be a natural application of the Lucas' critique.
Delete"Does borrowing money and blowing it on something inherently useless help the economy?"
DeleteYes, in a very special and a very simple case:
in the case when private sector is not willing to invest into projects that have positive NPV, but only in those states of the world when employment level is reasonable. In that case government can come in a blow the money, raise employment and that should send a signal to private sector to pursue those projects
so if government blows X but as result private sector invests into projects with NPV = Y and Y > X, blowing X helps the ecnomy
you implictly assume that private sector will ALWAYS invest into positve NPV projects because markets are efficient
Anonymous,
Delete"The economic argument for Keynesian stimulus is that borrowing (or taxing, the "balanced budget multiplier) from A and spending the money raises output and employment EVEN IF the spending is totally useless."
Even if the spending is totally useless (meaning it does not increase the supply of anything) it raises income levels - for instance unemployment benefits. Note that income is not output and employment. Output is a measure of how much goods are produced AND consumed. Employment is self explanatory. And so even if the spending by the government is on useless enterprises, that money can in turn be spent by the recipient, aggregate demand rises, and output rises.
The key thing here is that the federal government can add to aggregate demand by borrowing money. But they are not tasked to add to aggregate supply. It is not the role of the federal government to compete with the private sector in the production of price sensitive goods. And so government spending has an inflationary bias unless it is countermined by monetary policy.
Monetary policy (for instance under Paul Volcker) pushes up the cost of government borrowing above the rate of inflation. This allows private demand to fall to counteract increased government demand (people buy bonds instead of goods).
"You implictly assume that private sector will ALWAYS invest into positve NPV projects because markets are efficient."
No, the fact is the federal government is not some hedge fund or investment group looking to finance the next "insanely great thing" as Steve Jobs would call it. The federal government provides a legal system to maintain a civilized public. The federal government spends money on projects where profitability and productivity are a secondary concern (education, health care, defense of country, etc.).
And finally, those FRN's in your pocket are a medium of exchange on loan to you provided by an Act of Congress. And so it is the responsibility of the federal government to regulate both the pretax and aftertax cost of ITS money. Too many Republican's point fingers at the Fed without the slightest idea that the cost of money should ultimately reside with government, and that actual supply side economics is about the cost of money, not how much or how little of your income the government takes.
One other thing:
Delete"Trillions of dollars of spending and debt depend on the answer."
Apparently Mr. Cochrane never bothered to look at what that trillions of dollars of debt was doing.
http://www.federalreserve.gov/releases/z1/Current/z1.pdf
Page 9
2008: Total Financial Sector Debt - $17.12 trillion
Total Federal Debt - $6.36 trillion
2012: Total Financial Sector Debt - $13.85 trillion
Total Federal Debt - $11.11 trillion
Most of it (to the tune of about $3.3 trillion) was replacing debt run up by large financial "service" firms, with public debt. There was no money "spent" in this case. The federal government simply did a debt swap, meaning no money changed hands.
Low-quality debt for debt backed by taxpayers and force of arms if the taxpayers don't pay...
DeleteBut no money changed hands, so it's cool.
Anonymous,
DeleteThere is nothing cool about it. It is simply a reflection of how deeply ingrained the financial sector is ingrained into government policy.
Borrow $10,000 with no intent of paying it back and they throw you in jail. Borrow $3 trillion dollars with no intent of paying it back and suddenly you are too big to fail.
"To understand what’s wrong with that reasoning, think of someone who’s been in a terrible accident and has massive internal bleeding. After lifesaving surgery, the patient still feels rotten. But we shouldn’t conclude from this lingering pain that the surgery was useless — because without it, the patient would have died."
ReplyDeleteAll analogies are imperfect, but every imperfect analogy is imperfect in its own way (Sorry, Leo). And this one is imperfect in a very self-serving way.
First, Romer pretends to have observed not only the right symptoms but also made the correct diagnosis and treatment and claims to have "saved the patient's life" through that surgery. Well, these economic patients never really die, they just get sick and the disease is most often not diagnosed with any certainty. The patient is sometimes slow to recover, but they invariably do.
But having set the analogy up so that she could claim making the right diagnosis and "saving the patient's life" through heroic surgery, Romer then goes on to contradict herself in a very big way:
"Without knowing where the economy was headed in the absence of the stimulus, it’s impossible to judge what it contributed just from what happened afterward. That’s why empirical economists rely on other approaches."
Hmmm, having taken credit for not only diagnosing the patient's precise illness and for saving that patient's life (through stimulus, I suppose rather than faith healing) she says in that very next paragraph that "it is impossible to know what it (the stimulus) contributed just from what happened afterward".
When an economist cannot hold a logical thought from one paragraph to the next, I think one should reconsider commenting "This is very good...." even if that is a relative comparison.
Few quibbles in your piece I think I should point out:
ReplyDelete"This does not follow at all."
No, her logic is valid! You're not giving her a fair reading.
IF state A receives more ARRA money than state B
AND State A *fared* better than state B THEN ARRA contributed to growth.
The soundness hinges on the word "fared". But for all you know, and what she probably meant - it's what I inferred - is that it is at least true that A's employment > state B's decline, therefore AD still rises, therefore ARRA contributed to growth. Your analysis throws in extra information - illogic is not her problem - it is disagreement in the research.
"In addition to its near-term jobs effects, the Recovery Act may also be having more lasting benefits.
Fine, but that's not the issue either, and never was."
There is a reason Dr. Romer said "In addition to" - she obviously understands that this is not the main point of stimulus spending, it is icing on the cake. You can't call this illogical or be critical of it the way you wrote, you are straw-manning her position!
For all you complain, and rightfully so, about Krugman and DeLong's disrespect, I think you could make a small effort to show more here.
Your post this time was more Grumpy than Economist.
Professor Cochrane but using your logic one would argue that most of defense spending is useless because only small fraction of it is used later during the war (they can be desrcibed predominantly as spendings "for alien invasions"). But still they contribute positively to GDP.
ReplyDeleteBesides even if unconditional NPV of particular project does not look to be positive it can raise bussines confidence (because of lower unemployment and better sales prospects) to a point where it can be quite positive. I'm pretty sure you know Bayesian inference very well and you are just playing with pretending not to understand Keynesian logic.
let me just point out that its no excuse to say that the multiplier effect of stimulus is difficult to prove. Since it is the "stimulists" who want to use the coercive power of government to take money from some and give it to others, the burden of the proof relies on them. Stimulus shouldnt be policy unless there is clear evidence that it works.
ReplyDeleteGovernment do not need to take money from anyone because it issues it at its one will. The problem is that it can create inflation and this will transfer purchasing power from creditors to debtors. But if printing only prevents deflation I think it's a big stretch to say that creditors were robbed because no one ever promised them that real interest rate would be higher than nominal interest rate. And I don't think that any creditor ever expected it.
ReplyDeleteStimulus can work for the same reason that buying insurance can add value, even though it's a negative expected value proposition on its face
ReplyDeleteHaving eliminated certain bad scenarios can make it easier to engage in other activities
1. Keynes never advocated what you say he wrote or said. People infer certain propositions from his writings and comments but Keynes never advocated what you call Keynesian. To the contrary, Keynes was in balance, advocating that taxes should rise in good times to be off debts from bad times.
ReplyDelete2. You write, "This does not follow at all. I don't think anyone disagrees with the proposition that if the government takes money from residents of state A and splashes them on state B, the economy of state B improves. But this totally evades the whole issue: what about state A?"
You make a false assertion of assumption that the government took from state A, but there is no evidence of that. In fact, and most likely, all the money spent in state B was new money created by Banks, etc. (remember, no savings are actually required for a bank to make a loan and create money).
Professor,
ReplyDeleteWith all due respect, I think it is a common diesease in modern economists, particularly of those associated with Chicago, to regard an accounting identity as a production possibility frontier and completely ignore GDP growth.
New net spending by definition comes out of nowhere and generates new wealth. Debt and savings (two sides of one coin) are created in the process of net spending. So there is no need for ex-ante savings. Therefore a stimulus (or a bank credit, for that matter) is not about distributing existing funds but about creating new funds by spedning out of thin air. Your sentece "I don't think anyone disagrees with the proposition that if the government takes money from residents of state A and splashes them on state B, the economy of state B improves." shows that you are still not able to understand this. You are completely misstating the problem at issue.
Let me repeat, stimulus (or a granting credit) is not about allocation of existing funds between various uses (government vs. private sector) it is about creating new expenditure and therefore savings that would not have existed had it not been for the expenditure.
Of course, ex-post, savings equal investment and the neoclassical economist is therefore erred into believing that you must save in order to invest, particularly as he assumes away the effect of time. He does not notice that stimulus (or bank loans) increase GDP: savings and investment are always equal by definition, but their volume changes!
Romer’s op-ed is merely a twisted version of: “if will be different this time”.
ReplyDeleteKeynesian supporters love to refer to stimulus as "a jump start of the economy". That deficit government spending will jump start the private sector and hence bring an economy out of recession.
The jump start theory always comes with the lovely diagram of the "bucket". The bucket represents demand. The bucket's content is household, business, and government demand for goods and services. A recession is a bucket that is not full to the brim. The bucket is no longer full as the demand components of households and businesses has shrunk and hence its (according to Keynesians) the government's responsibility to increase its expenditures (increase its component of the bucket) in order to bring the bucket back to full.
Seems like common sense. However, the increased government deficit expenditure that attempts to fill the bucket is really draining the bucket simultaneously. Its counterintuitive. As the government increases deficit spending, private capital formation leaks out of the bucket (crowded out). Hence you try and try to fill the bucket but it remains below the brim.
Once you stop filling the bucket with government deficit spending, you now must pay for the deficit spending. Hence Keynesians raise taxes. The taxes then create another leak in the bucket as disposable income shrinks causing the demand for goods and services by consumers and businesses to shrink. Hence the bucket goes right back to the level that one began with before one started this wasted exercise.
Keynesians should wear the bucket over their heads.
As I read in one of the comments, what about iddle resources? I think what Keynes wrote (and now Krugman advocates) was only true for that special case in which there are iddle factors so the government doesn't need to compete with the private sector for them. If you give me a satisfactory answer about this issue, I will become an austerity advocate.
ReplyDeleteThis may not be satisfactory but here goes:
Delete"There is a special case in which there are idle factors so the government doesn't need to compete with the private sector for them."
What Krugman doesn't address is WHY there are idle factors to begin with. Factors become idle whenever the cost of putting those idle factors back to work exceeds the return on those idle factors.
The federal government has a direct role in regulating the cost of it's money (both pretax and after tax). And so the federal government can incentivize the return of those idle factors by changing the cost of its money.
Paul looks at every problem as a demand deficiency and so I don't put too much stock in what he has to say on economic policy.
"Factors become idle whenever the cost of putting those idle factors back to work exceeds the return on those idle factors"
DeleteGovernments yields are very low (1,7% for 10yr) so it's absurd to claim there are no profitable projects at that cost. Increasing education or infrastructure expenditures is certainly better than allowing the economy to stay permanently depressed.
"so the federal government can incentivize the return of those idle factors by changing the cost of its money."
Because of ZLB Fed cannot change cost of its money in a direct way.
Government can lower taxes but in ZLB environment they will be mainly saved (because real interest rate is too high to invest) so it will be not optimal. Of course it would be better than doing nothing but nonetheless it would prevent deficit reduction.
It would be good if any austerity advocate presented any coherent model that would justify that deficit reduction is good for the economy.
"Governments yields are very low (1,7% for 10yr) so it's absurd to claim there are no profitable projects at that cost. Increasing education or infrastructure expenditures is certainly better than allowing the economy to stay permanently depressed."
DeleteAnd when the federal government starts making spending decisions based upon a return on investment, then....
well the federal government never does that.
Instead one politician says to another I will vote for your social program if you vote for my invasion of such and such country. See Lyndon Johnson - civil rights legislation and the Vietnam War.
"Because of ZLB Fed cannot change cost of its money in a direct way. Government can lower taxes but in ZLB environment they will be mainly saved (because real interest rate is too high to invest)."
The federal government can also sell tax breaks with a rate of return and a duration. In that way the after tax cost of debt can go below the ZLB (think assets and liabilities -government tax break asset has higher future value than private sector debt liability).
"It would be good if any austerity advocate presented any coherent model that would justify that deficit reduction is good for the economy."
The austerity argument is one of politics - if I can't have my endless war in BFE, then you can't have your social spending agenda. Some Presidents (Eisenhower, Kennedy, etc.) were able to sell both in one package (space program, interstate highway system, etc.).
However the debt reduction argument is about productivity. If you accept that on a macro-economic scale productivity is defined as real gross domestic product / total debt outstanding and you accept that the federal government does not exist to compete with the private sector in the production of price sensitive goods, then you must admit that federal expenditures funded with debt are at best neutral in their affects on real economic growth.