Wednesday, February 04, 2009

Obama, Barber of York

There's an interesting article on the stimulus package in the Weekly Standard arguing that the current package manages - all at once - to be too small, too late and misdirected.

The public response to the package suggests that the change voters sought is not as deep as the House Democrats thought it was. As has become quite clear, the package is a grab bag of full of whatever was on the House Democrats' Christmas lists and there is really no coherent theory behind it except a rather simple-minded and somewhat outdated Keynesian assertion. As a friend e-mailed last night "[f]rankly it doesn't much matter what government spends it on ...." This is supposedly so because there is a liquidity trap in which people just don't want to borrow and spend so the government has to do it for them.

Another friend responded by e-mailing this paper by John Cochrane at the University of Chicago. He points out, contra Paul Krugman, that Keynesian fiscal stimulus has been largely discredited.

This is not fancy economics. Most of my arguments come from simply asking where the money is going to come from, simple arithmetic. Why are so many economists said to support fiscal stimulus? Am I some sort of radical? No, in fact economics, as written in professional journals, taught to graduate students and summarized in their textbooks, abandoned fiscal stimulus long ago.

Keynesians gave up by the 1970s. They saw that fiscal programs took too long to implement. They especially disparaged temporary measures, which would not stimulate the consumption that classic Keynesians thought was important to stimulus. Every undergraduate text has repeated these conclusions for at least 40 years. I learned this view from Dornbusch and Fisher’s undergraduate text, taught by Bob Solow, in the 1970s. Even the optimistic projections by the Obama economic team say that fiscal stimulus will not really kick in for two years, validating the durability of this view.


In textbooks and graduate curriculums across the country, stimulus is presented at best as quaint “history of thought” with no coherent defense that one should believe it in the context of modern economics. (For example, David Romer’s classic graduate text Advanced Macroeconomics) At worst, it is presented as a classic fallacy. (My view of the treatment in Tom Sargent’s,Dynamic Macroeconomic Theory and Sargent and Ljungqvist’s Recursive Macroeconomic Theory).


These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said “we’re all Keynesians now” just as Keynesian policy led to the inflation and economic dislocation of the 1970s, unexpected by Keynesians but dramatically foretold by Milton Friedman’s 1968 AEA address. Keynes disdained investment, where we now all realize that saving and investment are vital to long run growth. Keynes did not think at all about the incentives effects of taxes. He favored planning, and wrote before Hayek reminded us how modern economies cannot function without price signals. Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience. If we forget all that, we could repeat the economics of postwar Britain, of spend-and-inflate Latin America, and of bureaucratic planned India.

Part of the problem, according to Cochrane, is that people will spend the money that the government borrows and places in their pocket only if they believe that the ensuing public debt will not be repaid, i.e., will be inflated away. Otherwise it still makes sense to hang on to the money in anticipation of coming tax increases or spending reductions. But that has its own difficulties:

In sum, the US needs to keep its fiscal powder dry. The Government’s borrowing and taxing ability is limited. When the crisis fades, we will need fiscal resources to unwind a massive increase in government debt. If the debt corresponds to good quality assets, that’s easy. If the debt corresponds to government investments yielding a stream of tax revenue, that’s ok. If the new debt was spent or given away, we’re in more trouble. If the debt will be paid off by higher future tax rates, the economy can be set up for a decade or more of high-tax and low-growth stagnation. If the Fed’s kitty and the Treasury’s taxing power or spending-reduction ability are gone, then we are set up for inflation; essentially a default on the debt. Needless to say, no amount of monetary or interest rate policy – fooling with the split of government debt between money and treasury bills – would stop that inflation. Trading money for debt will do no good when people want to dump both equally.

Cochrane believes that tax rate cuts can help but only (and here's the part Bush missed) if you deal with the structural deficit. Otherwise, they are seen as temporary.

This doesn't mean, in his view, that government can do nothing. Given the demand for treasuries, government can borrow to meet it but only if, in doing so, it acquires valuable assets or creates assets that lead to economic growth. That's what's missing from the Obama/Pelosi package.


Anonymous said...

"Discredited" is one word, I suppose. "Unfashionable" is another. Presumably we are not to suppose that the discrediting of free-market capitalism during the middle of the 20th century meant that it was a mistake to swing back to that fashion, though.

The problem is that one must do something. That's what policy-making is. Is it obvious that Keynesian policies work well to actually make people better off? Nope. Which is why you, Mr Esenberg, and John Cochrane, are shoulder-to-shoulder with various Marxist groups on this score. Solidarity!

Yet it's hard to say with a straight face (though dealing with reality has never been a neo-con/libertopian strong point) that the answer is Friedmanian or Hayekian economics either, and that rather clearly seems to be the end game in this rhetoric -- certainly it's Cochrane's answer. To be crowing about the virtues of less government intervention in the current economic climate, on the grounds of problems with Keynesian economics, is to come across as claiming that waving the magic bones over the patient is the right thing to do, because the waving the magic sticks didn't work.

Anonymous said...

"The problem is that one must do something."

Is it?

Anonymous said...

"Is it?"


Choosing to do nothing new is to adopt whatever economics of policy-making shaped the status quo. There is no neutral ground here, as far as normative economic theories of government policies go; and the ethos of deregulation/non-involvement seems rather out of favor right now, as well.

Anonymous said...

Cochrane's article is name-dropping gibberish. Contrary to Professor Cochrane's implication, reports of Keynesianism's demise are greatly exaggerated.

When people aren't spending, the government must. The truth of Keynes' basic insight was proved by the economic impact of World War II: the only way the world's great economies were pulled out of the misery of the Great Depression was the massive government deficit spending necessitated by the war. That's what ended the Great Depression.

We did learn, after the war, that fiscal stimulus can be a clumsy tool. It does often take a while to achieve its desired result. Governments turned increasingly to monetary policy. Fine-tuning interest rates became the preferred method of addressing recession. Alan Greenspan issued one of his cryptic, adjective-laden statements, the Fed dropped rates a quarter point and -- presto! -- the economy improved.

Monetary policy (sometimes with a little fiscal stimulus tossed in for good measure) worked pretty well to pull us out of postwar recessions. But now we are at a standstill. The Fed funds rate is effectively at zero. Monetary policy can't do anything more for us. The economy is paralyzed, and in free fall.

For the government not to engage in fiscal stimulus now would risk a decade-long depression. The government engages in fiscal stimulation either by spending money, or by cutting taxes. Cutting dividend taxes and capital gains taxes in a depression does little to stimulate: the corporations aren't paying dividends, and assets are being sold at losses rather than at gains. Today's Journal Sentinel has an editorial containing one economist's calculation of the efficacy of various forms of stimulation. Like it or not, food stamps have far more stimulative effect than capital gains tax cuts, because food stamps get used, triggering increased consumption, whereas rewarding the thrify sellers of appreciated assets is far less likely to result in increased consumption. Perhaps your normative belief is that the government should reward the thrifty and penalize the indigent slobs on food stamps. But to adopt such a Hooveresque approach would hurt us all, by miring us all far longer in economic depression.