DeLong on Hobson’s Choice v. Cochrane’s Bernie Madoff Economics

I want to highlight two interesting discussions relevant to the fiscal policy debate. First up is Brad DeLong:

The original argument was John A. Hobson’s, in his 1902 book Imperialism. The poor have to spend their incomes in order to buy their necessities. The middle class have to spend their incomes to buy their necessities and the conveniences they need in order to ensure themselves that they are not among the poor. The rich can spend their incomes or not. Hence the more unequal distribution of income, the more the potential for slack aggregate demand. With monetary policy constrained by the rules of the game that was the gold standard, Full employment in an unequal society required either unusually optimistic financiers and industrialists or something else.

Brad continues by noting that this something else could be monetary policy unless we fell into a liquidity trap. Peter Coy has a nice discussion on why Keynes’s views on fiscal policy is relevant today but alas he does have to cite something from John Cochrane:

If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt. If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up. If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.

This weird tirade is just part of a very long tirade where Cochrane attacks the writings of Paul Krugman. Cochrane invokes Ricardian Equivalence as part of his case against the use of fiscal stimulus. Alas, he clearly does not understood Ricardian Equivalence or what the recent fiscal policy debate was about. First of all – the government is quite open about its finances so any suggestion that there is a Ponzi Scheme should alert the reader that Cochrane was on a silly rant. But he does admit that attempts to use fiscal stimulus amount to deficit financing. Ricardian Equivalence alerts us to the fact that the present value of all future taxes must match the present value of all future government spending as well as the current level of government debt. If no household is borrowing constrained, then the timing of taxes has no current effect on consumption demand. Brad’s post, however, should be seen as suggesting that some households are borrowing constrained. But it is this line that shows how clueless Cochrane is:

If you believe the Keynesian argument for stimulus, you don’t care how the money is spent.

Actually most Keynesians do care as we would prefer the stimulus in the form of infrastructure investment and not Hobson’ imperialism. This is also where Cochrane’s invocation of Ricardian Equivalence is most silly. Accelerating infrastructure is not a permanent increase in government spending and hence would not raise the present value of future taxes all that much. As such, any reduction in consumption would be very modest relative to the rise in government investment. And with this simple realism, Cochrane’s Bernie Madoff rant loses all relevance.