First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out.”
Calling Brad DeLong:
Now the NIPA savings-investment identity holds in all models--it is, after all, an identity, true by definition and construction. And every single model that has been built in which there is a possibility of high unemployment and idle resources is a model in which fiscal policy works because increases in government spending lead to unexpected declines in inventories and unexpected declines in inventories lead to firms to expand production, which leads to increases in income and saving. I would, therefore, say that Fama's claim is "wrong". Not only does it not hold in all models in the class, it does not hold in any models in the class.
His second “fallacy” is just strange:
Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. They evaluate past stimulus programs by whether people who got stimulus money spent it on consumption goods rather save it. But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.
Any reading of the General Theory by Lord Keynes would also say that advocates of fiscal stimulus would assign as high a multiplier to increasing investment demand as we assign to increasing consumption. Has Cochrane not noticed that the Obama fiscal policy wants to increase public investment rather than stimulate consumption?
He closes by showing he does not understand Ricardian Equivalence:
Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.
Oh good grief! If we were talking about temporary reductions in taxes – which would have to later be followed by tax surcharges – then Ricardian Equivalence predicts no increase in aggregate demand. But if we are talking about temporary increases in government purchases then rational households would realize that the increase in their lifetime tax bills would be quite modest, which would imply a small reduction in consumption demand relative to the large increase in government purchases.
I have to wonder John Cochrane could even pass the macroeconomic class offered at Greg Mankiw’s college! I also have to wonder why Greg Mankiw keeps posting without comment such incredibly silly arguments against fiscal stimulus.