Monday, January 26, 2009

Cochrane’s Fiscal Fallacies

Greg Mankiw has found another critic of fiscal stimulus with this one being even more silly than the predecessors. John Cochrane claims the proponents of fiscal stimulus rest their case on three fallacies. The first is that Fama crowding-out by identity canard:

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.


TheTrucker said...

I have to wonder why you, PGL, wonder about conservatives publishing total nonsense. Conservatism is a religious and political disorder that is simply "fascist" in nature. The "theories" need not make any sense and it is better if they don't make sense. It is entirely "faith based"


...Fascism [is] the complete opposite of…Marxian Socialism, the materialist conception of history of human civilization can be explained simply through the conflict of interests among the various social groups and by the change and development in the means and instruments of production.... Fascism, now and always, believes in holiness and in heroism; that is to say, in actions influenced by no economic motive, direct or indirect. And if the economic conception of history be denied, according to which theory men are no more than puppets, carried to and fro by the waves of chance, while the real directing forces are quite out of their control, it follows that the existence of an unchangeable and unchanging class-war is also denied - the natural progeny of the economic conception of history. And above all Fascism denies that class-war can be the preponderant force in the transformation of society....

After Socialism, Fascism combats the whole complex system of democratic ideology, and repudiates it, whether in its theoretical premises or in its practical application. Fascism denies that the majority, by the simple fact that it is a majority, can direct human society; it denies that numbers alone can govern by means of a periodical consultation, and it affirms the immutable, beneficial, and fruitful inequality of mankind, which can never be permanently leveled through the mere operation of a mechanical process such as universal suffrage....

Fascism denies economics.

Shag from Brookline said...

Mankiw's list is just in case Obama fails, as Rush Limbaugh wishes, so he can refer to it. If Obama is successful, Mankiw can state that he did not endorse the "silly arguments" of those on his list. Mankiw may be somewhat of a Mugwamp Economist, shifting his Mug and his Wamp depending upon the direction of the political air about him.

Bruce Webb said...

Definition of a Mugwump (sic): "a man with his Mug on one side of the fence and his Wump on the other".

(That image has disturbed me for decades now).

Shag from Brookline said...

Thanks for the spelling correction. Here's the Wikipedia link for Mugwump:

I am reminded of the story of a cold winter night in old England at at inn which a patron enters from a cold, snowy night. He blows into his hands as he orders a hot bowl of soup. The Innkeeper asks why he blows into his hands. The patron responds "Why to warm my hands." Then when the bowl of hot soup is served, the patron blows on a spoonful of the soup. The Innkeeper asks him why he did that to which the patron responds "Why to cool the soup." The Innkeeper is angered and then proceeds to eject the patron from the inn, declaring "This man is the Devil himself, he blows both hot and cold!"