Monday, April 6, 2009

Could Someone Let Robert Lucas Know That The Balanced Budget Multiplier Is Not Zero?

I thought Robert Lucas had a very strong grasp of macroeconomics – maybe not:

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash. It has no first-starter effect. There's no reason to expect any stimulation. And, in some sense, there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that.

Hat tip to Brad DeLong who is worried that Chicago-School economists believe certain falsehoods such as:

deficit-financed spending increases have no short-term stimulative effects on nominal spending

Since Kevin Quinn noted that Wikipedia’s discussion of Ricardian Equivalence had the same error, let’s see how Wikipedia describes the balanced budget multiplier:

Since only part of the money taken away from households would have actually been used in the economy, the change in consumption expenditure will be smaller than the change in taxes. Therefore the money which would have been saved by households is instead injected into the economy, itself becoming part of the multiplier process. In general, a change in the balanced budget will change aggregate demand by an amount equal to the change in spending.

Not only does this sound much more logical than what Professor Lucas claimed, it is also what is typically described in most economic textbooks. As long as the marginal propensity to consume is less than unity, there is something to apply a multiplier to. So might Professor Lucas explain to us why he thinks the marginal propensity to consume is equal to unity – especially when we are talking about temporary increases in government purchases and their implications for taxation over the long-run?


wellbasically said...

So why doesn't the government just run a $20 trillion dollar deficit if it's going to multiply?

TheTrucker said...


The government cannot run too big a deficit or the government's money will be made worthless in the near term. The repayment of dept in inflated dollars has its limits. The objective is to feed the economy only the amount it can swallow at a gain. To improve infrastructure is good. To create unneeded and unprofitable infrastructure can result in a total meltdown of the currency. If the currency loses its capacity to direct labor then the game is over.


If you believe that the wikipedia article on Richardian Equivalence is wrong then why not fix it? My own interpretation is that the article is right in that it describes "Ricardian Equivalence". The fact that "Ricardian Equivalence" is horsecrap is not a shortcoming of wikipedia. The article seems to do a pretty fair job of exposing the shortcomings of the theory. So what did I miss?

Anonymous said...

I thought Robert Lucas had a very strong grasp of macroeconomics – maybe not

Whatever gave you that idea? There is no evidence at all that Lucas has any understanding of evidence based macroeconomics.

Anonymous said...

wellbasically said...
"So why doesn't the government just run a $20 trillion dollar deficit if it's going to multiply?"

For the same reason that if your doctor gives you a prescription and tells you to take 3 pills per day, taking 30 per day won't help you get well faster.

Anonymous said...

"Whatever gave you that idea? There is no evidence at all that Lucas has any understanding of evidence based macroeconomics."

Brad DeLong has been posting examples of allegedly elite econopeople saying some very dumb things. It's no longer a case of questioning the right's theories or models, but that the right is lying, pure and simple.


wellbasically said...

There is plenty of room for growth in our economy, plenty of poor people. If there was a way to multiply them to prosperity then it would be irresponsible not to do it.

Trucker your comment is basically the other side of the same coin as the righty we're supposed to be putting down. The government only gets the money to deficit spend by selling a bond. Either that bond gets paid off by future taxes (righty) or future inflation.

Either way it will retard growth, by raising the risk to investment, unless what the government spends it on will result in a higher rate of growth. Nobody will make that claim though because it involves business decisions, and stimulus spending (supposedly) solved the Great Depression by buying tanks and bombs (which nobody wanted), so you really should be able to spend the money anywhere.

The theories in favor of a stimulus multiplier are so confused that even those in favor can't agree on them. That is why the stimulus bill was not written by believers in the multiplier, but by people who wanted to spend money on liberal programs.

Jon said...

You don't get any multiplier effect from tax-financed spending, at least not so long as the mpc of those being taxed is the same as the mpc of those receiving the spending. If the government levies a lump-sum tax of G on one group of people with multiplier m1, and gives that money to another group with multiplier m2, then the multiplier effect will be m2*G - m1*G.

Now if the government gives that money on condition of building a bridge, you do get the bridge. Whether that's worth while depends on the value of the bridge and the value of the other activities you crowded out.

To the extent that expected future taxes depress spending, deficit-financed spending is no different. Which is to say, not perfectly.