Greg Mankiw writes my post for me

He quotes Blanchard and Perrotti, neither of whom is a follower of Milton Friedman:

…we
find that both increases in taxes and increases in government spending
have a strong negative effect on private investment spending. This
effect is consistent with a neoclassical model with distortionary
taxes, but more difficult to reconcile with Keynesian theory: while
agnostic about the sign, Keynesian theory predicts opposite effects of
tax and spending increases on private investment. This does not appear
to be the case.

There is much more here and do read the whole thing.  The bottom line is that the evidence for the Keynesian effects of fiscal policy is far from overwhelming.  Keynesian results cannot be ruled out but we simply don’t understand the short-run dynamics of cycles very well.  So why should we be so convinced it is time to spend $1 trillion or more? 

Addendum: On this post comments seem to be working.  Sorry again for the troubles.

Comments

Testing the comments...

I did read that earlier, and I got the strong sense that the subtext was "all else being equal ..."

I think the whole deal here, the justification for extreme remedies, is that things are equal. These are argued to be unusual times.

If indeed this is akin to the Great Depression, you've got one other test case in the last 100 years to compare against. Much is not equal between now and then anyway. So in the end I worry that we have economists talking their gut, or using various parallels that they think are close enough.

(I'm thinking that IF this is an unusual time, and if an expansion of government payroll is justified, then it is time to build the sort of infrastructure I want: solar, wind, smart grid. It might be nice to do that in ordinary times, by shifting spending from stupider (mars mission) things, but that obviously difficult.)

Today's blog at the humorous http://missmarketcrash.blogspot.com/ has a word about Keynes as well --

P.S. Your blog is prolific and much appreciated,

Kind Regards,

Missmarketcrash

I have to say, this is like watching a bunch of chickens with their heads cut off.

'The Economy' is surely large and complex, but it is surprising (to me, and other laypeople I'm sure) that economists can't come to a consensus on even the theoretical prescriptions & proscriptions - much less the mechanics to carry out those policies.

I'm wondering if any of you are suffering a private loss of confidence in your field of study/practice.

It seems to me that any empirical analysis that does not allow for nonlinearity is bound to get the answer wrong. A fiscal expansion carried out when the economy is near full employment is going to end up competing with the private sector for scarce resources resulting in a lot of crowding out. When the same expansion is carried out at points of extreme economic slack, however, the same forces are not in play.

Another issue is expectations of future fiscal policy. Japan tried a whole lot of fiscal expansion in the 1990s and the consensus view is that it did not work. That said, the critics say that that was because the government kept promising to undo the expansion in the future. Rational agents would then look through the current lax fiscal policy to the forthcoming tight policy, integrate, and decide to save. That undoes the original policy. Thus, one must promise to be reckless.

It seems to me that any empirical analysis that does not allow for nonlinearity is bound to get the answer wrong. A fiscal expansion carried out when the economy is near full employment is going to end up competing with the private sector for scarce resources resulting in a lot of crowding out. When the same expansion is carried out at points of extreme economic slack, however, the same forces are not in play.

Another issue is expectations of future fiscal policy. Japan tried a whole lot of fiscal expansion in the 1990s and the consensus view is that it did not work. That said, the critics say that that was because the government kept promising to undo the expansion in the future. Rational agents would then look through the current lax fiscal policy to the forthcoming tight policy, integrate, and decide to save. That undoes the original policy. Thus, one must promise to be reckless.

Add to that I don't think anyone is suggesting US government will spend an additional $1 trn on infrastructure?

I think there's a real problem in that nobody believes economists anymore. I'm not sure what you can do about it. It's not merely that mathematics is unable to derive precise and useful predictions about complex systems. (Even in rather "simple" phenomena such as n-body planetary systems, physicists have settled for the empiricist tactic of improving the match between calculations and observations -- and your economic systems are no-where near that simple.) You have no theory of science that allows the separation of one factor to presume that it is operational overall. You are unable to justify statistical significance as a guide for practical policy. You hold up as your avatars a bunch of big names who had serious breaches in their understanding. You take the example of a country which was founded upon the new intellectual institution of technological and scientific purpose and freedom of thought, plus an enormous resource base, to be the proof of economic theory. You ignore the distribution of income without much comment, other than occasionally reasoning that it must be efficient. In short, you are in a good deal of trouble. You could go back to casuistic moral reasoning, but then of course, we'd all have the better of you.

meter wrote:

I have to say, this is like watching a bunch of chickens with their heads cut off.

'The Economy' is surely large and complex, but it is surprising (to me, and other laypeople I'm sure) that economists can't come to a consensus on even the theoretical prescriptions & proscriptions - much less the mechanics to carry out those policies.

I'm wondering if any of you are suffering a private loss of confidence in your field of study/practice.

Meter, right now I am hoping Paulson offers an econ PhD buyback program. You are actually being too kind to us. Forget the prescriptions; we can't even agree on the patient's temperature. Did you catch how Alex Tabarrok and I--who are fairly close on the ideological spectrum--can't even agree if the Fed is injecting liquidity?

This would be like a doctor giving a morphine drip, then the other doctor says, "Whoa that might make things worse!" and the first doctor saying, "What morphine drip? I passed a magnet over it so it's equivalent to saline."

(Yes Alex ends up being the bad doctor in my analogy.)

Can you repost al of GK's blog so we can have a place to post comments?

Here’s a simple neoclassical explanation for the high G (government purchases)–>Low Y (GDP) relationship:

More high-paying government jobs–>
More people waiting in line for those good jobs–>
Less private-sector employment.

Queuing for good Davis-Bacon jobs is what creates the problem.

It’s a new twist on the Cole and Ohanian story of high wages worsening the Depression, and Quadrini and Trigari told it in the Scandinavian Journal of Economics as well as here:

http://www-rcf.usc.edu/~quadrini/papers/PublicEmployPap.pdf

Their abstract is below. The very fact that government contracts–-for roads, laboratories, bridges, Wi-Fi networks–-will be required to pay Davis-Bacon “prevailing wages† in and of itself makes the recession worse in the Quadrini/Trigari model. People wait for those good jobs, they search harder for those good jobs, and they produce no output while waiting for those good jobs. That makes us all poorer.

Note that we get the most awful result–-with high G causing much lower Y–-precisely when government spending is most efficient: If government spending is purely wasteful, then high G makes us poorer through the wealth effect, and that makes us work more and makes us less picky about job offers. Wasteful government purchases might actually create more output, as in Baxter and King, "Fiscal Policy in General Equilibrium."

But if government spending is efficient–-if the roads, labs, and Wi-Fi networks actually make us better off–-then high G makes us feel richer and makes us pickier about what jobs we take. If we can’t get a good job, as least we can get good Wi-Fi.

Since tax cuts and cash transfers will mostly generate private-sector spending that pays market wages, tax cuts and cash transfers aren’t subject to the Quadrini/Trigari story. Quadrini/Trigari might resolve the puzzles over tax cuts versus spending hikes.

The abstract is below. The Quadrini/Trigari paper deserves more attention.

---------
Abstract: We add a public employment sector to the basic search and matching model in order to study the business cycle impact of public wage and employment policies. The government is assumed to follow exogenous rules for public wages and employment calibrated to match some cyclical features of the US policies. These features include a positive public wage premium and mildly pro-cyclical public wages and employment. We find that the presence of the public sector increases the volatility of employment and output.

meter wrote:

"I have to say, this is like watching a bunch of chickens with their heads cut off.

'The Economy' is surely large and complex, but it is surprising (to me, and other laypeople I'm sure) that economists can't come to a consensus on even the theoretical prescriptions & proscriptions - much less the mechanics to carry out those policies.

I'm wondering if any of you are suffering a private loss of confidence in your field of study/practice."

And thus the insanity of the political class is fully surmised. Why cant public policy simply make a better world?

And we are to fear the religious right wing? HAHAHAHAHHAHAHAHAHA

mike wrote:

"But, suppose one has prior beliefs that sit heavy on the neoconservative side of things."

Very odd sentence. What is the point of the use of neo conservative in reference to ideas opposing Keynsiansim?

Im very troubled by this use of language. Why the choice of such rhetoric? You do know that neo conservatism is a foreign policy ideology? Or did you knowingly use this word to intentionally malign anyone who doesnt agree with you? Which is sort of like calling someone Hitler who you happen to not agree with. LOL

From the Treasury according to its need, to the Spenders according to their ability.

Sounds like a good plan for firing up commerce; unless, of course, something really has changed, and people just woke up one day and said "We've got too much crap and too much debt. Time to cut up the credit cards Martha." If so, we're in for a long cold decade.

Oh sure the strict libertarians may be against 1 trillion dollar rescue packages, but we have a great depresion on our hands if we do nothing. Surely, a massive fiscal intervention is better than nothing. Tyler convinced me to support the Paulson plan and I think he is being a market fundamentalist to not support a rescue package of some sort at this point.

Okay John, a made a Freudian slip---can you blame me?

Call it the neo-wingnut side of things; or the Austrian-liberal side of things; or the non-reality-based side of things. To me, they're all pretty similar to neocons, since they're all grounded in pure ideology. The point is you've got to have extreme prior beliefs to justify a small stimulus as rational response in the current economic environment.

Thinking about how evidence relates to theory would be philosophy of science. Economists don't do philosophy.

So who the crap cares about evidence?

QED.

Comments for this post are closed