Paul Krugman’s response on fiscal stimulus

I'm not sure further progress will be made on what to me seems like
a largely semantic debate.  Krugman is making perfectly sensible economic arguments but then making a
semantic leap to claim he has proven something about permanent vs.
temporary.  He hasn't, as I'll consider in a moment.  But don't worry, the more important substantive
issue is government spending vs. tax cuts and on that I agree with
Krugman that very often tax cuts don't get you much stimulus.

Now let's turn to the details of the exchange.

Krugman argues, correctly, that fiscal policy can create a "bonds are net wealth effect" and also a "new bridge is built effect," and his post stresses the latter.  But playing up the "bridge effect" does not shift the evaluative balance between permanent vs. temporary fiscal policy, as both can be used to build useful things and indeed that is one element of the analysis which I have been explicitly holding constant across the two alternatives.  (I've not been denying the potential productivity of bridges or how gdp is calculated.)

Krugman also calls forth a "size of expenditure" effect (which is not in my view a true permanent vs. temporary comparison, but still let's go ahead and say it is).  He writes:

The question then is how much of that direct increase in government demand is offset by a fall in private consumption because people expect their future taxes to be higher; obviously that offset is smaller if they think the bridge is a one-time expense than if they think there will be a bridge built every year. That’s why temporary government spending has a bigger effect.

Even there I am not convinced, and that is because of the very last sentence of the paragraph.  If the government builds more bridges rather than fewer bridges, yes private consumption goes down more in the former case.  But if each bridge is valuable, the net stimulus (which is what matters) doesn't have to go down.  In this setting, with varying expenditure across the two cases, the permanent fiscal policy easily can have both more crowding out and more net stimulus.  Krugman is citing the higher crowding out but there is no demonstration (or even argument) of a smaller net stimulus from the permanent fiscal policy.  It still can go either way and no, figuring out the net effect isn't simple. 

Oddly, my position in this debate is that, within a Keynesian framework, "doing more over time" can in the theoretical sense work out in favor of stimulus.  It is thus instructive to see MR and Krugman commentators attacking my "right wing" position or Krugman's "left wing" position; it's a sign they don't understand what is being debated.  Krugman himself already mentioned that he was arguing under the rubric of Milton Friedman so I'll claim Keynes.  Keynes himself was a bigger fan of permanent than temporary fiscal policy and he thought it could provide ongoing stimulus by providing ongoing value for the dollar.  In this sense I am arguing for the theoretical coherence of the truly Keynesian view, even though when it comes to practice I am skeptical on public choice and Hayekian grounds. 

Addendum: Here is Megan McArdle's response.


so what you are both saying is that the first derivative of spending drives a stimulus?

When the Republicans were in control and 9-11 occurred, they used the bad situation and mass fear to get a whole conglomeration of dirty laws passed that they'd been drooling over passing for decades - called the PATRIOT Act. Now that the Democrats have control, they are using the bad situation and mass fear due to the horrible state of the economy (caused in part by 8 years of Republican mismanagement) as an excuse to pass a whole conglomeration of dirty laws that they've been drooling over for decades - called the "Stimulus Package."

The republicans used fear and hysteria to pass laws that take away rights of citizens, make it harder for immigrants to visit and stay in America, give the government more power, give the police more power, etc. The democrats are using fear and hysteria to give handouts (in the guise of "stimulating the economy") to favored groups who have been asking for it. Any handout of money from the government can be given some explanation as to how it will help/stimulate the economy.

The way I see it, though, the Republicans got their chance to pass a package of horrible laws, and they have no right to complain when the Democrats are now doing the same thing. They shouldn't have taken advantage of 9-11 to pass the Patriot Act, but they did, so they shouldn't be whining when the Democrats take advantage of the bad economy to pass their bad laws. I'd rather the government waste our money than take away our rights and liberties, so the Democrats' bad law is the lesser of the two evils, but that is beside the point. Neither should be done. But as a firm believer in ideological estoppel, the republicans have no right to complain about the democrats' doing the same thing they did back in 2001.

Want to fix the economy? Ban the "financial services industry" and make it illegal to recommend, for profit, the purchase or sale of an security. Financial marketing should be illegal. That's how we got into this mess. The Dow and Nasdaq could drop by 50% and they'd still represent extreme overvaluation. Marketing has become too powerful and coercive. Marketing securities - things with no intrinsic value - when there are commissions to be made and kickbacks to be earned should be against public policy. Every stockbroker should be out of a job. Banks should not be permitted to advertise. It should be illegal to advertise credit cards, send out "pre-approved credit card offers" and the like.

Why not?

They're the reason our economy is in such bad shape. You probably have a vested interest in providing such advice and don't want to lose your job (which consists of causing other people to lose their money).

The very notion that someone would take investment advice from a person who themselves is not a multi-billionaire makes me laugh and sad at the same time.

I think you are right about the shovel ready infrastructure proposed being even more valuable than any private investment that might have been crowded out. This spending was planned and would have likely gone ahead even if the economy did not hit the doldrums. That makes it even more valuable at a time like this. There is a shortfall in how much of this is available however, as Obama pointed out. The real question is what to do with the last dollars.

If I buy a house do I ignore the interest costs of the loan when I budget for the next thirty years?

Or assume that I buy a car straight out of high school, to get me to a summer job, but that expenditure on the car prevents me from an alternative investment - college. I enjoy the car and it allows me to generate income and pickup girls Should I be happy with my choice?

A group of people get together with their closest friends to throw a huge expensive party. They then tell me that I will have to pay for the party out of my future income (plus I'm not invited to the party). I am told that I should be happy to see all these caterers, bartenders, dancing girls etc. employed.

If I think this is the only party they will throw, how do I budget for the bills in my future? If the party is a one time event and the expense is not enough to affect my previous projections for permanent future wealth I may make minor adjustments in my budget. However if the party is very large, or I suspect that the party may become a regular event, I will need to drastically cut expenditures and start to find ways to protect my assets.

The party supplied immediate income for dancing girls, which is a good thing, and they are notorious for their high marginal propensity to consume. Thong sales skyrocket. However now I must tell my wife that I am uncertain about the future, we may face much higher taxes because the party has cost more then the combined incomes of all the members of my club. The size of the party scares me.

While the host of the party told me that this was a one time event, I know that he likes to keep dancing girls happy, (they are some of his biggest supporters) so I suspect that more parties with ever bigger giveaways are coming. Again I may need to plan if I think my permanent income has changed.

Oh No. I just realized that I may need to borrow from the guys across the river to pay for this. Before I just that we had taxpayers and bondholders playing from the neighborhood. But these guys wanted to be paid based on exchange rates and they think we are risky so I am, in effect, forced to take an ARM on my house to pay for the party. The future looks harder and harder to plan for, so I become more risk adverse and just hunker down for a period. Perhaps until a new party group comes to town.

So I try to get the party people to take tax cuts to pay for the party. I know what I can do with a tax cut. I have some control over what I can do it and planning is easier. I had a new investment that will pay a certain rate of return that I can invest in. Or I can buy that new car I wanted. Or I can buy my wife some new lingerie (thongs aren't her thing). But the dancing girls are very unhappy. They don't pay taxes so a tax cut does nothing for them. They threaten to stop providing happy time to the party throwers. The party throwers are very unhappy because they are not making their supporters happy.

The Stimulous package will almost surely pass. How many of those advocating the Ricardian equivalence theorum have increased their saving for that purpose? Not to offset the drop in your stock portfolio or the lost equity in your house. Not because you are worried about losing your job. Now, because you want to be able to pay the extra taxes you anticipate on the extra interest that will be needed because the stimulous package is likely to pass?

Japanese stimulus spending on big public-infrastructure projects ranged from 6.5% of GDP in 1990 to 8.3% in 1996. Didn't seem to help the "Lost Decade" much.

If this was a Keynesian business cycle, the stimulators would have a point, but it is an asset bubble burst (more Austrian in nature).

Also if government was actually interested in running a Keynesian economy where spending was reduced during good times, it would also be a different story. Overstimulating demand is just as inefficient as understimulating it.

I still say, let's work to reduce the structural reasons for low growth: end all wars including the drug war, legally accept more immigrants (especially educated ones), reduce trade barriers, and de-regulate medical insurance to allow the health care sector to innovate.

Tyler, I think that Krugman means that the *multiplier* for temporary stimulus will be greater than the *multiplier* for permanent stimulus. So permanent stimulus might have an aggregate impact over time that is greater than temporary stimulus (since 'permanent' implies spending a lot more money over time, this shouldn't be surprising) but the multiplier won't be as great as the multiplier for temporary stimulus in the first year for the reasons that Krugman mentioned.

So in parallel worlds, the first year of a temporary stimulus package would have a greater increase of GDP than the first year of a permanent stimulus package, where both packages spend $100 billion in that first year. In the temporary package world's subsequent year, GDP won't increase because the stimulus package has stopped. In the permanent package world, GDP will increase each year by the amount spent on the bridge less crowding out effects.

BTW, kudos to your emotional maturity for avoiding tit-for-tat derogatory comments with PK. He's proof positive that brilliance doesn't imply emotional maturity or grace of spirit.

Emotional maturity?

Kurt said: "How does the Keynesian framework actually differentiate between building bridges to nowhere, and building bridges that might actually alleviate traffic jams?"

It really doesn't, and this is its profound failing.

The Keynesian framework doesn't take into account actual wealth creation as opposed to just flow of money.

Markets are forward looking. They seem to reflect that a majority of people doubt that the stimulus will lead to prosperity in the private sector. People are responding to the uncertainty by investing in low risk investments. They have increased savings rate. How much of this is to pay for future taxes and how much is due to a drop in permanent income is hard to say. I expect high tax rates in the future, I have chosen investments that offer lower potential returns but, I hope safer returns, but the higher potential returns will be depressed by higher taxes.

The economy will tend toward full employment. Next borrowing money from the future means that you are sacrificing opportunities in the future. If the investments today are more productive then the investments in the future then we should invest today. It is hard to believe that a trillion in high return investments have just appeared. Instead the current spending bill is more about increasing government spending to reward interest groups.

Saying that building x will increase GDP is useless. Buying everyone a donut will increase GDP. So what

This is where the tension arises. From the beginning:

"But don't worry, the more important substantive issue is government spending vs. tax cuts and on that I agree with Krugman that very often tax cuts don't get you much stimulus"

vs. what we find at the end:

"In this sense I am arguing for the theoretical coherence of the truly Keynesian view, even though when it comes to practice I am skeptical on public choice and Hayekian grounds."

What do those mean, taken together? I don't think the evidence presented so far provides a coherent view, which is why the reach for the propaganda label gets made.

I say that understanding that the default public choice and Hayekian grounds are reasonable.

Either it's possible to do a good enough job, or it's not. It seems to have been possible to win World Wars, put a man on the moon, build the NYC subways, etc.


You want to claim that throwing a huge party today, because you have nothing better to do today, and putting all the bills on your credit cards, will not have a negative impact on your choices in the future.

The party will increase GDP in the current year, but the debt obligation will constrain you in the future.

That doesn't mean that that their are not current investment opportunities, just that they must be better then alternative choices.

Absent the stimulus what happens. Prices and wages adjust until resources are reallocated around the economy. Housing prices fall until the market decides they are correctly priced. Prices fall until people buy. Wages adjust till people find employment.

We can give people an advance on their future income by giving them a tax cut today. We can encourage them to consume more today, and payback in the future, with a tax cut today. I think Rivlin is correct to call for an immediate cut in payroll taxes as a stimulus. It is easy to make that temporary. You avoid the political games of public works projects.

"maybe he doesn’t consider the wages of the bridge-builders count, that only what they do with those wages matters. But that’s not the way either employment numbers or GDP are calculated: bridge construction is part of GDP."

Well, then: why don't we include unemployed people sleeping in their beds as testers of their own mattress, give them a tax rebate (which then we would call "salary") and include this in gdp and unemployment statistics? After all, if the goal is to boost those two statistics in a favorable direction, why not simply manipulate them?

I thought a nobel prize in economics could distinguish between merely raising the gdp statistic and creating real wealth, but maybe a trained economist is not interested in this kind of trivial issues.

The only way that repairing a bridge can produce a net wealth benefit in the short term is if the bridge was completely unusable. If people are using the bridge currently, but the repairs are intended to prolong the viability of that bridge, the only thing we are comparing to is the long term benefit of not having to repair that bridge in the future. So as a short term stimulus, this infrastructure bill fails. I would even argue that as a long term stimulus it fails because of the fact that we financed the repairs with debt and will be forced to pay interest on that debt well into the future.

"Do you think building a bridge is some sort of manipulation that artificially games the GDP statistics?"

Public expenditure enters GDP at its cost of production, but its true economic value (call it dcf, call it npv, call it whatever) can be positive, zero, negative. So raising GDP by boosting government expenditure does not necessarily imply increasing total wealth. If you build a bridge from nowhere to nowhere over a river in the middle of Alaska, GDP increases, but is that bridge really useful? Does it have any "value" at all? The point is: the bridge enters the gdp statistic at its cost of production, but that is irrelevant.
If you issue debt to build something without real, "intrinsic", value, you are raising gdp and destroing wealth: in the future you'll have to pay back the debt, and if the bridge does not add any value to the economy it won't produce cash flows big enough to pay back the debt used to finance its construction. It doesn't take an MBA, a PhD in finance or the CEO of a multinational company to understand that this is a bridge on the road to self-destruction.
Now, in my humble opinion, what we are truly interested in is increasing real wealth, not the gdp number. Unless, of course, increasing the gdp number produces some magic effect on expectations, in which case, why not simply artificially manipulate it? It's easier, faster, and less costly.
The way I understand economics, the goal is to find ways to improve the living conditions of humans, not how to increase the gdp number.

Perhaps you want to argue that taxpayers just pay bondholders and if you keep all the money internal our net worth stays about the same. Not many people will argue that these days because we do increasingly need foreign investment to buy our bonds. Simply it is very hard to figure out the total interest payments on this spending because it will likely become very volatile in the near future.

But if you are investing in projects that are wasteful, they are wasteful. The current stimulus bill is about changing budget priorities and creating what some consider a more equitable society. Listen to Pelosi, Franks, and Reid. They really don't care as much about job creation as political rewards to supporters. Pelosi is writing a plan to punish her opponents and reward her friends.

I really don't understand why you reject the notion that if we borrow against future income that reduces future investment opportunities. Say I was going to replace my roof next year but I want to employ my unemployed neighbor this year. So I borrow to pay for the new roof this year. Forget that I gave away one good year of the good roof I had. Next year when I payoff the new roof, isn't my consumption constrained by the debt obligations I am paying?

I boost GDP in year one by employing my neighbor. I don't radically change my consumption in year one and the neighbor has income. In year two hopefully my neighbor can find employment but I now have limits on my spending, unless I care nothing about the debts I am building up. BTW what happens if the banks see that I have increased my debt load and react by increasing the interest rates on my loans?

This stimulus, within reason, is worthwhile. I have some deadweight loss from replacing something prematurely but I have helped a neighbor.

But what if I decide to help build a new school. The old school building is OK. A new school building with a fancy pool would be nice. The community has planned to replace the school in ten years. We decide to build the new school right away to employ some people. GDP in year one increases. Again we ignore the deadweight loss of replacing a school that had ten useful years left. The community must now service that debt by increasing taxes. If the school board wants to increase spending in year two, three, to N, you want to claim that they face no restraints on their spending? How do they get the additional money? Raise taxes or what.

Suppose the community had also wanted a health levy for children from poor families. But politically this group isn't as organized as the school lobby. Faced with higher taxes from the schools, the community is unable to to get support for the levy. The community must begin to make choices, do they want to fund more programs or do they want to save for their retirement?

Gary Becker used to start his first class by saying that economics is the study of the allocation of scare resources. Student seems to think the world has unlimited resources

Bruce I agree with you on this:

The Dow and Nasdaq could drop by 50% and they'd still represent extreme overvaluation.

but banning marketing financial instruments cannot be done for many reasons, investors, who are generally in the upper half of IQ wise, have to learn to not be suckers. Sorry it is the only way. In the mean time you and should look out for ourselves. BTW I also think that right now some financial instruments are undervalued and those I am buying.

I'm trying to simplify this debate for my feeble political scientist mind (I had to really concentrate to understand Megan McArdle's reply; God, she's sexy!). It really just comes down to (I guess as usual) whether you believe the gov't will spend "better" than the private sector. "Better" meaning producing the most future production/econ growth (I'll leave aside distribution issues here). Elitist left-wing intellectuals like Krugman tend to think the gov't spends better b/c their team of experts is running the gov't. Libertarian-leaning folks tend to think the private sector does it better because, unlike the gov't, private entities have to compete against each other to spend efficiently (although all within a framework of property rights and contract law ultimately maintained by the gov't), plus all the public choice reasons that makes it difficult for gov't to spend efficiently (esp. the temptation of pork that will not produce future production/econ growth).

Is this, at bottom, an accurate assessment of the debate?

I'm disappointed that Krugman has to be rude.

I figure that the economic collapse was due to the expectation that Obama with 600+million in campaign finance would win over McCain with 84 million. The smart money pulled out of the markets. Soon businesses adjusted to the higher tax bill (and inflation is a tax) by cutting their work force. All and all an early vote of NO CONFIDENCE in the Light Worker. The only way back would be for Obama to govern as a conservative- Cut taxes, cut non-defense spending, and as people gain confidence, they will invest and hire. Of course, if wishes were horses, then beggars would ride.

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