Fiscal policy can raise measured gdp without improving the economy
or human welfare.  Take a polar case where there is zero crowding out
and there is one unemployed worker.  Government taxes a rich man who is
initially hoarding liquidity and spends that money putting the
unemployed man to work.

Measured gdp goes up but is the new state of affairs better than the old?

Say the unemployed man had valued his leisure at 20K and was not
taking the previously available jobs for 19K.  The government now pays
him 40K.  For the new worker that is a gain of 20K in value but of
course the cash itself is a transfer and does not represent a net gain
from an economic point of view (though you may like the distributional
effects).

Let’s say the new public sector output is produced by labor only.
40K is spent to produce output which, in a market setting, would be
worth $20K.

Put aside money flows.  We have 20K more of output value and a 20K sacrifice of leisure value.

That’s no net gain, but measured gdp has risen by 40K.  Note that
the contribution of the public sector to measured gdp doesn’t very
effectively measure true value added.

Introducing some crowding out makes fiscal policy look worse, as
would considered the deadweight loss from taxing the rich man. You
could make many other adjustments to the example; some would favor
fiscal policy, others would not.  The most obvious adjustment to make
fiscal policy look good is to assume that the new output a valuable
public good.  Or you might argue that the resulting spending multiplier
is higher than the real balance effect which results from the rich man
holding the money (lower prices for everyone else).

But keep this example in mind the next time you see a measured
empirical connection between fiscal policy and gdp.  "Money spent" and
"gdp registered" are not the same as "value created."

1. In the 1940s, Franco Modigliani showed that this kind of argument required infinite liquidity preference, not just very strong liquidity preference.  This kind of discontinuity matters in most models with liquidity preference.

2. The model suggests that negative supply shocks don’t hurt the economy yet the Dust Bowl was bad for aggregate output.  Arguably the AD curve should be kinked and vertical only after some inflection point.  But then we are back to negative supply shocks mattering.

3. The model implies that labor unions won’t hurt output but the model does not show that labor unions won’t hurt employment and indeed the latter question was the original point of contention.  A sufficiently high legally binding minimum wage will cause employers to lay off workers, vertical AD curve or not.  Maybe capital substitutes for labor or Y stays put for some other reason but employment will go down.

4. I no longer understand Krugman’s overall story.  He notes that the New Deal years saw a good bit of recovery (I agree), he notes that fiscal policy was not very expansionary (I agree), he believes there was a liquidity trap (I don’t agree), and he believes that positive supply shocks run up against a more or less vertical AD curve and thus don’t help output (I don’t agree).  Given all of Krugman’s views, AS doesn’t much matter and AD didn’t much expand.  So what exactly drove the (partial) recovery of the 1930s?

Maybe I am taking the model too literally but without the vertical AD curve there is not much else in the model to interpret.

Police have made an
arrest in an armoured car robbery in the US in which the suspect used
the free online classifieds website Craigslist to hire decoys…

Elsewhere in the series, here is runmyerrands.com, with reputational markers for the dogwalkers, courtesy of Steve Adeff.

The title is from Oliver Hart and Luigi Zingales writing in the WSJ:

Practically every day the government launches a massively expensive new
initiative to solve the problems that the last day’s initiative did
not. It is hard to discern any principles behind these actions. The
lack of a coherent strategy has increased uncertainty and undermined
the public’s perception of the government’s competence and
trustworthiness.

By principle, Hart and Zingales mean economic principle such as intervening only when market failure in the technical sense is an issue.  Bankruptcy, for example, is not the end of the world (As you may recall I have been pushing the idea of speed bankruptcy for which the FDIC has developed significant expertise.)  For example,

…what would have been so bad about letting Bear Stearns, AIG and
Citigroup (and in the future, General Motors) go into receivership or
Chapter 11 bankruptcy? One argument often made is that these
institutions had huge numbers of complicated claims, and that the
bankruptcy of any one of them would have led to contagion and systemic
failure, causing scores of further bankruptcies…

…This argument has some validity, but it suggests that the best way to
proceed is to help third parties rather than the distressed company
itself. In other words, instead of bailing out AIG and its creditors,
it would have been better for the government to guarantee AIG’s
obligations to J.P. Morgan and those who bought insurance from AIG.
Such an action would have nipped the contagion in the bud, probably at
much smaller cost to taxpayers than the cost of bailing out the whole
of AIG. It would also have saved the government from having to take a
position on AIG’s viability as a business, which could have been left
to a bankruptcy court. Finally, it would have minimized concerns about
moral hazard. AIG may be responsible for its financial problems, but
the culpability of those who do business with AIG is less clear, and so
helping them out does not reward bad behavior.

If only.  But now we have insurance in insurance:

For these economically uncertain times, the UnitedHealth Group has a “first of its kind” product: the right to buy an individual health policy at some point in the future even if you become sick.

Called UnitedHealth Continuity, the product is not actual medical insurance, but is aimed at people who may have insurance now but are worried they may lose it – and may not be able to obtain replacement insurance on their own. They may expect to retire early, for example, before they qualify for Medicare. Or they are worried about the possibility of losing their job and their health coverage.

People who are already sick will generally not be eligible for the new product. Those who do pass a medical review, will pay 20 percent each month of the current premium on an individual policy to reserve the right to be insured under the plan at some point in the future.

There is also a politics angle: by buying such a policy you are betting against comprehensive health insurance reform under Obama.  Here is a previous MR post on a related market.  Here is a post on why private health insurance doesn’t work better than it does.  And don’t forget Alex’s book on Entrepreneurial Economics, which promoted a version of this idea some time ago.

For the pointer I thank both Michael Buckley and Davis King.

From the comments, Garett Jones writes:

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…

There is more at the first link.  I am pleased to report that I have the honor of sharing a corridor with Garett Jones.