The Poverty of Mainstream Debate, Part I: Stimulus, Deficits & Ricardian Equivalence

You may notice that I rarely comment on current affairs. Mainly, this is because mainstream debate appears to be regressing rather than moving forward, the result being that it is behind where it was in 1829, and whilst many far more respected people with far larger platforms than me have been winning the argument for a long time, progress is not being made.

To start, we have the supposedly most intelligent economists in the world seriously debating Ricardian Equivalence. This is the proposition that people will respond to government spending increases by scaling back their own spending in anticipation of future taxes (mention this to someone who isn’t interested in economics and prepare to be looked at very strangely indeed). Let’s first note what Ricardo said about his own theory:

But the people who paid the taxes never so estimate them, and therefore do not manage their private affairs accordingly. We are too apt to think that the war is burdensome only in proportion to what we are at the moment called to pay for it in taxes, without reflecting on the probable duration of such taxes. It would be difficult to convince a man possessed of £20,000, or any other sum, that a perpetual payment of £50 per annum was equally burdensome with a single tax of £1000.

Is it any surprises that there is absolutely zero empirical evidence for this effect? Then why is everybody talking about it?

Another meme about deficits/stimulus is defining the amount of stimulus as the deficit. Really, this is quite simple and was summed up well by a commenter on Marginal Revolution:

“A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession.”

This would be a NET CHANGE that is CONTRACTIONARY. Going from a 10% deficit to an 8% deficit is easing off from the accelerator, so to speak. If you ease off on the accelerator while going up a hill… well you slow down.

Looking at net deficits tells us very little about the level of demand being created relative to what it was before the recession and to what would be needed to close the output gap.

As a final note on stimulus, the Obama stimulus is not a major point for anti-Keynesians, as it was largely offset by state and local contractionstoo small anyway and pretty poorly constructed. Having vampire squid banks that absorb much of the proceeds of growth surely doesn’t help, either. All in all, not a shining example in the history of fiscal expansion.

Now, none of what I’ve said is new or original – in fact, it’s incredibly old and has been repeated ad nauseum.  But this doesn’t stop everyone from everyday economists to ‘nobel’ prize winners trotting out the same tired lines about the money having to come from somewhere (never mind that applying similar logic an increase in private spending cannot increase employment either), how the New Deal failed (>10% growth is an obvious example of failure) and so forth.

But when your opponents are prepared to believe absolutely anything – from NDGP targeting to Austrian economics to Ricardian equivalence – just so that they can deny a positive role for the state, these things don’t seem to matter.

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  1. #1 by Jonathan M.F. Catalán on February 24, 2012 - 3:58 am

    I know it’s a minor point in your post, but I think that the New Deal does deserve very careful consideration. A lot of programs in the New Deal were counterproductive, and even Keynes recognized this in regards to some of them (such as the NRA). I think we have to distinguish between regulatory interventions (including price controls), organizational/managerial interventions, fiscal expenditure, and monetary stimulus (where the monetary stimulus could come from places such as the increase and pegging of the exchange ratio between gold and US dollars). Once we approach the Great Depression from a much more nuanced perspective, I don’t think it’s too wild to doubt the efficiency of the New Deal in promoting a recovery.

    • #2 by Unlearningecon on February 24, 2012 - 12:28 pm

      Fair point, the NRA was not a good policy. But I feel like denying that the New Deal had large successful elements (and that the 1937 crash was because of it and not because of the subsequent tightening) is just major revisionism. But you’re right in general that it’s better to look at individual elements.

  2. #3 by Unlearningecon on February 24, 2012 - 5:11 pm

    A large part of it was tax breaks, which in a time of recession are more likely to be saved and hence less stimulatory than direct spending. The whole things just seemed slap dash – I mean, from what I understand the U.S.’s infrastructure is still crumbling, education is massively underfunded and state and local governments are having bad funding problems. I saw a list of some of the things the stimulus was spent on and it just seems random.

    China 2008/9 is probably the best example of a large centrally allocated stimulus.

    As for financial crises in general, there are few where the government has had a political clout to deal with the flaws in the banking system and implement a stimulus simultaneously, so they are often sub par. Iceland is a good example of this, though.

  3. #4 by Bill Murray on February 25, 2012 - 12:26 am

    Sure the New Dealers tried many different things and not all worked, but many did. It was expected that not everything would work, that’s why they tried so many different ideas. But to think that the New deal didn’t provide a significant amount of help in ameliorating the effects of the depression is Sclaes-ian nonsense.

    • #5 by Unlearningecon on February 25, 2012 - 1:29 am

      Excuse me but your reasoned evaluation has no place in mainstream debate.

  4. #6 by invisiblebackhand on February 26, 2012 - 3:12 pm

    “Is it any surprises that there is absolutely zero empirical evidence for this effect? Then why is everybody talking about it?”

    It’s part of the low taxes campaign sponsored by the wealthy. They fund the lobby shops like Hoover and Mercatus to keep generating negative press about taxing the rich. The concept that someday, maybe possible future taxes has an effect on the economy now is ludicrous. But paid shills do what paid shills do.

    Similarly, back when Google News Timeline still existed (google has disappeared it) you could graph Higg’s ‘Regime uncertainty’ from it’s birth in 1998, to it’s complete disappearance during the Bush admin, to it’s sudden re-appearance just before Obama was elected. ‘Regime uncertainty’ only exists during Democratic administrations, apparently.

    • #7 by Unlearningecon on February 28, 2012 - 6:25 pm

      Yes, the U.S. political debate never ceases to amaze me. Brainwashed!

  1. Breakfast in America: February 23, 2012 | Recess Appointment
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