Jason had a great post a week-and-a-half ago about the stimulus debate. The debate as it stands right now in the newspapers, media, and blogs centers on the questions about the effect of government intervention (spending increases and tax cuts) on the economy in the short-run and in the long-run. Jason's comments were similar to those of Robert Barro (Harvard) in today's Wall Street Journal in making the case for multipliers on government spending and taxation being much lower than is being estimated by members of the Obama economic team. Barro focused on the government spending multiplier being close to zero, and Jason argued that the tax multiplier is bigger than the government spending multiplier. However, I think that the correct answer to the optimal amount of government intervention must incorporate more dynamic effects that balance any short-run benefits of intervention with long-run costs. It is, therefore, a question about how society discounts the future.
Greg Mankiw (Harvard), who has a background in Keynesian economics and is generally sympathetic to the idea of government spending (or tax cutting) having a positive effect in the short-run, wrote what I think is the most balanced evaluation of the debate that I have heard yet. In characterizing the two poles of the debate, he said:
"To put it perhaps a bit too bluntly, the Keynesian mutliplier is about income effects, while neoclassical tax distortions are about substitution effects. For those of us eclectic enough to see the world including a variety of effects, both Keynesian and neoclassical, policy decisions are far harder than they are for those eager to focus on one effect while setting the other close to zero. You can guess which effect those on the far left and those on the far right choose to focus on."
It is not clear how Barro made his estimations behind the near-zero multipliers reported in today's Wall Street Journal piece, but estimates of the government spending multiplier have a wide range between 0 and 1.5. Assume that government spending can increase GDP to some degree in the short-run (positive short-run multiplier). And assume that any government spending is more than offset in the long-run by decreased investment or crowding out (negative long-run multiplier). If individuals and society discount the future at some rate between 0 and 1, then there may be some optimal level of government intervention greater than zero in the face of economic downturns--even if it has some costs that must be paid in the future.
At least once a week, a colleague of mine asks me if all macroeconomists are now Keynesians. As someone who was trained in the classical tradition, I always answer that we are not all Keynesian. The problem, however, with the classical position is twofold. First, it has traditionally ignored key short-run frictions that are now well established (e.g., imperfect competition and sticky prices), although the current Real Business Cycle literature has incorporated these characteristics into more recent models.
The second problem with the classical position is more difficult. As I mentioned in a post yesterday, we don't have good data on how the economy responds in a deep recession to letting markets sort things out (no government intervention). Since the Great Depression, the U.S. has always faced deep recessions with the Keynesian axiom of increased countercyclical spending. Additionally, we don't have any good comparable examples from the last 80 years of big foreign countries letting markets handle recessions rather than responding with increased spending. So all arguments for the classical position must be made with theory, not empirics.
In an Econ Journal Watch article in which Daniel Klein asked economists how they would create more sympathy for the classical viewpoint within academic economics, Ed Prescott responded, "We are the economists. Be ambitious." In the same vein, Greg Mankiw stated that PhD students should take note of this debate as a "possible dissertation topic." In summary, the economics profession needs more work on harmonizing the short-run ideas of Keynes with classical long-run economics. And the link between the two will be how we assume society discounts the future.
"To put it perhaps a bit too bluntly, the Keynesian mutliplier is about income effects, while neoclassical tax distortions are about substitution effects. For those of us eclectic enough to see the world including a variety of effects, both Keynesian and neoclassical, policy decisions are far harder than they are for those eager to focus on one effect while setting the other close to zero. You can guess which effect those on the far left and those on the far right choose to focus on."
It is not clear how Barro made his estimations behind the near-zero multipliers reported in today's Wall Street Journal piece, but estimates of the government spending multiplier have a wide range between 0 and 1.5. Assume that government spending can increase GDP to some degree in the short-run (positive short-run multiplier). And assume that any government spending is more than offset in the long-run by decreased investment or crowding out (negative long-run multiplier). If individuals and society discount the future at some rate between 0 and 1, then there may be some optimal level of government intervention greater than zero in the face of economic downturns--even if it has some costs that must be paid in the future.
At least once a week, a colleague of mine asks me if all macroeconomists are now Keynesians. As someone who was trained in the classical tradition, I always answer that we are not all Keynesian. The problem, however, with the classical position is twofold. First, it has traditionally ignored key short-run frictions that are now well established (e.g., imperfect competition and sticky prices), although the current Real Business Cycle literature has incorporated these characteristics into more recent models.
The second problem with the classical position is more difficult. As I mentioned in a post yesterday, we don't have good data on how the economy responds in a deep recession to letting markets sort things out (no government intervention). Since the Great Depression, the U.S. has always faced deep recessions with the Keynesian axiom of increased countercyclical spending. Additionally, we don't have any good comparable examples from the last 80 years of big foreign countries letting markets handle recessions rather than responding with increased spending. So all arguments for the classical position must be made with theory, not empirics.
In an Econ Journal Watch article in which Daniel Klein asked economists how they would create more sympathy for the classical viewpoint within academic economics, Ed Prescott responded, "We are the economists. Be ambitious." In the same vein, Greg Mankiw stated that PhD students should take note of this debate as a "possible dissertation topic." In summary, the economics profession needs more work on harmonizing the short-run ideas of Keynes with classical long-run economics. And the link between the two will be how we assume society discounts the future.
