Somewhere, somehow, without as far as I know leaving any paper trail, Chicago-School economists became convinced of two false things:
Ricardian equivalence means not just that deficit-financed tax cuts have no short-term stimulative effects but also that deficit-financed spending increases have no short-term stimulative effects on nominal spending.
There are no issues worth discussing at the zero nominal interest rate bound: monetary expansion via open market operations retains its full potency and power to affect the level of nominal spending spending even when open market operations are just the swap of one zero-yielding government liability for another.
If anyone can help me understand the process by which these strange doctrines of economics became Holy Writ among the Monsters of the Midway, I would be very grateful...
The latest to show up in these camps is Robert Lucas:
Why a Second Look Matters: [1929-1932] added up to four years of negative [nominal income] growth averaging minus-8 percent a year.... [T]he Federal Reserve didn't cause this decline.... My guess is it was... people seeking safety in liquidity after the stock market crash... people... wanted to build up their cash holdings. [T]he Fed could have responded to that situation by... creating... reserves... to supply the added liquidity.... But the Fed didn't do anything to relieve this liquidity. They... cut interest rates to zero. They were, I guess, the believers that the only thing... monetary policy can do is fix interest rates. And once interest rates get to zero, you're over.
Friedman and Schwartz... [argued] that this passive response by the Fed must bear the ultimate responsibility for the severity of the contraction.... So even today, many people think of the Depression as evidence that monetary stimulus is ineffective when the real problem was that it wasn't used....
[T]his is one policy mistake that's not going to be repeated in the current situation. The Fed, under Bernanke's leadership, had added something -- I never know quite know what number to say, I'll say 600 billion (dollars) in bank reserves... [to] a system that operated with $50 billion in reserves last August... just a mountain of new reserves.... I think this is the right thing to do.... It is not possible to pull a modern economy through a neutral or painless deflation. Economic theory doesn't really tell us why -- what's hard about it. But, the evidence, I mean, it just doesn't work....
[W]ould a fiscal stimulus somehow get us out of this bind, or add another weapon that would help in this problem? I've already said I think what the Fed is now doing is going to be enough to get a reasonably quick recovery committed. But,could we do even better with fiscal stimulus? I just don't see this at all. If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that's just a monetary policy. We don't need the bridge to do that. We can print up the same amount of money and buy anything with it....
But if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder... then it's just a wash.... [T]here's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge... taxing them later isn't going to help, we know that...
