A correspondent complains that John Cochrane's (February 27, 2009) "Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?" appears to have disappeared from the internet. It may well be a configuration problem at http:/chicagogsb.edu/, but a quick check of the Wayback Machine does indicate that, indeed, "Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?" has not been successfully crawled since February 20, 2012.
And, indeed, Chicago GSB appears to have ditched http://chicagogsb.edu/ for http://chicagobooth.edu without properly setting up forwards from chicagogsb.edu to chicagobooth.edu. Sloppy...
And here, from four years ago, is my comment on Cochrane's fallacies at the time:
Time to Bang My Head Against the Wall Some More (Pre-Elementary Monetary Economics Department): Oh boy. John Cochrane does not know something that David Hume did--that the velocity of monetary circulation is an economic variable rather than a technological constant. Cochrane:
Fiscal Fallacies: First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out”...
But it does need a complex argument about "crowding out" to work. It is not just accounting.
It is not just accounting because there is no requirement that you spend your cash rather than hoard it, and even if you are spending your cash there is no requirement that you spend it always at exactly the same rate.
To assume that there is is to make a mistake that Thomas Robert Malthus and John Stuart Mill never made, and that Jean-Baptiste Say had figured out was wrong by 1829. We do not live in a pure cash-in-advance economy with an inelastic stock of money and a technologically fixed and rigid velocity of circulation.
I find this--still--fracking unbelievable.
I cannot imagine how anybody who has ever thought about how they pay for things for even an instant could say this.
Let us take this slowly and see if we can fix it...
Suppose that we have four agents: Alice, Beverly, Carol, and Deborah.
Suppose that Beverly has $500 in cash that she owes Carol, due in two months. Suppose that Alice and Carol are both unemployed and idle.
In one scenario in two months Beverly goes to Carol and pays her the $500. End of story.
In a second scenario Beverly says to Alice: "I have a house. Why don't you build a deck--I will pay you $500 after the work is done. Here is the contract." Alice takes the contract and goes to Carol. She shows the contract to Carol and says: "See. I will be good for the debt. Cook me meals so I will have the strength to build the deck--here's another contract in which I promise to pay you $500 within 90 days if you cook for me." Carol agrees.
Two months pass. Carol cooks and feeds Alice. Alice goes and builds the deck.
Alice then asks Beverly for payment. Beverly says: "Wait a minute." She goes to Carol and says: "Here is the the $500 cash I owe you." Beverly pays the money to Carol. Beverly then says: "But now could I borrow the cash back by offering you a long-term mortgage at an attractive interest rate secured with an interest in my newly more-valuable house?" Carol says: "Sure." Beverly files an amended deed showing Carol's mortgage lien with the town office. Carol gives Beverly back the $500. Beverly then goes to Alice and pays her the $500. Alice then goes to Carol and pays her the $500.
The net result? (a) Alice who would otherwise have been idle has been employed--has traded her labor for meals. (b) Carol who would otherwise have been idle has been employed--has traded her labor for a secured lien on Beverly's house. (c) Beverly has taken out a mortgage on her house and in exchange has gotten a deck built. (d) Carol has the $500 cash that Beverly owed her in the first place.
Alice has more income and consumption expenditure than if she hadn't taken Beverly's job offer. Carol has more income and saving than if she hadn't cooked for Alice and then invested her earnings with Beverly. Beverly has an extra capital asset (the deck) and an extra financial liability (the mortgage) than if she had never offered to hire Alice.
A deck has gotten built. Meals have been cooked and eaten. Two women have been employed. And all this has happened without printing any extra money.
John Cochrane would say that this is impossible. John Cochrane would say:
[I]f money is not going to be printed, it has to come from somewhere. If Beverly borrows a dollar from Carol, that is a dollar that Carol does not spend, or does not lend to Deborah to spend on new investment. Every dollar of increased Beverly spending must correspond to one less dollar of Carol or Deborah spending. Alice's job created by Beverly spending is offset by a job lost from the decline in Carol or Deborah spending. We can build decks instead of fountains, but Beverly stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out”...
John Cochrane is wrong.
You sometimes see this mistake in freshmen students in Economics 1--students who do not fully understand either the circular flow of economic activity or what a credit economy is. They think--like Cochrane does--that the flow of spending must be constant unless somebody "prints money" because, you see, you need "money" in order to buy things.
The premise is true--you do need "money" (it would be better to say: "money or credit") to buy things--but the conclusion is false. The flow of spending is not necessarily constant. In the world in which Beverly does not hire Alice but instead pays the $500 directly to Carol, that $500 turns over only once--its velocity of circulation is equal to one. In the world in which Beverly does hire Alice, the velocity of circulation of the $500 is four--it goes from Beverly to Carol, from Carol to Beverly, from Beverly to Alice, and from Alice to Carol.
Cochrane's mistake--an elementary, freshman mistake--is because he has not thought enough about how a credit economy works. He does not recognize that the velocity of circulation of outside money can be an economic variable, and does not necessarily have to be a technological constant.
As the velocity of circulation of outside money varies, the pace of the flow of spending varies as well: it is not the case that if Beverly borrows a dollar from Carol, that is a dollar that Carol does not spend.
Milton Friedman knew this. Irving Fisher knew this. Simon Newcomb knew this. David Hume knew this. John Cochrane does not know this: does not know that the velocity of circulation is an economic variable rather than a technological constant.
I do want to pound my head against the wall.
I do not know what else to do...
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