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The Jobless Recovery Continues

Economists' Views of Fiscal Policy: RetCon Department

Scott Sumner--who if he thought about it for long I think would conclude that this isn't wise--lumps Robert Barro together with John Cochrane and Eugene Fama and tries to defend them.

First, Barro does not belong in that basket: I think Barro is mistaken in his belief that right now fiscal policy multipliers are probably less than one, but he has reasons and analytically coherent reasons for thinking so--and they are not the reasons Sumner ascribes to him. By contrast, I cannot find an analytically coherent argument in Fama and Cochrane at all.

Sumner interprets Cochrane (and Barro!) as:

A Slightly Off-Center Perspective on Monetary Problems: basically saying: “if we hold nominal spending constant, fiscal policy can’t fix it.”... [I]t’s really rather sad when people like Krugman and Brad DeLong keep insisting that these guys don’t understand basic macro principles.... I don’t know for sure that Fama was using the same implicit assumption... [but] I think it quite likely that Fama was also cutting corners.... Lots of brilliant people talking past each other.... Welcome to elite macroeconomics, circa 2011.... If I was going to assign blame I’d single out Krugman/DeLong for rudeness and Fama/Cochrane for poor communication skills.

But the argument that Sumner attributes to Cochrane and Fama (and, wrongly, to Barro) is not a coherent argument: if you say "if I assume that fiscal policy does not affect nominal spending then fiscal policy does not affect nominal spending, and so I have proved my case" you haven't made an argument at all.

A coherent argument would argue, somehow, somewhere, that expansionary fiscal policy--the government selling bonds and buying stuff--does not increase nominal GDP. A coherent argument would have to succeed in arguing both of the following:

  • Even though the government is a very large organization that does not need to back each dollar of its spending by the same amount of transactions cash money as private households, when the government ramps up its spending the extra transactions cash balances it needs to hold will lead to a reduction the transactions cash balances in the hands of households, and they have to shrink their spending by the same amount that the government increased it.

  • Even though right now short-term safe nominal interest rates are zero and a great many households and businesses are holding cash as a safe savings vehicle rather than treating it as part of their transactions cash balances, nevertheless bond sales by the Federal Reserve will not lead households and businesses to swap out that cash in their portfolio for Treasury bonds and so raise the transactions money stock.

Cochrane and Fama, of course, do not make either of those arguments convincingly. They do not make either of those arguments at all.

And do recall the initial markers laid down by those who claimed that fiscal expansion would have no effects at all:

John Cochrane: [That spending can spur the economy] is not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false...

John Cochrane: Most fiscal stimulus arguments suffer from three basic 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”...

John Cochrane: [S]uppose... people or banks... are pathologically sitting on cash.... Suppose the government could [re]direct that money to people who are willing to keep spending it.... This is not a convincing analysis of the present situation however...

Eugene Fama: Government bailouts and stimulus plans seem attractive when there are idle resources - unemployment. Unfortunately, bailouts and stimulus plans are not a cure. The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another…. A common counter to my arguments about why stimulus plans don't work is to claim that the current situation is different. Specifically, the investment equal savings equation doesn't work because savers currently prefer to invest in low risk assets like government bonds rather than in potentially productive but more risky private investment projects. In other words, there is a "flight to quality." Sorry, but this is a fallacy. A flight to quality does raise the prices of less risky assets and lower the prices of more risky assets. But when new savings are used to buy government bonds, the people who sold the bonds must do something with the proceeds. In the end, the new savings have to work their way through to new private investment, and equation (1) always holds.

Robert Lucas: Christina Romer--here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this--in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.... [I]t's a very naked rationalization for policies that were already, you know, decided on for other reasons…. If we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder--the guys who work on the bridge -- then it's just a wash... there'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. And then taxing them later isn't going to help, we know that...

In claiming that Cochrane and Fama were really only making the tautological claim that "if we assume nominal GDP is fixed, fiscal policy doesn't affect nominal GDP", Scott is retconing.

"Retcon" is short for "retroactive continuity": the classic example is Damian Cugley's analysis of the coming series Saga of the Swamp Thing, in which a new issue revealed "facts" that up to that point "[were]not part of the narrative and were not intended by earlier writers.... [T]he revelation is that the [Swamp Thing's] memories are false and he is not who he thinks he is..."