Why History of Economic Thought Is Important: Whack-a-Mole Wall Street Journal/Arthur Laffer Edition
Why oh why can't we have a better press corps? Why oh why can't we have better right-wing economists?
As every even casual student of the history of economic thought knows, back before 1829 whether it was sensible to talk about increases in economic agents' planned spending raising and decreases lowering economic activity in the short run was an active research question in economic theory. Back then Say's Law ruled: since nobody produces for sale without intending to purchase, by "metaphysical necessity" planned spending must be equal to and could not be raised above or lowered below production. Thomas Malthus complained that this "Say-Ricardo doctrine" seemed sound in theory but did not appear to fit the world in practice, but he had no theoretical resolution to the problem.
As every even casual student of the history of economic thought knows, the question was definitively resolved by John Stuart Mill in 1829. Mill observed that people plan to spend their incomes not just on currently-produced goods and services, but also on financial assets. When economic agents in total plan to leverage up, planned spending in the short run is in excess of production--and then production rises and the economy booms. When economic agents in total plan to deleverage, planned spending in the short run is below production--and then production falls and the economy slumps.
No economist ever--except perhaps Friedrich Hayek: Hayek's reasoning on business cycles was and remains obscure--had argued that changes in business confidence that made businesses want to leverage up or deleverage had no effect on total spending and production. And as far as the effects of planned leveraging up and deleveraging are concerned, the government's plans are as good as those of any other economic agent. That is the logic of fiscal expansion to boost the economy in the short run in a downturn and of fiscal austerity to cool off the economy in the short run in an inflationary boom. And every even casual student of the history of economic thought knows that that logic has been secured in both the theory and practice of economics for nearly two centuries now.
That is why those of us who were even casual students of the history of economic thought were astonished in early 2009 to find that economists widely regarded as Nobel Prize or Clark medal caliber--the Lucases, the Prescotts, the Famas, the Cochranes, and the others--had either never done their homework to learn or had forgotten with John Stuart Mill had to teach back in 1829. It was, from our perspective, as if a modern physicist was denying that lightning was made of electricity or a modern atmospheric scientist was denying that carbon dioxide absorbed infrared radiation.
So we set about playing whack-a-mole.
And in the medium run--not, mind you, in the short run in which it would have done good in guiding policy responses--we won the argument: it has been a long time now since I have heard Robert Lucas say "there is nothing to apply a multiplier to" or Eugene Fama say that it is "logically impossible for fiscal expansion to boost spending or John Cochrane say that the idea that government investment spending might be like private investment spending and put people to work is "insane". (Prescott continues to say that all our ills are the fault of the policies of Roosevelt--Theodore Roosevelt, that is, and that statist interventionist Calvin Coolidge as well.)
But the need for whack-a-mole continues: for the Wall Street Journal gives a platform to Arthur Laffer.
Do your homework, Arthur! We do not live in a nonmonetary economy--or an economy with a fixed money stock and a rigid cash-in-advance constraint, for that matter! The government spending no more has a zero total income effect than private spending does!
If you believe, as I do, that the macro economy is the sum total of all of its micro parts, then stimulus spending really doesn't make much sense. In essence, it's when government takes additional resources beyond what it would otherwise take from one group of people (usually the people who produced the resources) and then gives those resources to another group of people (often to non-workers and non-producers).... Quite simply, government taxing people more who work and then giving more money to people who don't work is a surefire recipe for less work, less output and more unemployment.
Yet the notion that additional spending is a "stimulus" and less spending is "austerity" is the norm just about everywhere. Without ever thinking where the money comes from, politicians and many economists believe additional government spending adds to aggregate demand. You'd think that single-entry accounting were the God's truth and that, for the government at least, every check written has no offsetting debit.
Well, the truth is that government spending does come with debits. For every additional government dollar spent there is an additional private dollar taken. All the stimulus to the spending recipients is matched on a dollar-for-dollar basis every minute of every day by a depressant placed on the people who pay for these transfers. Or as a student of the dismal science might say, the total income effects of additional government spending always sum to zero...