And for those who want to argue that it’s the cuts to come. That everyone is pulling in their horns now given the future cuts. Erm, you do realise that’s a form of Ricardian Equivalence.
The RE which, if true, means that Keynesian stimulus cannot work?
Come again? That doesn’t sound like the Ricardian Equivalence I know about.
Ricardian Equivalence says that the timing of taxes do not matter, it implies that temporary tax cuts have no effect because people will save any short term tax cuts to cover the higher taxes in the future. It is basically the Modigliani-Miller theory for governments: Things cost other things and in competitive markets differences in the price of things should be arbitraged away.
Ricardian Equivalence implies stimulus spending cannot work if and only if “what the government buys (and distributes to households) is exactly what households would buy for themselves. [Ricardian Equivalence] by itself doesn’t do it.” Because that is pretty much impossible, you can only categorically say that if Ricardian Equivalence holds true then temporary tax cuts will have no stimulative effect. This rather awkwardly puts Tim in the position of arguing that his own policy suggestions are wrong. [1]
On the other hand, suggestions additional spending are stimulative are entirely logically consistent with Ricardian Equivalence. If the government buys something with borrowed money then your future self is going to end up paying for it one way or another, so under Ricardian Equivalence, you save towards it. But, because the cost is amortized, you don’t save as much today as the government spends more today, hence total outlays increase, hence stimulus. (c.f Bastiat)
The same story can be told in reverse. The government spends less, so you anticipate lower future taxes so you spend a little more today. But you don’t spend as much more today as the government spends less today, hence total outlays decrease, hence contractionary contraction.
If the government says it’ll spend less and others don’t pick up the slack then total spending must decrease and this in combination with stick prices and wages can depress economic activity. Now this won’t depress economic activity as much as a debt crisis but that is an entirely separate argument, so I hope Tim doesn’t try to change the subject from his misunderstanding Ricardian Equivalence (what terrible violence that phrase does to Ricardo’s reputation).
Of course all of this assumes the central bank will allow total nominal spending to career around. If it narrowly targets nominal expenditures then all of this talk is academic. However, we do not live in such a world, so this discussion is very important and Timmy is doing it wrong.
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[1] That is unless Tim is arguing some people are liquidity constrained and must spend the extra income now rather than save it. But this is several levels of nuance deeper than Tim usually opts for.
Filed under: Economics, History, Bastiat, Fiscal Policy, Monetary Policy, Ricardian Equivalence, Tim Worstall
I’m using RE as a shorthand for “people change their current behaviour given their views of the future”.
Agreed, not quite what RE really means.
But as there has been no austerity yet then those claiming that future austerity is causing slump are making the equal yet opposite argument that RE implies: that stimulus doesn’t work because people anticipate the future effects and thus negate the current effects.
And yes, agreed, this isn’t quite what RE really means. Yet I’ll still stick with my analogy.
If future spending cuts mean that activity declines now (ie, what’s in the blog post) then I’m happy enough going “Parp!”, that means that future tax rises mean that deficits now won’t work……
Now, I’ve two real objections to an expansion of spending based Keynesianism. Over and above the facts that it takes a long time to do, that it tends to be permanent not temporary etc. If we are to have stimulus, I’d rather have it as Keynes later agreed, through cuts in NI.
1) The way we measure G in our GDP calculations. We have no fucking idea what value G actually adds. So, in GDP, we assume that G adds value equal to its actual spending. Which means that if G spending increases then GDP increases even though, at least possibly, some G is value subtracting.
2) I refuse to believe that the solution to each and every economic problem, the slowing down of economic activity, is to piss away yet more money however the half-wits in Parliament would like to have spent the money they didn’t have.
Finally, I am not convinced that every recession/depression has the same cause: thus I am deeply unconvinced that every one has the same cure.
I am increasingly convinced that what we have here is indeed a financial crash(Rogoff and, umm, I want to say Carmen Miranda but that’s not right). But more than that, we’ve a real underlying structural change going on as well.
Try the first few paras of Keynes’ “Economic Possibilities for our Grandchildren”. As so often, he was a very perceptive economist. But of course, people only pay attention to hte bits they like….very like the Bible in that sense.
“I’m using RE as a shorthand for “people change their current behaviour given their views of the future”.”
Well that is just your common and garden rational expectations, I don’t think you should throw around terms like Ricardian Equivalence when that isn’t what you’re talking about.
“Finally, I am not convinced that every recession/depression has the same cause: thus I am deeply unconvinced that every one has the same cure.”
Recessions are monetary phenomena, just like inflation is. Were nominal expenditures to be on path then I think you’d have a point about “all recessions being different” but nominal expenditures haven’t been, they’ve slumped, all round the world correlated with real economic activity.
Where nominal spending is changing at a constant rate and you have economic contraction, then yes, look for real causes, otherwise don’t worry.
The US economy (on which the reporting is much more thorough), was shifting people out of construction and into export industries just fine as of 2006/7 it was only late that any sort of “structural transformation disruption” showed itself, which just so happened to coincide with a banking crisis and huge nominal shock.
So the “recessions have multiple causes” arguement is cute and important, but not right now.
We have had a financial crash, but different responses produce different recoveries. Financial crashes tend to produce timid responses and meagre growth, but this isn’t essential. Good policy can produce good responses. Intermediation hasn’t broken down to the extent that we cannot grow anymore. Australia is undergoing the same structural change, and it is just fine. Handwaving and shouting “structural change” isn’t good enough to explain why a million extra people in the UK are out of work.
PS Carmen Reinhart.
As always, I like people toa rgue with the strongest possible version of my arguments, which often means not arguing with me at all. Take it up with Scott Sumner on your “multiple causes of recessions” (by mulitple, I take you mean non-nominal) http://www.themoneyillusion.com/?p=12362