Eco-War

I’ve been following this economics war (argument may be more appropriate) between the usual Keynsian and Chicago schools. I have picked out some of the posts in this spat rather than collect all of them since many are just flanking in nature and weren’t advancing the debate.

John Cochrane (Univ of Chicago) makes the case that fiscal stimulus does not work as the fiscal multiplier is zero. The argument is simple: government can spend only out of taxes or borrowing. Higher taxes reduces consumption, higher borrowing can only be backed up by expected future taxes & therefore have the same impact as higher taxes (Ricardian equivalence). He raises Keynsian heckles by saying:

For these and other reasons, Keynesian ISLM models have not been taught in any serious graduate school since at least 1980, except as interesting fallacies or history of thought.

Simon Wren-Lewis gets worked up and calls out Cochrane (and Robert Lucas too) by saying that government spending works here and now, but any fall in consumption due to higher taxes is smoothed out over time, leading to fiscal stimulus. Wren-Lewis also cites a Brad de Long post arguing the same thing. This post seems to be just a commentary without any charts or equations to support his case. He ups the ante a bit on the spat with this line:

I prefer to just note that if any undergraduate or graduate student in the UK wrote this in an exam, they would lose marks.

Scott Sumner wades in saying that it is tough to argue against an identity. With the example of a closed economy, he breaks down in four steps why Cochrane is right and Wren-Lewis is not. Sumner’s quote I pick:

Undergraduate quiz?  He’s going to bitterly regret that snide remark.

And then, the champion of Keynes, Paul Krugman wades in with a dismissive post on comparative statics. He makes the standard ISLM claims in what he calls a very wonkish post, but sadly seems to have missed most of Sumner’s argument. While Krugman is brilliant (I have been following his work my entire career going back to the Asian financial crisis), in recent years his Keynesian bias has gotten so bad that he is unwilling to give credence to any other point of view. He wasn’t always this way, but he says his earlier views were incorrect.

Sumner thinks we have made some kind of basic error, and ties himself into knots trying to set us straight. It’s really very sad.

I am going to give Sumner closing comments in this debate with his post where he says that by now “I should be used to Paul Krugman responding to arguments I never made.”

Thus they are forced to fall back on the argument that the basic Keynesian model is true because we assume it’s true.  Fine, then say so.

Stay classy guys.

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