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Macroeconomics without Supply
Paul Krugman writes:
...if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect.
Brad DeLong writes:
But surely we believe that if the U.S. government were to follow the Countrywide plan--to send its representatives out onto the streets to have them walk up to people and say: "Here's $500,000. You can have it if you go buy a house"--then that would drive a recovery, right?
What's interesting about these statements is not so much whether they are right or wrong (let's just say that it depends) but that Krugman and DeLong are so immersed in the Keynesian viewpoint that they cannot even see any other way of looking at the issue. Thus "even the critics" and "but surely we believe," as if no other view were conceivable.
Well if the only frame you can see is the "spending increases employment" frame then whether the spending is private or public may seem like a niggle. But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."
Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial. Moreover, when we remember that employment drives spending we focus attention on the real allocation of labor and capital across sectors of the economy, on internal and external fiscal balance, on investment as well as on consumption and on time paths of development. The "spending drives employment" frame misses all this.
Posted by Alex Tabarrok on December 29, 2008 at 07:35 AM in Economics | Permalink
Comments
It's easy to see how to increase spending (and therefore employment). How are we to increase employment in the short-run without increasing spending?
Posted by: fusion at Dec 29, 2008 7:45:45 AM
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Posted by: Mike at Dec 29, 2008 7:51:12 AM
Why not give security to your fam for the holidays? Lots of good deals on AV out there. Just saw Panda Security for $20, good until new year's day, apparently:
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Posted by: Mike at Dec 29, 2008 7:52:29 AM
I know squat about macroeconomics, but this looks like a niggle about which came first, the chicken or the egg. Employment or spending. And I don't know that I buy Alex's accusation that DeLong and Krugman "cannot even see any other way" than one phase of the cycle.
I'd like to see somebody make a good case why it would matter which came first.
It also looks as if Alex is supporting WPA-type programs by insisting on employment first.
Posted by: Mike Huben at Dec 29, 2008 8:15:34 AM
Why do you want economic employment at all?
It's not to keep people busy and off the streets.
It's because the standard of living of the nation rises, and that all depends entirely on disagreements over value.
Namely, I trade something I value less than you for something you value less than me. We disagree about what they're worth. The result of that disagreement is that we can both profit; and the result of such voluntary trades over the nation is a rise in the nation's standard of living.
Voluntary means not any old trade, but only ones that occur voluntarily, namely those where there's this mutually profitable disagreement over value.
One of the chief enablers of disagreement over value is the division of labor. People specialize and turn out lots of their product easily; other people value them much more highly.
Division of labor takes capital, which means extra money, to supply the power equipment for the division of labor.
And capital isn't moving.
Posted by: Ron Hardin at Dec 29, 2008 8:20:24 AM
How about rephasing (reniggling?) the debate this way:
... if you believe that a surge in private spending [of money one doesn't have] would [be bad] -- and even the critics agree on that -- it's very hard to explain why a surge of public spending [of money one doesn't have] wouldn't have the same effect.
Posted by: KipEsquire at Dec 29, 2008 8:24:52 AM
I'm on the left myself, but I'd be willing to accept Tyler Cowen's views on the proper way for the government to address a recession if he supported them using a coherent argument rather than ex cathedra announcements. To me, the New Deal experience is conclusive: 1) FDR employed a modest degree of fiscal stimulus in the period 1933-1937 and achieved modestly good results in employment and GNP; 2) encouraged by this, he reverted to Calvin Coolidge economics in 1937 and wound up with a steep recession; 3) starting in 1939, a combination of British and French purchases of military equipment followed by massive US government military expenditures ended the Depression.
If this experience doesn't suggest that fiscal stimulus works, why doesn't it? My feeling is that the government should run a surplus in good times and a deficit in bad times to provide negative feedbacks to both bubbles and busts. If I'm wrong, tell me why. And please, Professor Cowen, avoid moralistic arguments about how awful it is to run deficits in your answer.
Posted by: Stan at Dec 29, 2008 8:46:08 AM
I know squat about macroeconomics, but this looks like a niggle about which came first, the chicken or the egg. Employment or spending. And I don't know that I buy Alex's accusation that DeLong and Krugman "cannot even see any other way" than one phase of the cycle.
I'd like to see somebody make a good case why it would matter which came first.
It also looks as if Alex is supporting WPA-type programs by insisting on employment first.
An interesting admission, given your previous criticism of Austrian BCT.
To understand why it matters what came first, consider Crusoe on a desert island. He is faced with a choice of consuming all of what he roots out of the ground, or saving some of it so that he can invest in making a capital good, a fishing net for example. This would enable himself to become more productive and to increase his future consumption, which could then include fish.
I think the modern macroeconomic focus on garbage like general eqilibrium theory is part of what is to blame for the widespread acceptance of Keynesian hornswoggle, and the failure of Keynesian types to understand how an economy actually works. I don't know which is worse.
I also think the widespread ignorance of business and accounting among academic economists makes the problem worse. If there was one course I should have taken as an undergraduate econ major it would have been accounting, the lingua franca of business.
I still remember the not-so-hidden disdain and even contempt for business and business people on the part of the Keynesians and Marxoids in my economics department, two or three in particular. They should have been sued for malpractice.
Also, WPA programs were ostensibly about employing people, but as Rothbard points out in Man, Economy, and State, government spending is really waste consumption and depredation, not investment.
Y = C + I - (G + T).
Posted by: Bill Stepp at Dec 29, 2008 9:22:34 AM
Looks like Gordon Brown is hedging is bets and is emphasising both fiscal stimulus and employment-though I'm not sure how rapidly dropping benefits and pushing people into a dwindling job market is going to help.
Posted by: Naadir Jeewa at Dec 29, 2008 9:27:59 AM
Alex's argument is a fine example of why Say's Law remains central to understanding macroeconomics, and why Keynes' ignorant dismissal of it continues to plague his followers to this day. Employment does indeed drive spending, as it takes income to spend.
Posted by: Steve Horwitz at Dec 29, 2008 9:28:31 AM
Public spending is about increasing political power while private investing is about the efficient allocation of limited resources. Public spending is about politicians forcing the allocation of resources in a manner that free markets would not allocate resources. Public sector spending has a lower multiplier then the private sector spending.
So I disagree with Cowen and Krugman. I don't care if spending drives employment or if employment drives spending. Both statements can be true given various conditions. But the key issue is how do we allocate resources so that we can encourage long term growth.
Government allocation of resources has never been shown to be superior to the private sector allocation of resources. Efforts by Social Democrats, such as President Elect Obama, have not worked, will not work.
Spending driven by the public sector will create downstream and upstream problems in the economy. Wasteful government spending today will quickly become a severe burden on potential growth tomorrow. And the prospect that we must pay for this wasteful spending will not only be a burden on future generations but the regulatory and structural changes that such massive new spending will become an immediate burden on long term growth potential. Potential private sector employment will be reduced as more resources are allocated to the public sector.
Krugman favors increases in the public sector. He just uses the current economic troubles to argue for what he wants to do regardless of the state of the economy
Posted by: DanC at Dec 29, 2008 9:29:50 AM
More critique with no plan. Just more niggles to add ammo to Krugman's point.
Posted by: Mark at Dec 29, 2008 9:38:37 AM
Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial.
This is the part I need explained to my puny non-economist brain, I guess. Why does it matter whether I'm spending my private paycheck or my government paycheck? Are government workers not really employed?
I can see that the gov't paycheck comes from tax dollars, but private paychecks come out of the public's wallets too. Is there some assumption here that money spent on gov't services is "wasted"? Depends on the services, doesn't it? Is money spent on private goods and services just assumed to be money well spent?
Posted by: Anderson at Dec 29, 2008 9:53:36 AM
I think this needs unpacking a bit too (for the untrained like me). Why is it better to create jobs that the market doesn't demand than to give people money straight out? Giving people money creates real demand because people can follow their preferences, so any jobs that come out of that will be useful. If you start with the jobs you have to guess which will be most useful - and you'll be wrong.
Posted by: Finnsense at Dec 29, 2008 10:07:48 AM
I continue to be amazed at how far the economics profession has digressed from reality. Lost in the discussion is why we work in the first place. It seems that consumption and employment have both become an end, rather than a means to an end.
Posted by: erichwwk at Dec 29, 2008 10:13:38 AM
"...if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect."
Spending such as, for example, the housing bubble? The bubble put a lot of people to work building, selling, and financing. That doesn't mean it was desirable, it was a net destroyer of wealth. Spending for it's own sake amounts to a wealth transfer policy. Krugman is confusing activity with production. "Looking busy" is not the same thing as being productive.
Posted by: Bill Nichols at Dec 29, 2008 10:22:52 AM
Also, what if the public spending comes out of private spending? Then the question is "which is better?"
Is this downturn the same as any other? It seems not, consumer spending drops have lagged.
In Joseph Ellis book "Ahead of the Curve", he put spending drops at the front of the downturn. What caused the spending drops? Spending bubbles caused by inflation and spending cuts caused by Fed tightening. This is just another installment of the pros who know, not doctrinaire Austrians.
Posted by: Andrew at Dec 29, 2008 10:32:23 AM
Why is it better to create jobs that the market doesn't demand than to give people money straight out?
How is (say) infrastructure spending "jobs that the market doesn't demand"? Or were you talking about something else?
In America, the government builds the roads and bridges. Everybody in my neighborhood can say "wow, we'd love to buy a new road," but that's not going to get it for us -- it has to go through the public sector.
You can argue for privatizing infrastructure (bad idea, says me), but I don't get the "jobs the market doesn't demand." Those sound more like certain private-sector jobs ... at GM, say.
Posted by: Anderson at Dec 29, 2008 10:52:58 AM
Tyler:
1) As usual, you show yourself to be an uncommonly flexible libertarian economist . . . willing, in various ways, to countenance some monetary stimuli to our economy and even some fiscal stimuli too --- especially if targeting local and state governments. All that is commendable, no other word for it --- and particularly amid a system-wide financial meltdown and global crisis that hasn't materialized until this year since the gloomy 1930s' Great Depression.
2) There are some ambiguities --- maybe even peculiarities --- in your policy positions though.
* You emphasize "real" causes of the current recession, with an emphasis on sectoral changes. This reflects real business cycle theory, of course; and that theory --- embraced as the main explanation of the ups and downs in short-term manner of long-term economic growth . . . the latter, of course, due strictly to supply-side factors: 1) growth in the capital stock, 2) growth in the labor force (plus improvements in labor-quality), and 3) improved knowledge, whether embodied in machines or in better understanding of managing business firms and marketing their products.
* Real business cycle theory, though, revives the pre-Friedman, pre-monetarist classical and neo-classical views about money: it's strictly neutral in its ability to influence GDP, rather only changes in the price-level of the economy.
Presumably you don't buy that orthodox view. Good. But then it's strange, isn't it, to find Robert Lucas endorsing a financial bailout of a huge sort to restore "liquidity" to the financial system, isn't it? I mean, how could money injections influence "real" sectoral and other changes?
* In real business cycle theory, after all, the causes of short-term ups and downs are found in 1) changes in productivity across economic sectors, driven by technological shocks; or 2) marked shifted in consumer preferences (which cover both shifts in what consumers prefer to buy and their willingness to go into debt or not for consumption); or 3) resource problems, such as the unexpected and surging price of oil in 1973 and against in 1979. Or maybe --- forgotten by most economists, it seems --- by a big war.
* So how, if money is neutral, how could either fiscal or monetary stimuli influence such factors? If anything, in real business cycle theory, such efforts are likely to backfire and delay the return of the economy's growth to its long-term potential-trend, right?
......
3) Against this background, the link to Robert Lucas is all the more surprising. After all, it's is work on rational-expectations that shows how changes in the money supply --- or presumably in interest rates caused by the Fed Reserve --- can work only if the public is "surprised". Who these days has been surprised by the continued efforts of the Federal Reserve for more than three months now to bring short-term interest rates down close to zero, along with the use of quantitative easing?
Lucas is on record, it's true, for saying recently that in "a fox hole, we're all Keynesians?". Does your endorsement of monetary expansion mean that you reject real business cycle theory and rational-expectations views of economic agents in favor of Keynesianism too . . . or, more likely, Friedmanite quantity-theory monetarism?
---(For the posters in this thread who aren't familiar with rational-expectations in its full-blooded form, it argues that all economic-agents --- including workers, consumers, business managers, savers, and investors --- understand the economy's causal workings just as well as the models of Nobel prize-winning economists. And supply and demand, therefore, except for real shocks, are always in equilibrium.
---It does leave you wondering 1) which economic models and theories they test rational-expectations theorists mean? and 2) whether, in periods of surging uncertainties about the economy and financial markets, economic-agents aren't as confused as the controversies among economists indicate that they don't agree on which models and theories are the right ones now too . . . except maybe on faith or doctrinal biases.
.....
4) You have asked for concrete evidence about the impact of fiscal stimuli in the New Deal era --- or in Nazi Germany at the same time --- and rightly so. Here, in the work of a J.P. Morgan specialist, is a link to a graph that shows a very close trend-correlation between the size of Federal deficits and unemployment levels between 1930 and 1950 for the U.S. economy.
The trend-correlation looks very close and way beyond any random effects, no?
......
Michael Gordon, AKA, the buggy professor
Posted by: the buggy professor at Dec 29, 2008 11:53:44 AM
When I was a student Milton Friedman used to ask pedagogically: Are shirts on the shelf in a clothing store unemployed? We can add: Should they not be simply given away -- after all the opportunity cost of idle resources is zero? This is clearly a confused way of thinking. So now there is (some) unemployed labor and other resources. What kinds and how much and in which locations? -- let's bypass these niggling issues. The issue is whether the government ought to encourage resource allocation in a sector that was previously over-expanded. The housing industry, and hence construction industry, was fed by an unsustainable boom. Now the idea is to encourage more resources into that same sector -- for some temporary period -- rather than encouraging the allocation of resources out of that sector. Re-allocation will take time and result in idleness, no doubt. But this is the fundamental problem. In general, the advocates of stimulus, of which Paul Krugman is one of the most visible, are more concerned with the technical problem of producing activity than the economic problem of producing the right kind of activity. It is the neglect of this difference that has brought us to the place we are at now.
Posted by: Mario Rizzo at Dec 29, 2008 12:11:16 PM
There is a slight difference between private and public spending: the former does not increase taxes, and thus does not increase the tax wedge and deadweight loss.
Posted by: Jean-Jacques Rosa at Dec 29, 2008 12:25:21 PM
I don't understand why Prof DeJong thinks that his "Countrywide example" of "giving everyone $500,000 as long as they buy a house", would "fuel a recovery", or at least a lasting one. Isn't that just pumping up a flat tire without patching it? How do the favored homebuyers either repay that loan, or if it is a gift, how do they monetize the home equity? What value would a home equity lender ascribe to a house so purchased? Surely none would be so stupid - now - as to take the purchase price in such an artifically inflated environment as the value of the home. As well, the distortive effect of further housing subsidy would seem to augur poorly for the durability of such a recovery.
Posted by: Mark T at Dec 29, 2008 12:40:45 PM
Since I apparently do not share Mr. Stepp's enthusiasm for Rothbard's anarchistic capitalism, I wonder if I could ask him to take another stab at explaining why it matters whether spending precedes employment or vice versa. Mr. Crusoe, after all, is neither spending nor employed, so his example makes very little sense without further discussion. Stepp's non-sequiturs about economists studying accounting do not make his point clearer.
Perhaps he means to say that Crusoe's home-made fishing net would catch him more fish than one given him by government. If so, he should offer some empirical evidence supporting this assertion, and help the rest of us master his understanding of "how an economy actually works."
Posted by: R. Stanton Scott at Dec 29, 2008 12:58:12 PM
Michael Gordon, Alex wrote this post, not Tyler. So I'm not sure your evaluation of his position on business cycle theory is correct. Obviously money is not neutral, and many actors do not hold accurate expectations (I've never liked the term "rational" expectations) of the future. The question is how these incorrect assumptions simplify the model and affect its accuracy. In my mind the answer to the later is "a lot".
I must say I find Krugman's whole point of view confusing. Why would we want to increase employment? I rather like being unemployed. What I don't like is not having any money to buy things, so I work. The central problem would seem to be a drop in production; thats what gets me the stuff I like. Unfortunately, some [censored] people in the housing business decided to make way more houses than I wanted, leaving me with less of the things I do like to consume. To top it off, some similar people in finance actually thought I'd want that many houses, and didn't even plan to produce enough other goods. It was a tragedy, to be sure, but I'm not understanding how a stimulus can replace the wealth that was lost by these mistakes.
I could go out and spend more money, and as Krugman indicates that would increase employment. But why would I do this? There isn't enough of the stuff I like out there. Some morons made houses instead. So what would I spend money on? Some crap I don't want? Then people would produce more crap I don't want, and we'd be right back where we started: too many of good X being produced.
Brad DeLong's suggestion seems even weirder. I have enough houses! I don't want any more!
Posted by: Grant at Dec 29, 2008 1:04:11 PM
Mr. Crusoe, after all, is neither spending nor employed, so his example makes very little sense without further discussion. Stepp's non-sequiturs about economists studying accounting do not make his point clearer.
Crusoe is employed, as in self-employed. So are lots of small business owners. Everything Crusoe does from consuming berries or fish to storing some food (i.e. saving) to making a fishing net (investing) is a one-person counterpart of what he would do in a more advanced economy. He has no need for money because he doesn't live in an economy where it were necessary, but as soon as Friday comes on the scene, he could spend some berries in exchange for apples or fish supplied by Friday. The basic economic ideas are the same, and the economic problem still confronts him thanks to the scarcity of resources. He has to save and invest in order to increase his productivity and his income. Of course he could get his income, G, the way the State does and just steal some fish from Friday. Then maybe he could give some of it to Jones, who is unemployed because he's a deadbeat, keeping some vig for himself naturally.
You can figure out for yourself what the--reaching for the laughtrack button--"Keynesian multiplier" is here. (Hint: it ain't 1.4 or 1.8.)
Studying business and accounting certainly is an aid to understanding why Keynesianism is a non-starter.
Even better would be working in a business.
Posted by: Bill Stepp at Dec 29, 2008 1:31:55 PM
