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Source link: http://archive.mises.org/10542/even-when-krugmans-right-hes-wrong/

Even When Krugman’s Right, He’s Wrong

August 27, 2009 by

Prashanth Perumal insisted that I comment on this Krugman blog post from January. The reason I didn’t comment on it at the time was that my views here are rather nuanced. It’s one of those tricky situations where I agree with Krugman that his opponents are wrong, but I deny that Krugman is therefore right. In other words, Krugman’s enemies–Eugene Fama and John Cochrane–use invalid arguments but reach a true conclusion, namely that big government deficits don’t help an economy in recession.
So here’s Krugman’s opening paragraph:

Brad DeLong is upset about the stuff coming out of Chicago these days — and understandably so. First Eugene Fama, now John Cochrane, have made the claim that debt-financed government spending necessarily crowds out an equal amount of private spending, even if the economy is depressed — and they claim this not as an empirical result, not as the prediction of some model, but as the ineluctable implication of an accounting identity.

Then Krugman goes on to quote from each. Just so Mises.org readers know the full context, I’ll reproduce them here as well. So first Fama:

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.

And now Cochrane:

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.1 This is just accounting, and does not need a complex argument about “crowding out.”

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. They evaluate past stimulus programs by whether people who got stimulus money spent it on consumption goods rather save it. But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

And then Krugman goes on to rip the above views as sooo 1935. (I.e. the year before Keynes came out with his General Theory.)

But at the risk of giving Prashanth a stroke, let me say: Krugman is totally right. (!!) Fama and Cochrane are wrong in spinning out what appear to be tautologies above. And I say this, knowing full well that plenty of free marketeers–myself included–critique deficit-spending using the exact same arguments when writing an op ed or getting interviewed on the radio.

To a first approximation, and especially if you’re dealing with somebody who doesn’t know the first thing about scarcity, then yes I think it’s fine to say, “Every dollar the government spends just means one fewer dollar spent in the private sector.” But that’s actually not correct, at least not in the way most people believe. And it’s also not literally true to say, “If the government creates a job in industry X with a subsidy, then there must be an offsetting job destroyed in industry Y because of higher taxes or interest rates.”

This is actually quite simple: Suppose the government imposes a one-shot head tax on Bill Gates of $1 million, and then uses the revenue to hire 50 people at $20,000 each to work for a year scrubbing graffiti off bridges. Do Austrians really want to say that it’s an accounting necessity that this causes Bill Gates to adjust his behavior such that precisely 50 other people lose their jobs, but only for a year? Of course not–it would be a miracle if exactly that happened because of the new tax on Bill Gates. In fact, no matter how many people are initially laid off because of changes in Gates’ spending and investing, if wages adjust quickly enough, then that excess unemployment can be whittled away.

So does my concession to Krugman mean that he is right to champion government deficits as a way to prop up aggregate demand, to get “money circulating,” to create jobs and start using idle resources?

Of course not. In contrast to the all-clearing-all-the-time view of markets held by Fama and other Chicago School believers in the “efficient markets hypothesis,” Austrians know that it takes time for the market to adjust after the bursting of an unsustainable boom. So yes, during a deep recession, it’s possible for the government to reduce the unemployment rate through various means, especially through printing money. But that doesn’t mean it’s a good thing. The idle period of spare capacity (in both capital and labor) serves a definite purpose in a market economy, and the government sabotages the cleansing process by forcing those resources back to work on any old project that’s “shovel ready.”

I elaborate on this point in some detail here, and Arnold Kling (with a nod to the Austrian School) comes to the same conclusion from a different angle here.

In conclusion, free marketeers shouldn’t focus their efforts on trying to prove that the government is incapable of boosting “total spending.” For one thing, that’s a false proposition, so it’s a bad move to try to prove it. But more important, it concedes that boosting “total spending” is a good thing. No, the important thing is for the economy to steer resources to their most efficient uses. If that process requires, say, prices in general to fall–and hence nominal aggregate expenditures–then who cares? You consume goods and services, not a flow of green pieces of paper.

{ 43 comments }

Conservative Economics August 27, 2009 at 10:26 pm

Good point Bob. That was a mistake that I am afraid I would have made myself had I not read this piece.

Joe August 27, 2009 at 10:37 pm

Good stuff. Very well explained. I definitely have a much better understanding after reading this article as well as that other one you mentioned.

Walt D. August 28, 2009 at 12:22 am

The Government had several ways to spend $1.4 trillion dollars it did not have. For instance,
A) Bailout financial institutions.
B) Cut the Corporate tax rate to zero.
C) Pay off the balances on 140 million people’s credit cards.
D) Pay off $1.4 trillion of car loans and leases.
Who is to say that choice a was the most effective?
Choice B would cause the stock market to rise by 55%, and go back up to close to its bubble level. Seniors would start feeling rich again and take their trips to Las Vegas. Florida and Arizona real estate prices might start to rebound. Besides which, the companies would have extra savings to invest
Choice C & D would get consumers back to their (over) spending habits.
It seems that the only thing going for A is that it allows the government to meddle and micromanage the financial institutions that were bailed out.

ktibuk August 28, 2009 at 3:22 am

There is one more thing that is especially important that is missing, I think.

Yes government may boost the short term production of total goods and services. But where does this short term boost come from?

From total capital stock of the economy.

In short when government intervenes as it did, the good short term effects that are felt, come at the expense of the capital stock.

Governments force people to eat the seeds. And after the short term effects pass, it is much harder to adjust because the capital lost in this stimulus period has to replenished.

For nearly 20 years all the central banks diluted the capital stock with money. So people actually consumed their capital thinking they were actually consuming the profits.

That is what inflation does. Distorts accounting where you can not calculate if you are making a profit, or you are at a loss.

Now people have to make up for their “mistake” and save much more than they used to to bring the capital stock back up.

Renegade Division August 28, 2009 at 3:38 am

Walt D. you are doing a mistake in the above analysis.

You are forgetting the fact that govt wouldn’t have got this money 1.4 trillion dollars from their treasury where it was kept in the Savings account of US Govt.
That money was created out of thin air. This means the govt can actually make everybody’s taxes to zero and still fund the Iraq War and Healthcare bill and not reduce any govt expenditure.

That money has been offset to the other people who hold their savings in dollars. This would still create the next bubble, and is no worse than bailing out companies or to pay off credit card bills or home and car mortgages(except for of course in one case its the companies and in other case its the consumers benefitting).

Suggesting reducing corporate taxes to zero by cutting govt spending is different than suggesting reducing corporate taxes to zero by using $1.4 trillion bailout money. Because in first case the money will flow from public to private sector, in the later case the money will be flowing from private to private sector in a very messed up manner.

Buzungulus Rising August 28, 2009 at 6:34 am

“So yes, during a deep recession, it’s possible for the government to reduce the unemployment rate through various means, especially through printing money. ”

But Cochrane explicitly excludes this case (resort to the printing press). C’mon, this isn’t really as subtle as you think: if the govt consumes real resources, they have to come from somewhere in the private sector.

Nathan August 28, 2009 at 9:03 am

I think this essentially boils down to, inflation/deflation isn’t instant, so the government can indeed increase aggregate spending and jobs in the short term. Of course this extends the bubble with with another crash is the ultimate result.

Walt D. August 28, 2009 at 10:19 am

Renegade Division
I was not suggesting that it was a good idea for the government to spend $1.4 trillion that it does not have. I was merely suggesting that given the government was intent on spending $1.4 trillion dollars it did not have, that there were different ways of doing this, each of which would have different economic outcomes. (None of them good from the Austrian point of view; all of them equally good from the Keynesian point of view.)
The Federal Government has no money, per se, outside of the gold in Fort Knox. Therefore, the Federal Government can only give someone money by taking it away from someone else who has saved, borrowing the money from someone else who has saved (domestic or foreign), or inflation – writing a check out of thin air – they do not actually need to print money. Indeed, it is not in their interest to actually print money – the Fed would have to conduct an auction to back the paper currency. If no paper currency is involved, all the Fed has to do is to create a balance sheet entry. Since the Fed can make loans based on virtually any type of collateral, based on its own evaluation of what the collateral is worth, there is effectively no control over what the Fed does with the money supply.

Rafael Garcia August 28, 2009 at 10:28 am

I have trouble understanding this argument. First of all, what is “total spending”? The reason government can’t boost it is that it doesn’t exist. The only way to boost aggregate nominal spending is to inflate the money supply. Otherwise, a dollar spent by government means a dollar taken from the private sector. Whether 50 jobs in one sector equal 50 in another is entirely irrelevant and a straw man. The point is that the tax of $1 million means that government spends $1 million extra (on unproductive work that no one is purchasing freely) while Gates has precisely $1 million less to spend. So total spending is not increased.

Also, what is “unemployment”? If 100 auto workers are laid off and refuse to work for $8 per hour at Wendy’s, then they are considered “unemployed”. If the government seizes enough cash (or seizes enough real resources via printing money) to pay them to keep building crappy cars, then the “unemployment” statistic goes down. But obviously, the economy would be more productive, in the sense of generating more value for consumers, if these men were forced to go to work at Wendy’s or WalMart and lower the price of fast food and groceries. There is no such thing as “unemployment” that needs to be reduced. There are only people who prefer leisure to the wage rate they can earn on the free market.

So both of Prof. Murphy’s claims, that government stimulus can increase “total spending” and decrease “unemployment”, appear to be based on confused Keynesian macroecon terms that don’t mean anything in real life. To re-emphasize, even in the “short term”, government cannot increase anything meaningful that is meant by the phrases “total spending” or “employment”.

Silas Barta August 28, 2009 at 10:48 am

But more important, it concedes that boosting “total spending” is a good thing. No, the important thing is for the economy to steer resources to their most efficient uses. If that process requires, say, prices in general to fall–and hence nominal aggregate expenditures–then who cares? You consume goods and services, not a flow of green pieces of paper.

Bingo! This point cannot be emphasized enough, even to libertarians. Too often people get focused on whether “consumers are buying enough” or some such thing. No, what we need is for individuals to move up on their preference scales. That means only buying things *that are worth more to you than the forgone money*. No one should be buying junk out of some bizarre urge to “keep the economy strong”, and more importantly, no one should regard such behavior on the part of others as a good or noble act!

Buzungulus Rising August 28, 2009 at 10:53 am

Rafael Garcia,

Excellent post. In fact, it’s essentially what Fama and Cochrane said in the first place. For reasons that are unclear, Bob appears to be engaging in some strawman-bashing.

Joe August 28, 2009 at 12:03 pm

Very good points Rafael. This has turned into an enlightening post all around. Got to admit, the way you put unemployment I haven’t heard before but it’s entirely accurate.

Walt D. August 28, 2009 at 12:16 pm

Here’s another way for the government to provide a Keynesian stimulation. Give the 30 million unemployed the minimum wage of $20,000. That’s another $600 billion. Doing nothing is equally as stimulating as digging and filling in holes in the ground.

fundamentalist August 28, 2009 at 1:06 pm

I have to go along with Rafael on this one. I think Murphy is being a little unfair to Fama and Cochrane in that I think he changed the time parameters of the debate. I could be wrong, but it seems to me that Krugman and Fama were debating the short run consequences of policies. Government spending creates jobs relatively quickly. Borrowing or taxing reduces jobs relatively quickly. In the intermediate term the economy adjusts to make the good done in the short term not so good and the bad done not so bad, but I don’t think the intermediate was being discusses.

Prashanth Perumal August 28, 2009 at 1:07 pm

First, thanks to Mr. Murphy for his efforts at satisfying my request.

Second, as much as I don’t think Fama and Cochrane said anything like a 50 jobs created by Government spending will offset exactly 50 jobs in the private sector, neither do I think Mr. Murphy makes the straw man deliberately.

Moreover, I kept Mr. Murphy engaged in doing this under his busy schedule. He was kind enough to keep me updated on the progress of the work. So it isn’t justice to be implicating him now. Thanks all! It was a good learning experience for all.

Prashanth Perumal August 28, 2009 at 1:12 pm

First up, thanks to Mr. Murphy for expending his efforts to take up my suggestion.

Second, I don’t think Fama and Cochrane make any case like ‘a 20 jobs created by government spending will offset exactly 20 jobs in the private sector’. If that is a straw-man that is committed there, I believe it would not have been a deliberate attempt by Mr. Murphy. He was kind enough to keep me updated on the progress of the article in the last few days. And he was quite busy when I got to him.

Third, I still believe Krugman is entirely wrong!

Thanks everybody!

Prashanth Perumal August 28, 2009 at 1:35 pm

Rafael Garcia,

I don’t think Mr. Murphy says Governments can increase total spending(that is a real increase in the productive wealth of society). You ain’t understanding him right.

And inflation(increase in money supply) can indeed have temporary positive effects on unemployment before companies adapt to the new price level.

Rafael Garcia August 28, 2009 at 2:00 pm

Prashanth, please call me Rafael.

PRASHANTH: “I don’t think Mr. Murphy says Governments can increase total spending(that is a real increase in the productive wealth of society). You ain’t understanding him right.”

MURPHY: “In conclusion, free marketeers shouldn’t focus their efforts on trying to prove that the government is incapable of boosting ‘total spending.’ For one thing, that’s a false proposition, so it’s a bad move to try to prove it. ”

ME: As you can see, Murphy does indeed explicitly claim that “government is []capable of boosting ‘total spending.’” I never said anything about “the productive wealth of society.”

PRASANTH: “And inflation(increase in money supply) can indeed have temporary positive effects on unemployment before companies adapt to the new price level.”

ME: This is too vague, but I’m pretty sure it’s wrong whatever it means.

1) What is unemployment? I have just shown that it is a meaningless term.

2) We were not talking about inflation, we were talking about fiscal stimulus (as Cochrane explicitly differentiates the two). Government spending cannot even do what you (presumably) mean by “decrease unemployment” if not accompanied by inflation.

3) Let’s assume the usual definition of unemployment and also that we are talking about inflation. This is still a confused way of putting it, that inflation has “positive” effects in the short term. Inflation will allow (otherwise) loss-making enterprises to bid resources (including labor) away from profitable enterprises, temporarily increasing the nominal rents to each factor of production they bid on(including labor). But because no goods were produced by the inflation, total real wages cannot go up. This is an important accounting tautology. Even in the short term, there is no total increase in prosperity as we wait for the economy to adjust to the new price level. That is a common misunderstanding. Inflation and fiscal stimulus reduce total wealth. They both do this, individually, and in combination. They do this always, regardless of the circumstances. And they do this beginning immediately, regardless of whether you say you are talking in the short-term, middle-term, long-term, north-by-northwest-term, or whatever. (What you can say, of course, is that as the new money flows through the economy, those workers whose wages are bid up first gain, while those whose wages are bid up last lose.)

Prashanth Perumal August 28, 2009 at 2:11 pm

Rafael,

I would give it to you on the first instance, since it deals only with fiscal spending. So yes, mere fiscal spending can’t improve the conventional unemployment figures.

Regarding inflation, it can have positive effects on the conventional unemployment figures. Of course inflation can’t improve real wages. But it can help the conventional unemployment figures, by temporarily putting people into work. We ain’t talking about the validity of the conventional unemployment figures here.

Prashanth Perumal August 28, 2009 at 2:15 pm

Rafael says: As you can see, Murphy does indeed explicitly claim that “government is []capable of boosting ‘total spending.’” I never said anything about “the productive wealth of society.”

Me says: Read Murphy again: “In conclusion, free marketeers shouldn’t focus their efforts on trying to prove that the government is incapable of boosting “total spending.” For one thing, that’s a false proposition, so it’s a bad move to try to prove it. But more important, it concedes that boosting “total spending” is a good thing.”

Rafael Garcia August 28, 2009 at 2:20 pm

Prasanth:

I think you are completely right, and I like the way you put it. Inflation can indeed improve the “conventional employment figures”. But of course, if government instituted a 70% tax on all incomes, banned all private sector employment, and hired all workers itself, we would have zero unemployment by the conventional measures. Not only do these figures pretend that millions are “shut out” of the labor market, when in fact they are freely enjoying leisure instead, but they pretend that government jobs and subsidized jobs are “employment”. These satisfy no demonstrated needs of consumers on the market, so how can we call them “jobs”? Murphy’s graffiti-removing example is thus even more horrifyingly Keynesian. Yes, you create 50 “jobs”. But people would actually pay Gates for the products he and his workers make with that $1 million. The same can’t be said for stimulus make-work projects. Let’s not pretend that “unemployment” as understood by the mainstream is anything other than a great way for economists like Krugman to promote socialism while pretending to be capitalists.

I also agree with you, by the way, that “Krugman is entirely wrong.”

Ned Netterville August 28, 2009 at 3:00 pm

In any discussion comparing government spending to that of individuals and private organizations, a point I think libertarians ought to mention if not stress, is the crucial distinction, to wit: Individuals and NGOs spend their own money, whereas governments and government operatives only spend OPM (sounds like opium, is equally addicting, stands for other people’s money). The libertarian judgment that taxation is theft, and the obviously following conclusion that, not only the tax collectors but as well their accomplices who share in the guilt by consuming the booty, are thieves, need not be explicitly mentioned, because in many forums those on whose foot the implied shoe fits may immediately close their ears. Unfortunately, the shoe and the epithet (thief!) fit most everyone in the USA today. However, since most people, recognize the fact that carelessness, inefficiency and waste are more likely to be involved in spending OPM than one’s own funds, the distinction is worth highlighting.

Of course what I have said above requires some elaboration to substantiate its logical veracity, which I won’t go into at length here. But for one example: private persons and organizations are spending OPM when funds they spend are stolen. However, if this objection is raised it presents libertarians with a wonderful opportunity to discuss and favorably compare the public action, the terrible example set thereby, and the ubiquity of government agents collecting taxes by force and coercion versus the relatively limited effects of theft by privateers.

An objection might be raised that, as Mises, stated, “Praxeology and economics deal with the means for the attainment of ends chosen by the acting individuals…They apply to the means only one yardstick, viz., whether or not they are suitable to attain the ends at which the acting individuals aim. The notions of abnormality and perversity therefore have no place in economics.” (Human Action, p. 95) But Mises goes on to say, “One must not tell the masses: Indulge in your urge for murder; it is genuinely human and best suits your well-being. One must tell them: If you satisfy your thirst for blood, you must forego many other desires…The dangerous life and the frenzy of sadism may please you, but they are incompatible with the security and plenty which you do not want to miss either. Praxeology as a science cannot encroach upon the individual’s right to choose and to act. The final decisions rest with acting men, not with the theorists. Science’s contribution to life and action does not consist in establishing vaIue judgments, but in clarification of the conditions under which man must act and in elucidation of the effects of various modes of action. It puts at the disposal of acting man all the information he needs in order to make his choices in full awareness of their consequences. It prepares an estimate of cost and yield, as it were. It would fail in this task if it were to omit from this statement one of the items which could be of influence in people’s choices and decisions.” (HA, p. 173)

The cost of a robbery to the victim is easily understood, but not so the panoply of consequences the perpetrator must suffer. It seems to me that elucidating some of these is well within the ambit of praxeology. The victim’s loss is replaceable whereas the thief’s loss is unremitting. A thief is a thief is a thief forever after. Should not praxeology elucidate the fact that the beneficiaries of the “Cash for Clunkers” program are on the dole and indistinguishable from other welfare queens (or kings)? Perhaps we at LvMI should rechristen the program “Cars for Queens.”

Ned Netterville August 28, 2009 at 3:37 pm

Walt D. wrote, “The Federal Government has no money, per se, outside of the gold in Fort Knox. Therefore, the Federal Government can only give someone money by taking it away from someone else who has saved, borrowing the money from someone else who has saved (domestic or foreign), or inflation – writing a check out of thin air – they do not actually need to print money. Indeed, it is not in their interest to actually print money – the Fed would have to conduct an auction to back the paper currency. If no paper currency is involved, all the Fed has to do is to create a balance sheet entry. Since the Fed can make loans based on virtually any type of collateral, based on its own evaluation of what the collateral is worth, there is effectively no control over what the Fed does with the money supply.”

Actually, and unfortunately, the Federal Government does own assets, which can be converted to money. I’m not sure how much the government would realize if it sold off all of the real estate it owns, but the sum might be sufficient to liquidate all federal liabilities–even in this era of depressed RE markets and bloated deficits. (Perhaps someone here can compute the value of all of the fed’s real and other property holdings–or may know where to look for some estimate thereof on the worldwide web.) I’m a bit of a dreamer, but I can envision the government spending itself into such financial insolvency that its only recourse would be to sell everything. One of the new federal governments dramatic early grasps of power it ought not have was Jefferson’s very un-libertarian Louisiana Purchase. Dissipating the power derived from owning resources is long overdue.

Walt D, August 28, 2009 at 4:50 pm

Ned wrote:
“Actually, and unfortunately, the Federal Government does own assets”.
Don’t forget General Motors! It also has considerable debt and equity securities in the financial companies it bailed out. There are also all the mineral reserves on Federal land.
The obvious solution would be to shrink the size of government. However, we are currently headed 180 degrees in the wrong direction.

Phil August 28, 2009 at 6:03 pm

@Rafael – I agree with your analysis. I am re-reading the article a bit more closely, and from what I understand the transfer of ‘capital’ from Gates to the government which then uses that capital to fund ‘employment’ is what is argued. A transfer of capital in terms of cash balances = $1 million dollars will then be translated to 50 jobs.

I think the misunderstanding lies in the nature of capital structure. Certainly not all the $1 million of Gates’ capital will be invested in labor. He may invest a portion in a new addition at One Microsoft Way, or he may try to refresh the hardware at his Quality Assurance department, etc…

Indeed, all these capital investments are made in an entrepreneurial fashion so as to maximize profitability as everyone here know. Government has no such profit motive so its a waste whatever is done with the confiscated capital.

Whether the million dollars is used for labor or R&D or whatever capital investment made by private owners, an analogy cannot be made within government. Thus comparing the two expenditures of capital – one that Gates may do and the other government may do is specious reasoning. How do you compare apples and oranges?

Rafael Garcia August 28, 2009 at 7:28 pm

Apples and oranges, indeed. Well put, Phil. And the oranges are rotten, so all the more reason not to trade in the apples for them..

Dr. Rock August 28, 2009 at 7:29 pm

Fama and Cochrane state the issue clearly and correctly in the passages Bob himself quotes. Why there has been so much ink spilled here over a pretty basic piece of logic is baffling. The fact that Bob has yet to respond suggests he knows he stuck his foot in his mouth (deeply).

Bob Murphy August 29, 2009 at 2:43 am

I feel somewhat silly replying to people who refer to themselves as Buzungulus Rising etc., but since no one has picked up this point let me clarify: I am fully aware of what Fama and Cochrane were claiming, in the quoted paragraphs. And they were wrong. I focused on money creation since, for Austrians, it should be clear that the government can temporarily “cure” a recession by printing money–that’s our theory of the business cycle after all. (I.e. that Greenspan should’ve let the dot-com crash play out, rather than stimulating an artificial boom.)

And although Cochrane (or Fama I don’t remember) talked about fiscal policy, I have heard plenty of free marketeers say things like, “The gov’t can only raise funds through taxing, borrowing, or inflation. But regardless, it doesn’t create wealth, it just rearranges it. That’s why any job the government creates through spending, is necessarily destroyed somewhere else.” So if the Austrian story about what Greenspan did is correct, then the quotation is wrong.

As far as pure fiscal policy, Buzungulus and my other critics here are forgetting that people might have otherwise added to their cash balances. That’s why in the post I said something like “government spending doesn’t necessarily reduce private spending dollar-for-dollar, at least not in the way most people use the term.”

So let’s say the government takes $1 million from Bill Gates through a tax, and spends it on bombs for Afghanistan. You say, “Oh well Bill Gates would have either consumed or invested that $1 million, so total spending is the same.” No, because Bill Gates might have ‘invested’ $200,000 in additional cash balances.

See? It’s not true that if the government spends more, then the private sector spends less, unless you count putting $10 into a piggy bank as spending $10.

And last point, if the government minded its own business, then there would be some idle resources. We already know it is theoretically possible for the government to get those resources back into employment–it can print money. So it’s certainly theoretically possible that by running a deficit, the same thing happens. I’m not predicting that it will, or saying it’s empirically likely; it’s probably not. But the point is, Krugman is right when he says Fama and Cochrane (and Buzungulus and Dr. Rock etc.) are wrong for thinking this is an accounting tautology. It isn’t.

Finally, let me stress that of course there is nothing bad about consumers stockpiling cash, or with resources remaining idle. That was my take-home message, that we shouldn’t try to prove the Keynesians wrong when they say the government can boost total “spending” or that the government can reduce “idle” resources. Yes, in theory it can, but that just thwarts the market’s recovery from a previous boom.

anon August 29, 2009 at 3:10 am

It is not that Bob’s analysis is wrong, it’s just incomplete.

Prashanth Perumal August 29, 2009 at 4:07 am

Cochrane says: “Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.”

May be this is where Cochrane is wrong(provided we aren’t going to give him the benefit of the doubt since probably we are reading too much into a single vague line).

Prashanth Perumal August 29, 2009 at 4:42 am

Hey wait, let me read Cochrane again.

Cochrane says: “Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.”

Doesn’t this actually make sense? If the US government is going to spend money by taxing private companies and create 500 jobs, it obviously would have employed those 500 people by bidding them away from some other private use, no?

Assume away the unemployed crowd. They too are potential employees of private companies.

Buzungulus Rising August 29, 2009 at 7:11 am

Bobs response is hair-spliiting. It’s a simple matter of logic that resources expended by the govt must displace the use of those resources in the private economy, so there’s no teal gain. That is exactly Cochrane and Famas point (and other free marketers). The idea that this entails a 1-to-1 transfer of jobs is a strawman of Bobs own making.

Buzungulus Rising August 29, 2009 at 9:07 am

Spot the difference:

A:
“Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. ”

B:
“”"If the government creates a job in industry X with a subsidy, then there must be an offsetting job destroyed in industry Y because of higher taxes or interest rates.”"

Rafael Garcia August 29, 2009 at 10:22 am

MURPHY: “I feel somewhat silly replying to people who refer to themselves as Buzungulus Rising etc.”

ME: You deserve the benefit of the doubt that this was intended in a completely different way than it sounds.

MURPHY: “I am fully aware of what Fama and Cochrane were claiming, in the quoted paragraphs. And they were wrong. I focused on money creation since, for Austrians, it should be clear that the government can temporarily “cure” a recession by printing money–that’s our theory of the business cycle after all.”

ME: Yes, you “focused on money creation”, which Fama and Cochrane never mentioned. So, Fama and Cochrane are not wrong, which it would behoove you to admit at some point.

MURPHY: “And although Cochrane (or Fama I don’t remember) talked about fiscal policy, I have heard plenty of free marketeers say things like, “The gov’t can only raise funds through taxing, borrowing, or inflation. But regardless, it doesn’t create wealth, it just rearranges it. That’s why any job the government creates through spending, is necessarily destroyed somewhere else.” So if the Austrian story about what Greenspan did is correct, then the quotation is wrong.”

ME: Fine, you are trying to refute a claim that, you now realize, Fama and Cochrane did not make. So “the quotation” (of your devising) being wrong does not make Fama and Cochrane wrong. Moreover, which part of the quotation do you say is wrong? I know you are not suggesting that inflation can “create wealth”, so that part of the quotation is right. You are saying that jobs don’t disappear one-for-one? I’m afraid they do, actually, and Prashanth sees why. Each job paid for by stimulus is filled by a man who otherwise would be forced to find a lower-paying job on the market that produces more for consumers. So each job gained is matched by AT LEAST one job lost, and wealth is indeed destroyed.

MURPHY: “See? It’s not true that if the government spends more, then the private sector spends less, unless you count putting $10 into a piggy bank as spending $10.”

ME: This explanation clarifies your post a bit, and is appreciated. So, either the $10 in the piggy bank will be spent in the future, or it will not. If so, the tax merely shifts the spending earlier in time (and thus increases short-term “total spending”). If not, the $10 is not a part of the money supply for any economic purposes, and cannot bid away resources, so economic activity is unaffected by this “hoarding”. So, you have pointed out that in the short term, government can boost “total spending”. But it can do this only by moving the spending up from the future, and this is only a nominal increase. Real economic activity is not increased, all that can be said is that consumption is shifted forward, or equivalently, investment is converted to consumption. Presumably Fama and Cochrane understand that the spending lost in the private sector may have been future spending, so I don’t see that you have proved them wrong unless you are assuming the most ignorant interpretation of their quotes.

MURPHY: “We already know it is theoretically possible for the government to get those resources back into employment–it can print money. So it’s certainly theoretically possible that by running a deficit, the same thing happens.”

ME: This is a perplexing statement. Fama and Cochrane are pointing out that any resources that are “idle” are so only because their “use” is more costly to society than their disuse. Therefore, any idle resources brought into use by inflation or fiscal stimulus are necessarily costing society more than they are providing. The point is, fiscal and especially monetary stimulus distort the p&l that accountants see in nominal terms. But accounting in its pure sense refers to true economic activity, and it is indeed a tautology that anything that does not produce wealth (such as fiscal or monetary stimulus) but which bids previously idle resources into action must necessarily destroy more than equivalent value elsewhere. Otherwise, these resources would not have been idle. You are assuming that Fama and Cochrane are referring to the nominal accounting rather than the true accounting of the economy. This assumption is, I think, unwarranted.

Rafael Garcia August 29, 2009 at 10:39 am

As I continue to think about it, perhaps the source of our confusion about your post is the phrase “total spending”. You, better than anyone else here presumably, know that total spending has nothing to do with wealth. So when you saw what you thought was Fama and Cochrane equating the two, you wanted to speak up and remind us that even though total spending is increased by inflation (and possibly, in the short term, by fiscal stimulus), this does not signal increase in wealth.

Moreover, maybe it is not so silly after all to think that Fama and Cochrane are not seeing through to the difference between nominal spending and true economic activity. I personally think that their “accounting tautology” is a beautiful way to emphasize that the apparent gains of stimulus must necessarily be offset by more losses elsewhere. Given the elegance of this way of arguing against bidding idle resources into action, I personally like to think they get it.

The rest of our differences are based on my and others’ inability earlier to see that you were referring merely to nominal spending and not to real production being increased by government. Also, you appear to have taken some liberty with Fama’s and Cochrane’s quotes in order to prove your point.

And finally, your supposedly incorrect quotation, that government “cannot increase wealth” but can only “move resources around” is actually completely correct. So I think that was too hastily put together. The point is that even if government can increase nominal spending (or “national income” or whatever), still it cannot increase real wealth or do anything to real resources except move them around (detrimentally).

Lord Buzungulus, Bringer of the Purple Light August 29, 2009 at 2:51 pm

Another excellent post by Rafael.

Rafael Garcia August 29, 2009 at 4:29 pm

And likewise to you, sir. I heartily approve of the ever-amusing name changes.

Joe August 29, 2009 at 8:30 pm

Thanks for the clarification Dr. Murphy.

Walt D. August 29, 2009 at 10:18 pm

Another ()Austrian) perpective
http://finance.yahoo.com/tech-ticker/article/313552/“Krugman-Is-100-Wrong”-About-Deficits-and-Govt.-Spending-RCM’s-Tamny-Says;_ylt=AljI2De6Z5ctBbxRYamWHmJO7sMF;_ylu=X3oDMTE1YmZzMWRiBHBvcwM3BHNlYwN0ZWNoVGlja2VyBHNsawNrcnVnbWFuaXMxMDA-?tickers=^DJI,^GSPC,SPY,DIA,TLT,TBT,GLD,

Mike D. August 29, 2009 at 10:28 pm

Bob Murphy is wrong on this one. Google “marginal productivity of debt”. Currently it is now NEGATIVE.
While theoretically, it could be positive, it certainly not positive now in the US economy. Krugman is wrong! Bob should, and does know better than this. Search Mises for his excellent talk at “the myth of green jobs” where he blows the concept of creating jobs out of the water. The moral of the story – when you are having a dream that Paul Krugman is right, slap yourself on the face and enjoy the absurdity of your dream when you wake up!

Rafael Garcia August 30, 2009 at 1:32 am

Thanks Walt and Mike. The Yahoo link is broken, but I found it anyway. And yes, Murphy’s articles are beautiful refutations of fiscal stimulus. This post was really an esoteric commentary on whether all markets clear immediately. He is (of course) correct that they do not. He is also correct that this doesn’t matter for policy concerns. And he is possibly correct, but probably not, that these two Chicago School economists believe wrongly that they do.

Prashanth Perumal August 30, 2009 at 2:56 am

Rafael says: “These satisfy no demonstrated needs of consumers on the market, so how can we call them “jobs”? Murphy’s graffiti-removing example is thus even more horrifyingly Keynesian. Yes, you create 50 “jobs”. But people would actually pay Gates for the products he and his workers make with that $1 million. The same can’t be said for stimulus make-work projects. Let’s not pretend that “unemployment” as understood by the mainstream is anything other than a great way for economists like Krugman to promote socialism while pretending to be capitalists.”

Me: BINGO!!

John David August 31, 2009 at 10:54 am

Another three-run RBI triple for the Austrian School. :-]

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