I Can Take Back the Crazy Pills–I Wasn’t Straw-Manning the Keynesians
[UPDATE below.]
In response to one of my posts on austerity, the magnanimous “Lord Keynes” quoted me and then responded like so:
(3) Murphy shows himself incompetent in even understanding basic elements of Keynesian economics. He asserts:
“First let’s consider the deficit as a % of GDP, which is how Keynesians typically evaluate stimulus in the 1930s.”
Um, no, they don’t, Murphy – at least not serious Keynesian economists. How Keynesians “evaluate stimulus in the 1930s” will be find in E. Cary Brown, 1956. “Fiscal Policy in the ’Thirties: A Reappraisal” (American Economic Review 46.5: 857–879): it does not evaluate stimulus in terms of some crude citation of deficits. There is a reason why. It is not the size of a budget deficit per se that will show you if a budget is expansionary or contractionary in terms of fiscal effects. It is perfectly possible to have a budget deficit and have contractionary fiscal policy (as in Ireland and Greece today).
At this I was taken aback–perhaps I invented this notion that Keynesian economists evaluated fiscal policy in the 1930s on the basis of budget deficits?
But no, that wasn’t it. It took me a few minutes to hunt it down, but I distinctly remember reading Christina Romer on the matter. After all, it was her incredibly misleading claims about Hoover vs. FDR that led me to pen this article.
Anyway, Christina Romer–a “serious Keynesian” I would like to think–said the following, not in her personal journal after throwing back a few beers, but in prepared remarks to the Brookings Institution, in March 2009 when she was the new head of the Council of Economic Advisors and was touting the Obama stimulus package. Here’s what she said:
One crucial lesson from the 1930s is that a small fiscal expansion has only small effects. I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression. From this, some have concluded that I do not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be farther than the truth. My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression, fiscal policy failed to generate recovery “not because it does not work, but because it was not tried.”
The key fact is that while Roosevelt’s fiscal actions were a bold break from the past, they were nevertheless small relative to the size of the problem. When Roosevelt took office in 1933, real GDP was more than 30% below its normal trend level. (For comparison, the U.S. economy is currently estimated to be between 5 and 10% below trend.) The emergency spending that Roosevelt did was precedent-breaking—balanced budgets had certainly been the norm up to that point. But, it was quite small. The deficit rose by about one and a half percent of GDP in 1934. One reason the rise wasn’t larger was that a large tax increase had been passed at the end of the Hoover administration. Another key fact is that fiscal expansion was not sustained. The deficit declined in fiscal 1935 by roughly the same amount that it had risen in 1934. Roosevelt also experienced the same inherently procyclical behavior of state and local fiscal actions that President Obama is facing. Because of balanced budget requirements, state and local governments are forced to cut spending and raise tax rates when economic activity declines and state tax revenues fall. At the same time that Roosevelt was running unprecedented federal deficits, state and local governments were switching to running surpluses to get their fiscal houses in order. The result was that the total fiscal expansion in the 1930s was very small indeed. As a result, it could only have a modest direct impact on the state of the economy. [Underlined emphasized in original, bold added by RPM.]
Now let me anticipate the obvious: Lord Keynes is going to look at the above quote and say, “Duh, that’s exactly what I said Murphy, you need to look at the output gap before determining how big a stimulus is needed. Man you Austrians are dumb.”
I hope sympathetic readers will see why, by the same token, I look at the above Romer quote and conclude: Duh, that’s exactly what I said. Christina Romer showed us that when assessing whether a government is providing stimulus, we look at the deficit. A rising deficit means rising stimulus, and a falling deficit means falling stimulus. So if we’re trying to tell whether other governments applied more Keynesian stimulus in the recent crisis compared to the US, one obvious metric is to compare the respective government budget deficits. This, after all, is how Romer compared Hoover to FDR, and FDR-1933-1936 vs. FDR-in-1937. (The fact that her Hoover/FDR comparison is bogus, is beside the point.)
UPDATE: Oops, to see Romer’s take on what happened in 1937, you need to read her Economist piece from June 2009, where she wrote:
The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.
However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.
So again, when Romer wants to give us an idea of how contractionary these measures were, she shows us how much they reduced the deficit as a share of GDP. This is what led me to say that Keynesians typically evaluate fiscal policy in the 1930s by looking at the deficit as a share of GDP. Romer didn’t say, “Sure, the deficit as a share of GDP went up, but the output gap rose even more, so therefore it was fiscal contraction.” No, she said such and such reduced the deficit by 2.5% of GDP, exerting significant contractionary pressure. I.e. we know there was significant contractionary pressure, because the deficit fell sharply as a share of GDP.
These last few blog posts have been awesome.
You still didn’t get the sectoral balances did you?
Nevermind, many Keynesians don’t get them either.
This isn’t about “sectoral balances”, plagiarist.
This is about LK’s claim that “serious” Keynesians don’t look at deficits as a percentage of GDP when determining the extent of government stimulus, and Murphy showing that Romer, who is a “serious” Keynesian, looks at deficits as a percentage of GDP when determining the extent of government stimulus.
If you want to use private sector cash balance quantities to determine the extent of government stimulus, then so what, it has nothing to do with the substance of this post.
More chirping…
Is that you Richie or is it the other [the adult male of the domestic MF edited by PRM]-sucker?
MamMoTh, can we let bygones be bygones and cease being antagonistic towards each other? I don’t see anything good coming out of the way things are going like this.
I’ll start: I’m sorry for antagonizing you, and I’ll try to be more open to what you’re saying.
So what do you say? For the sake of advancing the discussion, and no longer hijacking Murphy’s blog with personal vendettas?
Kudos!
Now that my editing skills were improving so much?
OK, fine with me.
Where’s the fun now?
Kudos as well!
I think the fun got lost much earlier already…
The fun is in striking jabs and poking fun at each other’s ideas.
While that may not be as “fun” for you as some random stranger paying a thousand dollars to fly to where you live for the sake of fisticuffs, I think the novelty of that would wear off pretty quick, and you’d probably end up feeling empty. That would be against my interests on this blog, because it’s always good to have different views like MMT. If everyone thought exactly like me, it would be pretty boring for me.
LK is extremely rude and condescending (freely tossing around words like “cultist,” “idiot,” “naive,” “laughable”). If he can’t behave like an adult, I think you should seriously consider banning him from the comments section. He benefits more from the traffic directed to his blog than you do from his “contributions.”
I agree 100% – this is not a Bob on crazy pills case (although I think youtube has a few of those).
And I was going to mention Romer too when I started reading the post. I link to an article by J.R. Vernon that criticizes precisely this data choice by Romer (her fantastic article on what ended the Great Depression), so this isn’t even a 1930s thing.
I’m still with J.R. Vernon (and I guess LK too) that it’s not the best thing to look at because:
1. MPCs for private and public are different meaning a 0% budget deficit with increase in spending is going to have a multiplier effect, just a smaller one than an increase in spending financed by a deficit, and
2. Tax revenue is a function of income. Recessions mean less income. You can have spiking deficits in a recession with absolutely no change in demand.
Deficits aren’t meaningless obviously – we should look at them. They tell you about the government’s demand for loanable funds. That’s the very straightforward reason why Bob is right that people have been looking at it for decades. I’d just look at more than that (or at least move forward having a good sense of what is driving your deficit numbers).
Isn’t even *just* a 1930s thing.
I link to an article by J.R. Vernon that criticizes precisely this data choice by Romer (her fantastic article on what ended the Great Depression)
Fantastic article on what ended the Great Depression? You mean Romer spoke about government spending falling by 2/3, and taxation falling by roughly half, in 1946?
MPCs for private and public are different meaning a 0% budget deficit with increase in spending is going to have a multiplier effect, just a smaller one than an increase in spending financed by a deficit
Would it shock you to learn that the MPC doctrine is utterly fallacious? That it does employees no good, that it does production no good, if expenditures on output rises? The only income that can possibly be earned by way of the multiplier process is profit income. For that is the income earned on increased spending on output. Now you can’t say that what the MPC really means is that businesses will take those additional sales revenues and invest them in capital and labor, because the MPC is specific that the economy is allegedly only helped to the extent that money is NOT saved, but consumed. Indeed, consumption spending, if it is increased far enough, is capable of reducing economic productivity, by redirecting too many resources into consumption, and not enough into those stages that consumer stages depend on which of course requires saving to sustain.
Tax revenue is a function of income. Recessions mean less income. You can have spiking deficits in a recession with absolutely no change in demand.
Only if government spending remains the same. The collapse in taxation cannot be considered a “cause” for the deficit, because a deficit is a function of TWO causal numbers, not just one. Spending and revenues. It seems that too often spending is treated as a “given”, when it is really not. BTW, ALL government spending is “discretionary”, if by discretionary we mean it’s brought about by the choices of policy makers.
Deficits aren’t meaningless obviously – we should look at them. They tell you about the government’s demand for loanable funds.
And they tell you about inflation of money, since deficits cannot persist via borrowing alone. Without inflation, a persistent deficit will result in interest rates on government debt to keep going up, until the interest expense overwhelms their ability to tax. Debt simply has to be monetized in order for the government to run persistent deficits, which they have for decades, with the exception of the early 1950s.
MPC is utterly fallacious?
What is “fallacious” about the idea that out of an additional dollar, some other dollar amount will be consumed?
Sometimes I wonder if you have a room full of chimpanzees writing your posts, MF.
One part of the MPC that is fallacious is the assumption that everyone consumes a dollar in the same proportion.
What is “fallacious” about the idea that out of an additional dollar, some other dollar amount will be consumed?
The other half of the doctrine which asserts the higher the propensity, the allegedly better it is for the economy, and employment, while the lower the propensity, the allegedly worse off it is for the economy, and employment.
Sometimes I wonder if you have a room full of chimpanzees writing your posts, MF.
Says the yahoo who believes ABC is brought about by government spending, yet has the gumption to say he knows more about it than I do.
A bunch of things come to mind. Put most simply, it’s an aggregate, so it doesn’t tell you much about anything.
Beyond that, the distinction between “consumption”, “savings” and “investment” is a three way split, but MPC pretends to only see a two way split “consumption” vs “non-consumption”. It’s already thrown away 1/3 of the useful information.
Worse, the split itself is largely arbitrary and subjective. Let’s suppose we all go out and buy iPhones (we can hang with the cool crowd), so that’s obviously consumption. Then a year later someone comes up with a 50c app that you can download which makes your iPhone really useful somehow and everyone downloads that app and boosts productivity. Suddenly the iPhone spending from last year retrospectively changes from consumption into investment. How about that?
It gets worse when only half of the iPhone owners bother to download that app, so only half of them become productive but the other half just play games. The Keynesians work everything into aggregates so they go out and claim that every iPhone sold is actually a split 50% saving and 50% investment, and that’s obviously crap seeing as how the iPhone could be 100% investment, or 100% consumption depending on the person buying it and how they use it.
Ten years later, war breaks out and we discover that the people who sat playing games on their iPhone make brilliant pilots for drone bombers in the Middle East, and so consumption from ten years earlier retrospectively gets converted to investment. Multi-dimensional world huh?
“Lord Keynes is going to look at the above quote and say, “Duh, that’s exactly what I said Murphy, you need to look at the output gap before determining how big a stimulus is needed. Man you Austrians are dumb.””
Duh, that’s exactly what I said Murphy, you need to look at the output gap before determining how big a stimulus is needed.
The issue here is your inability to understand that when she talks about 1934, 1935 etc, this is the point where tax revenue had stopped collapsing so a quick reference like “deficit rose by about one and a half percent of GDP in 1934” is just an alternative way of referring to Roosevelt’s discretionary spending increases.
“At the same time that Roosevelt was running unprecedented federal deficits, state and local governments were switching to running surpluses “
The issue of surpluses is quite different. Since running a surplus is a contractionary measure, whereas a deficit is not necessarily expansionary.
Isn’t that just semantics? I mean this is only about what you define as starting/reference point. Is it last years government spending or is it actual tax revenue.
I guess you would agree that if a deficit arises because of decreasing tax revenue because of a recession, that if the government went down with spending as revenue decreased that this was anti-stimulus, right? So every dollar spend in excess to tax revenue still stimulates the economy according to your view. So what counts as expansionary entirely depends on what you consider to be the reference point. And is there an official Keynesian definition for this somewhere? Austrians are generally against government deficits no matter if they are there because of increased spending or decreased tax revenue.
If I look it up in Wikipedia, it says:
“- Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions.
– Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.”
http://en.wikipedia.org/wiki/Fiscal_policy
Sorry, that double post was me. But first I didn’t even see it… Strange. Anyway this one (inclusive this one) can be deleted.
No – surpluses could be expansionary if they are run along with large spending increases.
It’s sort of an odd situation, but it’s no more necessary that surpluses are contractionary than it is that deficits are expansionary. The logic of why that’s the case is identical.
A government budget surplus can never be expansionary.
You can have a surplus and expansion at the same time though,
if the private sector increases its debt or spends its saving, or if the external sector increases its spending.
It’s all about the sectoral balances, as some brilliant commenter keeps saying.
MamMoTh, the sectoral balances point is not as brilliant as you might think (or – let me put it this way – you are not applying it brilliantly here).
What might be accurate to say is that there are contractionary things about a surplus (your sectoral balances point) and – if it’s a surplus with spending increases with little prospect of crowding out, there are expansionary things about a surplus.
You and I are probably on the same page when it comes to our reaction if the government ran a surplus today. But it’s not true that it can “never” be expansionary.
Stop reasoning from an accounting identity. That’s going to lead you in the wrong direction.
The government budget outcome can never be considered by itself in any meaningful way without considering what the other sectors are doing.
Right – so don’t say it can “never” be expansionary.
It can never be the cause of an expansion
It can never be the cause of an expansion
Actually there is a possibility where a surplus can be a cause for expansion.
This is the rare situation, which is possible where the government is printing money at a very high pace, and is getting closer and closer to hyperinflation and rejection of the currency altogether, and they consider themselves faced with the choice of either:
A. Not running a surplus and letting the inflation in the private market spiral into hyperinflation and rejection of the currency, which I am sure you will agree is not an expansionary monetary policy; or
B. Run a surplus and not letting inflation in the private market spiral out of control, even though cash balances are somewhat rising in the private sector, which “saves” the currency, and this all I am sure you will agree is still expansionary monetary policy.
Because running a surplus prevented a destruction of the monetary system, because I have set this situation up so that expansionary monetary policy proper takes place only when the government chooses surplus rather than no surplus, I can legitimately say that the surplus “caused” the expansionary policy to take place, rather than no surplus and destruction of the currency making it impossible to take place.
Causality in human action is about choosing ends GIVEN available alternatives. If the alternative is surplus in order to maintain control over expansionary policy, or no surplus and losing control in maintaining expansionary policy, then choosing surplus will bring about, it will cause, expansionary policy to take place.
Admittedly, this situation is rare, but I submit it is POSSIBLE.
Yes a budget surplus might be necessary to keep inflation in check.
I am not sure I would call that expansionary rather than avoiding self destruction.
Let me ask you this. What does the federal government spend – about 3.5 trillion dollars? With what, 1.2 trillion deficit?
As a fellow admirer of Keynes, what would you rather see:
1. A reduction of federal spending and taxes by 2 trillion giving us the same 1.2 trillion deficit, or
2. An increase in spending of 1 trillion and an increase of taxes by 1.5 trillion to give us much more spending but only a 0.7 trillion deficit?
If you opt for the former, I think you need to reassess your relationship with Keynes.
Of course we all like deficits right now. But the spending matters a lot and if you bolster spending with a balanced budget or even a surplus that can still be very good.
I’d rather balance the budget right now if it comes with increased spending, myself. I’d prefer not to settle for that, though. We don’t need a tax increase right now.
First, the budget outcome is largely endogenous due to the automatic stabilizers and the net saving desires of the domestic private sector and the external sector.
If you want to balance the budget now, with the current trade deficit, it means the private sector must run a deficit again, and that’s not going to happen yet.
DK – This is immediately what I thought. Zing.
If what you and Daniel are saying is true here than a quick reference to a growing deficit proves just nothing! Though instead a chart that just shows how government spending went up over the years should be “quickly” referred to.
And even this was not enough because you also would need to show that government spending didn’t go up because of unaltered policies but only because of “cyclically adjusted government spending” however that is defined.
*…true here then a quick..*
Isn’t that just semantics? I mean this is only about what you define as starting/reference point. Is it last years government spending or is it actual tax revenue.
I guess you would agree that if a deficit arises because of decreasing tax revenue because of a recession, that if the government went down with spending as revenue decreased that this was anti-stimulus, right? So every dollar spend in excess to tax revenue still stimulates the economy. So what counts as expansionary entirely depends on what you consider to be the reference point. And is there an official Keynesian definition for this somewhere?
If I look it up in Wikipedia, it says:
“- Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions.
– Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.”
http://en.wikipedia.org/wiki/Fiscal_policy
That is directed at LK.
I just read the other part below which quite makes your point:
“However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclic fluctuations of the economy cause cyclic fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not considered to be policy changes. Therefore, for purposes of the above definitions, “government spending” and “tax revenue” are normally replaced by “cyclically adjusted government spending” and “cyclically adjusted tax revenue”. Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral fiscal policy stance.”
Though first it replaces two defined terms with terms that are not defined. And secondly the last sentence really doesn’t make sense because Keynesians always argue that at some point in the future the budget will be balanced and “excess” debt is reduced to sustainable levels, so there would never be an expansionary fiscal policy at all, making this term void of any meaning.
Can you tell me how is “cyclically adjusted government spending” and “cyclically adjusted tax revenue” defined?
A simple numerical example that will hopefully get our local MMTer to keep his sectoral imbalances to himself (unless, of course, he decides to append plausible behavioral theories to his accounting identities):
Let’s say:
X is fixed at 100
M is fixed at 100
Y = C + I + G + X – M, and of course,
S – I = G – T + X – M which is the same as saying,
C = Y – S – T
Case 1:
S = 500; I = 300; G = 600; T = 400, so
Y = C + 300 + 600 + 100 – 100
Let’s run with Modigliani and Friedman for a second and assume that current income has little to do with consumption, and let’s just say C = 800.
Then Y = 1,700
Case 2:
S = 500; I = 500; G = 700; T = 700.
DAMN IT! Bowles-Simpson got their way! I balanced the budget!
Y = 800 + 500 + 700 + 100 – 100
But now Y = 2,000!!!
So doesn’t that mean sectoral imbalances say we should balance budgets???
Do. Not. Reason. From. An. Accounting. Identity.
You see what I did, I hope. I balanced the budget while increasing spending by 100. Then I assumed a big-ass multiplier that boosted investment too. That’s precisely the sort of theory that you need to add to these skeletal accounting identities before you can say anything definitive about the implications of sectoral balances.
Don’t waste any more time.
I only said, repeatedly, that you can’t say anything meaningful by looking at the government sector.
But people keep trying to say something deep by looking only at the government sector.
Here is my question for Daniel Kuehn (and Lord Keynes):
Perhaps looking at the government deficit as a percentage of GDP is not a perfect measure of how much fiscal stimulus a country is doing. But is looking at government purchases really a better measure? Cause it’s government purchases that Krugman has been relying on of late to prove his point.
I think it’s just different. I think looking just at purchases is probably a worse measure than looking at transfer payments and purchases. The people getting transfer payments are not high-income people. They have a very high MPC. The multiplier can’t be all that different. Both are temporary so neither really impact expectations. There’s an argument for purchases: they’re unanticipated, for example. But it’s not that strong of an argument.
But it’s different. Deficits are telling you something different: they’re telling you about government demand for loanable funds. I think it’s really apples and oranges.
The thing with the deficit is that it doesn’t tell you much about demand directly since a big source of the deficit right now is the recession itself and its impact on revenue! Demand matters a great deal to me, so when I see deficit figures and I don’t feel informed about demand, I’m gonna want to see or know more.
I hope I never gave the impression that I took a hard line about looking at deficits anyway. I’m fine with looking at deficits. What I thought was more important about that last post is that it only looked at federal spending.
Maybe I’m reading too much into LK and MamMoTh’s comments, but this whole thread really makes me wonder about the sort of dialogue we’ll have in the next several decades.
A lot of people have learned over the last four years that deficits and government spending can be a very good thing for the economy. I think it’s very good that they’ve learned that. In my own small way, I’ve helped dozens of undergrads learn that at AU, and hopefully I’ve helped more people learn that on my blog.
But I wonder, now… are these people going to recognize the need to reign in deficits in the medium to long-term? There seems to be an implicit suspicion of deficit reduction. Hopefully that’s just because we’re still in this depression, and it will pass. I’ll try to be optimistic. Keynesians have done well in the past at recognizing the imperative of deficit reduction. But this does make me wonder…
DK wrote:
There seems to be an implicit suspicion of deficit reduction. Hopefully that’s just because we’re still in this depression, and it will pass. I’ll try to be optimistic. Keynesians have done well in the past at recognizing the imperative of deficit reduction. But this does make me wonder…
Don’t worry, DK, as soon as there is a Republican in the White House, deficits will matter again to Krugman and Friends. 🙂
Very true.
Might want to check the late 2008 record on that (pre-November especially). I think he wanted a big ol’ Republican deficit (although he may have been preoccupied with the banks at the time.
Don Boudreaux on Keynesianism, and why it is fatally flawed:
http://cafehayek.com/2012/04/a-wing-and-a-prayer.html
An economy is the sum total of a huge number of individual decisions and transactions – maybe trillions per year. Yeah, if you print money and spread it around, sure its good for some people. It’s also bad for other people. But how can you really know? Here is Frank Shostak on the myth of GDP (an “empty concept”) and the economy (“The so-called economy is a metaphor—it doesn’t exist”):
http://mises.org/daily/770