In my never-ending quest to achieve total magnanimity, I gently ask the following questions to make sure I understand how rival camps view the world.
(1) To the Keynesians: I understand the point that “Ricardian Equivalence,” even if true, would not undermine the boost to current Aggregate Demand from a large government budget deficit. For example, if the government increases the deficit by $1 trillion this year, yes that will make taxpayers increase their saving to pay the higher taxes necessary to finance the bigger debt. However, the taxpayers will spread this pain out over time. If the interest rates on government debt and what taxpayers earned on their own savings were identical, a good first approximation would say that the taxpayers would just save the interest expense of the new debt.
So if the government runs a $1 trillion stimulus this year (spending money on bridges and schools with borrowed funds), and the average interest rate on this new debt is 2%, then the taxpayers in a rational expectations model with no frictions etc. would save an additional $20 billion this year. So on net the stimulus plan would still add $980 billion to Aggregate Demand.
But hang on, that’s not the end of the story. We have now reduced Aggregate Demand by $20 billion forever. So don’t we at least need to take that into account? Or is the idea that there is some critical threshold, and as long as AD is above that, the market can fend for itself?
(2) To the Market Monetarists: You have said that the Fed is being unreasonable with its (price) inflation forecasts, and that the markets have known all along that NGDP would grow anemically. OK, well we’ve been like this for 8 years now. Haven’t most wage contracts been written in the present environment, and so shouldn’t most people now be operating on the basis of contracts that expected these levels of NGDP?