20 Mar 2009

DeLong Blows Up Cochrane

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I’m sorry kids, but I have to call it like I see it. And in this blog post Brad DeLong blows up Chicago’s John Cochrane. If you’re a guest on a talk radio show, I think it’s fine to say (as Cochrane does) that the government can’t create jobs because every dollar it spends ultimately comes from the private sector.

However, if you are writing actual economics, you have to be much more nuanced. It is possible for the government to “create jobs,” but so what? The way to answer DeLong and Krugman is to say that periods of unemployment are necessary as the market redirects misallocated workers. You can’t just point to accounting, as Cochrane and some others do. For one thing, it’s not really correct, and for another, DeLong and his smug fans will tear you apart.

In that light, let me take two pot shots at Cochrane myself. (And incidentally, I’m not saying Cochrane is dumb, or that his general views of macroeconomics are wrong. I’m just saying, he was sloppy at times on the crucial points.)

* When pointing out how much modern economists know more than Keynes, Cochrane says:

We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.

But wait a second. A little while later Cochrane also writes:

Robert Barro’s Ricardian equivalence theorem was one nail in the coffin. This theorem says that [fiscal] stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today’s consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of.

Hmmmm. Let’s say Britain is fighting World War II and has raised taxes enough to cover the spending. But with those crippling tax rates, the most productive people don’t work as much, and a bunch of low-skilled people get laid off.

So the British government uses a time machine to call an important economist from the future. They get lucky and get Cochrane on the horn. They ask him if they should borrow the money to pay for the war, so that they can cut taxes and try to stimulate the economy. I believe Cochrane’s answer would be, “Yes we now know you should do that, but we also know it won’t work.”

* In his effort to rip the Keynesians, Cochrane says:

Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus.

Holy cow John, you keep talking like that, and I’m going to buy The Return of Depression Economics. Why don’t you compare them to evangelicals next? Then you’d really raise my sympathy and make me doubt your confident assurances that you’ve got it all figured out.

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