28 Dec 2010

“Have Events Vindicated Keynesian Models?”

Economics, Krugman, Shameless Self-Promotion 12 Comments

This is a follow-up article to the one last week that concerned Jim Manzi’s debate with Karl Smith. In this new article, I walk through Paul Krugman’s citation of Mark Zandi’s forecasts. Krugman thought Zandi’s projections of the impact of the Obama stimulus–coupled with the ex-post record of actual GDP performance–was a great confirmation of Keynesian models. Yet I argue that Krugman is conveniently looking at rates, and not levels.

This leads me to revise the popular swimming pool analogy:

When the stimulus was a hot topic, conservative and libertarian opponents often invoked a swimming-pool analogy. They would point out that every dollar the government spent, it had to first get from the private sector through taxing or borrowing (we’ll ignore inflation). With this insight, the critics said that trying to boost the economy with stimulus spending was like trying to raise the water level in a swimming pool by taking buckets of water from the deep end and dumping them in the shallow end.

Now it’s true, things are a bit more complicated than this. An extra dollar spent by the government doesn’t necessarily translate into a dollar less spent by the private sector, because of issues of expectations and how a private household or firm adjusts its present spending in light of permanently higher future taxes. (That’s why Brad DeLong expressed disagreement — in his usual way — with what he viewed as an improper oversimplification by Steve Horwitz.)

Even so, let’s take the swimming-pool analogy as a good proxy for the free-market view, but with a tweak: because the people carrying the buckets will inevitably let some of the water spill out onto the patio, in practice the plan of redistributing water from the deep to the shallow end will actually lower the level of the pool.

In this context, what would be the analog of Paul Krugman’s defense of Keynesian stimulus policies, when he relied on the two charts above? It would look something like this: Krugman would look at the level of the pool right before someone dumped in a bucket. He would exclaim, “Aha! When someone empties a bucket into the pool, the level goes up, just as I predicted. And what’s more, when they empty a big bucket, the water level rises more than when they empty a little bucket.”

The critics of course come back with this retort: “Hold on a second, Dr. Krugman. After implementing your bucket plan all afternoon, the water level is lower than when we started — just like we predicted!”

To this, Krugman could only reply, “Nonsense! You Neanderthals need to study your fluid dynamics; I can write some differential equations if you want. Obviously what is happening is that there is a leak somewhere in the pool. If it hadn’t been for my bucket plan, the water would be three feet lower right now than it is. If only we had had the willpower to go find bigger buckets this morning, like I suggested …”

12 Responses to ““Have Events Vindicated Keynesian Models?””

  1. David L. Kendall says:

    Brilliant, as always.

  2. Daniel Kuehn says:

    Doesn’t your bucket metaphor imply full employment of the means of production? Your analysis then boils down to “when there is full employment the stimulative effect of government spending will be low”. I’d agree with that, Bob. I’m guessing Krugman would too. This is why I’m not especially excited about the prospect of this debate – you’re inevitably going to be talking past each other.

  3. Daniel Kuehn says:

    And having a hypothetical Krugman call you a Neanderthal isn’t that effective a way of garnering sympathy, particularly when you pick an example like this as if the logic of wasteful government spending and crowding out escaped us and that’s the source of our disagreement.

    • Daniel Kuehn says:

      …sorry – didn’t finish that thought… when you act as if that logic escapes us it comes across as implying that we’re Neanderthals.

    • bobmurphy says:

      DK, the Chicago guys (whom DeLong and Krugman said were from the Dark Ages–comparable to calling them “Neanderthals”) said that at best, stimulus spending would do nothing. Some of these types of critics (I can’t remember if Cochrane and Fama themselves) went further and said actually, stimulus spending would be harmful, would cause unemployment to actually go up.

      DeLong and Krugman said this logic was right at full employment, but that it was wrong with big unemployment.

      After the stimulus was implemented, unemployment went up much higher than most Keynesians said.

      So looking at just the raw facts, if anything, the Chicago guys are vindicated.

      You are now saying, “In an alternate universe, where we started at full employment and did a stimulus, the Keynesians would agree with the Chicago guy. so what’s your point?”

      You really don’t see the point? We are disputing the Keynesian models. You seem unable to grasp that. What would the world look like if the standard Keyensian approach–in which stimulus does NOT help things, even when we are NOT at full employment–is wrong?

      • Daniel Kuehn says:

        What I am saying is that your bucket metaphor strikes me as completely useless as a way of analyzing Krugman’s argument unless you think we are at full employment – and if you think that then we have bigger fish to fry than your chosen metaphor.

        re: You really don’t see the point? We are disputing the Keynesian models. You seem unable to grasp that.

        You claim you are, but you don’t seem to be – or perhaps you’re trying to be and the disputation simply isn’t that convincing. If I were to dispute Keynesian models, I would find something wrong with it, not assume away everything that makes a model Keynesian and then after assuming it away point out that it no longer works the way Keynesians say it does.

        As for the raw facts of the unemployment rate, unless you have a viable counter-factual I don’t see how you can make the claim you do about it vindicating the Chicago School. And that’s the problem – nobody has a counterfactual because we can’t observe it.

      • Daniel Kuehn says:

        In other words – of course any model is conditional on its assumptions. Simply failing to hold the same assumptions does not amount to a “disputation”.

        If you want to dispute the model you’d highlight what’s wrong with making those assumptions.

        Unfortunately, most of the public doesn’t think about Keynesianism in terms of how the economy operates differently at full employment or below full employment. The public is more than happy to adopt your bucket metaphor and think in terms of full employment. I say “unfortunately” because that gives birth to a view of Keynesianism as “crude Keynesianism”. where to quote the recent youtube sensation “C, I, G altogether adds to Y – keep that total growing watch the economy fly”. Unfortunately, that’s not Keynesianism and these full employment assumptions play to the public’s willingness to simply assume that the economy is zero-sum.

      • Daniel Kuehn says:

        I should also say (sorry for “also saying” so much) that strictly speaking even at full employment this isn’t a complete argument against government spending. If there are legitimate public goods or positive externalities to spend on – something we think the market implicitly underinvests in – it’s perfectly legitimate to think about private investment crowding out public investment.

        But that’s really a separate discussion – it doesn’t have to do with macroeconomic policy, and as a general rule “wasteful government spending” is a pretty safe rule to live by.

  4. Blackadder says:

    To be clear, Bob, you are saying that Zandi’s estimates of what would have happened absent a stimulus (unemployment doesn’t break 9%, etc.), are all correct, it was only his prediction as to the effect of the stimulus that was wrong, right?

    • bobmurphy says:

      I’m not necessarily saying that, Blackadder, but I’m saying if we’re going to judge the accuracy of Zandi’s models, then surely it’s relevant that unemployment is higher after we implemented (some of) his “solution” than he predicted would be the case if we did nothing.

      • Daniel Kuehn says:

        I’m confused by this line of reasoning, though. Presumably the inaccuracy of Zandi’s models forecasting the unemployment rate has to do with his inability to model financial markets with precision. It has nothing to do (that I’m aware of) with any elements of his model that have anything to do with the impact of fiscal policy.

        Why would you assume relevance to that point? I would think the only relevant point is “it’s very hard to chart the trajectory of financial crises”.

        Is there something about the way that Zandi predicts the impact of fiscal policy that is related to the way that he predicted (and messed up on) unemployment that I’m not aware of?

      • Blackadder says:


        You are using one set of predictions Zandi made (what would happen absent a stimulus) to test the accuracy of another set of predictions (what would happen with a stimulus). That only works if you assume the first set of predictions are accurate.

        For example, suppose Zandi had started with some gloomier assumptions that told him without the stimulus unemployment would peak at 12%. If so, his model would have told him that unemployment would peak at around 10% with the stimulus, which is what happened. So to say that the model was wrong, you have to say that the baseline assumptions about what would happen with no stimulus were roughly accurate.