Tag Archives: Krugman

An Interview With Robert Barro

Some of you may recall that Paul Krugman referred to Robert Barro’s analysis of the multiplier associated with World War II spending as “boneheaded.” Admittedly, I did agree with Krugman to the extent that the period in question is not ideal for such measurement given the variety of other simultaneous changes (e.g. price controls, rationing, etc.). Nonetheless, I did acknowledge that “Robert Barro essentially wrote the book on government from a macro perspective.” Further, Barro’s analysis was not “boneheaded”, but merely less than ideal.

Now over at The Atlantic, there is an excellent interview with Robert Barro where he discusses the stimulus package, his analysis, and Krugman. First, in response to Krugman:

He said elsewhere that it was good and that it was what got us out of the depression. He just says whatever is convenient for his political argument. He doesn’t behave like an economist. And the guy has never done any work in Keynesian macroeconomics, which I actually did. He has never even done any work on that. His work is in trade stuff. He did excellent work, but it has nothing to do with what he’s writing about.

On stimulus:

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much.

Read the whole thing.

Krugman on the Bad Bank

Krugman revives an old joke:

As the Obama administration apparently prepares to launch Hankie Pankie II — buying troubled assets from banks at prices higher than they will fetch on the open market — it occurred to me that an updated version of an old Communist-era joke may be appropriate: under Bush, financial policy consisted of Wall Street types cutting sweet deals, at taxpayer expense, for Wall Street types. Under Obama, it’s precisely the reverse.

Thoughts on Stimulus, UPDATED

The debate over stimulus is growing quite divergent. First, there is understandable disagreement about the nature of stimulus policies in and of themselves. Second, the is a growing debate as to whether or not the Obama stimulus plan itself will be successful. (I have previously offered my thoughts on stimulus here.)

The first debate is laid out explicitly by Robert Barro, who in today’s WSJ discusses the multiplier associated with government spending:

Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called “multiplier” effect of government spending on economic output is greater than one — Team Obama is reportedly using a number around 1.5.

To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy’s total output expands by enough to create the airplane or bridge without requiring a cut in anyone’s consumption or investment.

The explanation for this magic is that idle resources — unemployed labor and capital — are put to work to produce the added goods and services.

If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.

Barro then uses World War II spending to estimate the multiplier effect of government spending. What he finds is that the multiplier for this period is about 0.8. What this means is that for every $1 that the government spent, GDP increased by $0.80. For times of peace, he finds that the multiplier is statistically insignificantly different from zero (we cannot reject the hypothesis of a complete crowding out of private expenditure, for non-econ nerds). Indeed, this is consistent with Hayek’s critique of Keynesian policies. Hayek pointed out that while Keynes criticized classical economists for assuming full employment, Keynes was implicitly assuming unemployment of resources.

Barro’s peacetime finds warrant further investigation as he does not state whether this measurement is for all periods or times of less than full employment as well as whether he is referring to temporary or permanent government purchases. However, it is clear that his findings regarding World War II fail to satisfy the ceteris paribus assumption needed for such analysis. As Paul Krugman explains:

Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort. Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone? I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.

Nonetheless, the debate about the multiplier is perhaps the important question regarding the stimulus package and despite the possible flaw in using World War II data, I think that Barro’s conclusion regarding the multiplier being below 1 is likely correct. After all, I don’t think that we can make the claim that there is no crowd out effect or that the multiplier overwhelms any crowding out.

On this point, Casey Mulligan has offered some interesting thoughts. His main conclusion is as follows:

Government spending will reduce private spending virtually anywhere it may be targeted. The case for government spending should thus be made on its intrinsic, not stimulation, value.

I think that this is perhaps the best way of thinking about stimulus. I agree with Barro and Mulligan in that the multiplier is likely between 0 and 1. I do not buy the argument that it is zero in the current environment. Thus, if it is close to one, there is an argument that can be made for spending based on its intrinsic value. For example, the modernization of government facilities and the rebuilding of infrastructure represent these types of ideas. Ultimately, the multiplier is dependent upon the spending itself. For example, if spending is temporary (as is implied in the examples just given) the multiplier is likely to be larger than if spending is permanent. In the latter case, there is substantial reason to believe that the multiplier is quite small and perhaps near zero.

This brings us to the question as to the likelihood of success of the Obama stimulus package. Mulligan warns of the particular aims of the stimulus:

Despite the recent increase in unemployment rates, I see little reason why the multiplier situation is realistic. For example, President Obama’s economists have explained that about half of the jobs they plan to create (both directly and indirectly) are for women. But the large majority of this recession’s employment reduction has been among men. Thus, the Obama spending plan is not intended to primarily draw on the pool of people unemployed in this recession.

President Obama has a vision to spend more on health care, largely for its intrinsic value. Its stimulation value is minimal because unemployment is low in that sector; health sector employment has actually increased every single month during this recession.

I am not optimistic about stimulus in terms of lifting us out of the recession and, in particular, I am not optimistic about many aspects of the Obama stimulus plan. Further, the assumption of a multiplier of 1.5 is incredibly unlikely. I would much rather see meaningful tax reductions (e.g. lower marginal rates, lower corporate tax rates).

UPDATE: There has been a great deal of discussion in the blogosphere surrounding the nature of the rhetoric, especially with regards to Krugman’s comment that Barro’s analysis was “boneheaded.” In this respect, I think that Tyler Cowen’s comments sufficiently summarize my view:

Either way you cut it, there aren’t any boneheads in the room.

Indeed. After all, Robert Barro essentially wrote the book on government from a macro perspective. The tone of the debate is trending down and I think that we would all do well raise the level of discourse to a respectful tone.

Again, my view (free of name-calling) is that:

1. Stimulus will not get us out of the Depression.

2. The multiplier for government spending is likely between 0 and 1, which means that $1 spent by the government results in less than a $1 increase in real GDP.

3. Given (2), the proponents of the stimulus package must make their proposals based on intrinsic value rather than on promises that are impossible to keep. On this point, Barro is right on, “Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called ‘multiplier’ effect of government spending on economic output is greater than one — Team Obama is reportedly using a number around 1.5.”

Krugman refutes Friedman and Schwartz…

…or so he thinks. Our friend David Beckworth points Krugman to Christina Romer’s excellent work on the Great Depression (which I have mentioned here and here).

My thoughts on Krugman’s take are in the comments on Beckworth’s site.

Keynesian Policies and the Depression

Paul Krugman writes:

Now, you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump. Here’s the Cary Brown estimates, from Brad DeLong…Net stimulus of around 3 percent of GDP — not much, when you’ve got a 42 percent output gap.

Alex Tabarrok responds:

Now there is actually a lot of truth to this but the way in which Krugman, Rauchway, DeLong and others present this point is esoteric and likely to mislead even many economists. What Krugman seems to be saying is that the government didn’t spend enough during the thirties (Rauchway, who also cites Cary Brown, says directly “there was never enough spending to achieve the desired effect.”) Yet federal spending during this time increased tremendously. So what is really going on? The answer is actually quite simple.

During the Great Depression federal expenditures increased tremendously but so did taxes. Thus, the reason spending was not stimulative was not that spending wasn’t tried it’s that taxes were also raised to prohibitive levels.

This may seem a bit strange, but both Krugman and Tabarrok are correct here. Much of the increased spending was offset by tax increases as Tabarrok notes. However, I would also point out that one of the main problems with New Deal policies was that they were decidedly NOT Keynesian in that they did not attempt to stimulate demand, but rather attempted to stimulate prices. Many of the New Deal policies were aimed at restricting supply (namely in the agricultural sector) in order to raise prices. Keynes himself in an open letter to Franklin Roosevelt argued against such policies:

Now there are indications that two technical fallacies may have affected the policy of your administration. The first relates to the part played in recovery by rising prices. Rising prices are to be welcomed because they are usually a symptom of rising output and employment. When more purchasing power is spent, one expects rising output at rising prices. Since there cannot be rising output without rising prices, it is essential to ensure that the recovery shall not be held back by the insufficiency of the supply of money to support the increased monetary turn-over. But there is much less to be said in favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the natural result of an increase in the nation’s purchasing power.

[…]

But too much emphasis on the remedial value of a higher price-level as an object in itself may lead to serious misapprehension as to the part which prices can play in the technique of recovery. The stimulation of output by increasing aggregate purchasing power is the right way to get prices up; and not the other way round. [Emphasis added.]

Cowen, Krugman, and the Austrian Business Cycle

Tyler Cowen highlights (and joins in on) Paul Krugman’s criticism of the Austrian business cycle theory. You can find my thoughts in the comments over at The Austrian Economists blog.

Inflation and Why this “Feels” Like a Recession

Paul Krugman writes:

But as I said, this time around there’s no wage-price spiral in sight.

The inflation hawks point out that consumers are, for the first time in decades, telling pollsters that they expect a sharp rise in prices over the next year. Fair enough.

But where are the unions demanding 11-percent-a-year wage increases? (Where are the unions, period?) Consumers are worried about inflation, but you have to search far and wide to find workers demanding compensation in the form of higher wages, let alone employers willing to accept those demands. In fact, wage growth actually seems to be slowing, thanks to the weakness of the job market.

And since there isn’t a wage-price spiral, we don’t need higher interest rates to get inflation under control. When the surge in commodity prices levels off — and it will; the laws of supply and demand haven’t been repealed — inflation will subside on its own.

Krugman is right in pointing out that wages are not beginning (or in the midst of) an inflationary spiral. Krugman seems to blame the invisible presence of the unions. Their invisibility could be due to their declining power and/or the fact that inflation today is quite different than the 1970s, but not for reasons that Krugman emphasizes. In my view, it is not the case that invisibility of the labor unions is the cause of a different kind of inflation, but rather that a different kind of inflation is causing the invisibility of the unions.

During the 1970s, the inflation rate was rising at a much higher rate than is currently the case. Energy prices were high, but there were also a great deal of other prices on the rise as well. As Krugman points out:

In May 1981, the United Mine Workers signed a contract with coal mine operators locking in wage increases averaging 11 percent a year over the next three years. The union demanded such a large pay hike because it expected the double-digit inflation of the late 1970s to continue; the mine owners thought they could afford to meet the union’s demands because they expected big future increases in coal prices, which had risen 40 percent over the previous three years.

Where the current situation is different is that the rise in the price level is less diversified. Food and energy prices are leading the charge, while technology and globalization are putting downward pressure on other prices. The result is that despite the fact that prices of consumer staples are rising, the overall inflation rate remains low by historical standards. This may also explain Krugman’s claim that, “it feels like a recession to most people” even if it technically isn’t. When the economy is slowing and the prices of consumer staples are rising, it forces some belt-tightening.

What to do about the current situation, however, is somewhat more difficult. Krugman believes that there is too much risk involved in raising rates and precipitating further crisis in the financial markets. However, one must also bear in mind that the low rate policies in the wake of September 11 and afterward largely set the stage for the current credit crisis. In my view, thanks in large part to financial market innovation, inflation targeting has proven to be quite inept. In addition, targeting a rate of inflation and simultaneously ignoring the forces of globalization and productivity growth leads to an environment of easy money. The economy is (and has been) moving ever toward completely inside money of the variety described by Wicksell, which makes monetary policy and especially inflation targeting more difficult to conduct.

In any event, I am convinced that the Fed Funds rate is below the natural rate and leaving it there for some time will only lead to further asset price bubbles. If there are underlying problems in the financial market, we cannot ignore them by keeping rates low and hoping that they will go away.