There is a fascinating debate raging right now among the world’s most prominent economists, who are kicking and screaming at each other across newspaper columns, interviews, and their personal blogs.
The diatribe was ignited by this January 22 opinion in the WSJ by the esteemed Robert Barro, whose class I was fortunate enough to attend one semester. (Unfortunately the same can’t be said of Professor Barro). Barro notes that Obama’s stimulus assumes a government spending multiplier of 1.5, which is to say that every $1 the government spends increases the gross domestic product by $1.50. In other words, government spending has a negative cost (he wonders “Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases”).
Barro cites his own research, and that of others, to suggest that even in the best examples of government spending – he identifies World War II as the single greatest moment – the government multiplier was only 0.8. This implies that each dollar of government spending only costs society $0.20. One argument in favor is that government spending utilizes otherwise idle resources, and therefore produces a unit of output at severely reduced cost. The only evidence of any multiplier above zero (where $1 costs less than $1) comes during war, when the entire economy is at full tilt. There is no peacetime evidence.
But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes’s 1936 “General Theory of Employment, Interest and Money.” The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.
Paul Krugman, who is the most recent recipient of the Nobel Prize in Economics and lately has been moonlighting as a political commentator for the NYT, fired back:
…the prospect of a Keynesian stimulus is having a weird effect on conservative economists, as first-rate economists keep making truly boneheaded arguments against the effort.
Oh, snap! His argument [which I choose not to paraphrase since it's short and I find his tone amusing]:
But just to say it again: there was a war on. 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.
Krugman makes a good point that rationing suppressed consumer spending. He attempts to make a good point that this precludes using the World War II period as a model for contemporary spending analyses. However, I believe this overlooks a key fact – we are about to enter the worst epoch for discretionary spending since World War II! These numbers are not adjusted after-the-fact to account for the impact of rationing – they simply mean that 2008 (and 2009E) exhibit levels of consumer spending not seen since 1942 when, as Krugman indicates, the government itself was suppressing spending. When we take that into consideration as well, it means that today represents the lowest amount of consumer spending EVER. So that’s the mindset.
The next day, Krugman was at it again:
You see, Robert Barro made much of the fact that private spending actually went down during World War II — which he took as evidence of “crowding out”. But what types of private spending fell, and why?
Well, the chart below, drawn from Millennial Historical Statistics, shows spending on new homes and cars before, during, and after the war years. Both basically collapsed. Why?
The answer is that (1) There were draconian building restrictions in effect — in fact, the end of those restrictions helped set off the postwar housing boom, and (2) new cars weren’t being produced, because the factories were making tanks instead (and if you did manage to acquire a car somehow, gasoline was rationed).
Let’s see, autos and home sales declined… you mean like this? Or like this? How about this chart, look familiar? It’s the change from the peak in the Case-Shiller housing index comparing this housing collapse to the one a decade ago.
I’m at a loss to decipher Krugman’s point. He offers reasons that auto sales and home prices were depressed in the 1940’s, as if the reasons let us ignore the fact that the absolute level of consumer spending has fallen. Autos and homes have fallen off the chart now as well. Does the lack of a government-imposed reason make this catatrosphe any less impactful on aggregate consumer expenditures?
But the punches have been thrown and the economists are going at it! Greg Mankew tried to play it cool by linking to Barro’s opinion without comment. In the weeks since, however, he has been going back and forth with his own idea – it’s a rarity for him to post opinions – as well as others from both sides of the fence.
A rather tame post by Matt Yglesias (I didn’t know, either) was met with a vitriolic defense from UCLA professor Brad DeLong, who writes
One of these people is a tenured university professor. The other is a juicebox-drinking basement-dwelling bathrobe-clad weblogger.
Professor Ty Cowen next joined the fray, noting – in one of the more balanced analyses – that pro-stimulus economists tend to rebuke attacks without offering positive evidence of their own views:
I’ll say it again to the pro-stimulus forces: a stimulus is going to happen, so I’d love to be cheered up by your evidence. Put it on the table.
Ultimately, he decides he is not enamored with the WWII example, though he does not look forward to the stimulus for other reasons.
Connor Clark, of the Atlantic, interviewed Barro several days ago. Among the choice quotes is Barro’s response to a question framing the stimulus against the “Larry Summers standard:”
Barro: 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.
Clark: Well, presumably Larry Summers is not an idiot.
Barro: [laughs] That is another conversation. I have known him for 25 years, and I have opinions about that.
Clive Crook authored an opinion in the FT essentially accusing Barro and Krugman of putting politics first and good economics second, at great cost (more on that to follow). Their responses provided the stage for yet another indirect battle. In a subsequent post in the Atlantic (what’s with their CC fetish?), Crook fields a personal attack from Krugman, and takes the opportunity to conduct an email interview with Barro. Krugman, among other things, announces
Clive used to be a reasonable guy; in his mind he probably still is a reasonable guy. But he has misunderstood what it means to be reasonable….And it means hysterical attacks on yours truly for actually taking sides in this debate…
Barro, on the other hand, engaged Crook in a (relatively more) pleasant email conservation. Candidly, Barro noted
As to Krugman, my response would likely have been more moderate if he had not referred to my ideas as bone-headed. But I promise to behave better in the future….
Oh yes, the bone-headed remark is what started things.
This debate continues to reverberate through the media, blogosphere and lecture halls of the respective combatants. Both sides have some hot-headed and questionably accurate arguments, but none I would call “boneheaded.” This is an untested approach to economic stimulus, and though we can draw on history for parallels there is no concrete analogy. Amidst the hustle, I feel that Crook comes out as the clearheaded voice among them.
