Paul Krugman,
Mark Thoma,
Brad DeLong, and others are on the rampage against sloppy thinking by conservative anti-stimulus skeptics. And they are certainly right to criticize. In
this widely-circulated video, for example, Robert Lucas - Nobel Prize winning macroeconomist, the founder of modern non-Keynesian macroeconomic theory - makes some astoundingly boneheaded statements. For instance, he says that one of the virtues of monetary policy is that it is easily reversed, whereas if we try to stimulate the economy by say laying a bunch of fiberoptic cable, what are we going to do when the recession is over, dig it up again? Robert, Robert, you're confusing stocks and flows - physical capital does not stimulate the economy, investment does! Throughout, the stimulus critics rely on the crudest of crowding out arguments. Buying stuff, the argument seems to go, does not increase production, it merely reallocates resources - an argument which if true would apply to private spending as well as government spending. At any rate it leaves unexplained where production comes from in the first place: surely the first act of spending stimulated production, and successive acts of spending continued to expand production until society's resources were fully employed. Meanwhile, these otherwise brilliant economists seem to believe that money creation has some mystical power to stimulate production in the short run. Create money, they argue, and production miraculously springs from the earth - ignoring that to stimulate production money creation must first stimulate some sort of spending, which they don't believe can stimulate squat.
The stimulus skeptics have said some smart things, though. Smartest of all was the statement of John Cochrane in the question and answer part of the above-referenced forum. Cochrane said "I've looked through graduate course outlines and textbooks and I can find nowhere in the last fifty years where anyone in economics has said fiscal stimulus is a good idea. The Keynesians gave up on it by the time I was an undergrad... I haven't found a single academic article saying 'oh, we've learned a new theory that fiscal stimulus works,' the empirical work is well, you know, we put leaches on the patient and he got better... What are we doing giving advice sort of based on beliefs when there's nothing in what we teach our graduate students or what we write saying fiscal stimulus makes any sense?"
Cochrane does not seem to have done a thorough search of EconLit, but he has a point. If Keynesians are bewildered by the confused theorizing of the stimulus skeptics, if they are frustrated at their inability to convince their fellow economists that fiscal stimulus makes sense, then to some extent they have no one to blame but themselves. Because Cochrane is basically right when he says that macroeconomists have not spent much time at all in the last fifty years developing models that show that fiscal policy works. In the 1960s economists of all stripes recognized that the long lags of fiscal policy made fiscal stabilization policy problematic. In the 1960s and 1970s Friedman and Barro convinced most of the profession that temporary changes in taxes had little or no effect on demand. Government spending became passe in the political universe of the 1970s, and Reagan's budget deficits of the 1980s took activist fiscal policy completely off the table. Economists and policymakers were quite content to hand the whole business of stabilizing the economy to the Fed.
It would be interesting to find out how many Ph.D dissertations have been written since the 1970s on the subject of fiscal policy as a stabilization tool. My guess - not many. Meanwhile, the advances in our understanding of monetary policy as a tool of stabilization policy have been astounding. Economists considered all of the major theoretical objections to the Keynesian approach to monetary policy - rational expectations, the lack of microfoundations - and developed sophisticated models that reconciled something like the old policy prescriptions with the new methodological approach. The workhorse New Keynesian model is truly a wonder to behold - you've got utility maximizing consumers choosing consumption and labor supply interacting with imperfectly competitive firms choosing prices in the face of price adjustment costs and a central bank implementing an optimizing monetary policy, the entire model capable of being simplified to a three-equation setup that danged-if-it-doesn't look just like what we've been teaching all along in our intermediate macroeconomics classes. Now people are adding bells and whistles to this model in the form of financial market frictions, banks, exchange rates, and so on.
Back in the 1970s economists worried about issues like credibility and the politicization of monetary policy. Wham! economists came back at them with a coherent theory of optimal monetary policy rules, efficient contracts to constrain the worst impulse of central bankers, central bank independence, coherent discussions of transparency and accountability. We have debates about whether central banks should target inflation, the price level, or something else; whether central banks should rely on forecasts or be backward-looking; we analyze monetary policy rules for their stabilizing or uniqueness properties; we ask what is the effect of learning on the part of the central bank or the public. And the amount of empirical work that has been done testing the myriad hypotheses about monetary policy developed over the last 40 years would fill a liberal arts college library.
As for fiscal policy? The debates between the stimulators and the skeptics amount to trading quotes from Keynes (1936) versus those of his misguided opponents in the British Treasury. We're still ruminating over whether the evidence supports Friedman's views from the 1950s over whether consumers respond more strongly to permanent versus temporary changes in their income. We're struggling with Barro's 1974 argument that changes in taxes not matched by changes in spending affect the economy at all. Oh, there's a branch of research on supply-side policy showing that a switch to a hypothetical distortion-free tax code would add a few percentage points to GDP which the supply-siders can pull from their briefcases in times like these to argue for cuts in the corporate tax rate or elimination of taxes on interest and dividends. There are a lot of tests of Friedman's permanent income hypothesis, the conclusion of which seems to be that he is kind of right and kind of wrong, but we can't be sure how right or how wrong. You can find a handful of papers that test for the effect of fiscal policy in a purely atheoretical empirical model; there's some interesting stuff on the microeconomics and behavioral issues behind consumer spending. But where is the full blown macroeconomic model with a well-developed fiscal policy component? All of the concerns about lags and the inefficiency of government spending are valid and important - where is the sophisticated analysis of these issues, where are the proposed institutional fixes analogous to those that have been suggested (and sometimes adopted) for central banks?
Since the apparently modestly successful use of fiscal policy in 2001 there has been some movement in the direction of developing a coherent theory of fiscal policy. Google papers by Auerbach, Taylor, Krugman, and others. But there's still a long way to go. We're still confronted by the problem that Keynes had in the 1920s - as much as he knew that macroeconomic policy could be used to fight the looming depression, he was unable to make any headway until he developed a theory to back up his intuition. You can't fight something with nothing - we macroeconomists have to come up with something that's better than the nothing we're employing in our policy debates now.
