Friday, January 23, 2009

War of the economists

War - Or why the public cannot trust economists redux:

Matt Yglesias has a very good post on Robert Barro's latest. Brad DeLong seems to agree with Matt. Paul Krugman uses the word "boneheaded" to describe the Barro piece.
This exchange is a good micro-cosm of how the stimulus debate has proceeded. A
highly respected anti-stimulus economist puts up some anti-stimulus evidence in a highly imperfect test (in Barro's defense, he did cover more than just WWII). The anti-stimulus economist is attacked by pro-stimulus economists. But the pro-stimulus proponents are focused on attack. They are not putting up comparable empirical evidence of their own for the efficacy of fiscal policy and there is a reason for that, namely that the evidence isn't really there.

The pro stimulus economists have already put up their evidence. The anti-stimulus economists just don't like it. Likewise the pro stimulus pack don't like the evidence of their opponents. There is great uncertainty over the evidence on both the tax cut advocates and the fiscal stimulus advocates. There is some sense that we might want to try both (Scroll down to see that Mark Thoma does not object to tax cuts per se but he feels that spending in public projects is way overdue, for instance, tax cuts won't build schools). Unfortunately, this approach can divide resources to the point that neither is effective. (I'm in the both camp even though it may end up being ineffective.)

For instance, Warren Buffet via MR: "All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. "

Being in the "both" camp then requires us to find projects that are beneficial. Why build schools if they are not needed? In this case, the paper by Linda Bilmes is relevant. Corruption can become a problem. However, if I were in the pro-stimulus camp I would consider the findings of this paper to be interesting but tangential. Whether or not fiscal funds are put to "good" use is irrelevant as long as it gets recycled into the economy. Digging holes and then filling them up again is a Keynesian presciption out of a liquidity trap.

The pro tax cut camp also wants to use tax cuts to spur investment. Seeing that we had almost a decade of "spurred" residential investment that accompanied the housing bubble I question the need to "spur" more investment unless the pro tax cut advocates are proposing that the government "cause" another investment bubble in public works type projects. Perhaps in this case companies like Bechtel, Siemens and various construction companies will become beneficiaries. And "hopefully" we'll have another bubble that will lift us out of the recession. After all during the dot-com bubble there was a lot of IT "investment" e.g. laying down fiber optic cables, etc. (At least I think there was. I need to find a reference for this.)

Update: Menzie Chinn has some diagrammatic expositions of fiscal policy analyses which I found useful. Again these are theoretical arguments and as far as I can tell there are no empirical estimates of the slopes of IS-LM models.

Update: This is getting fun!
Rodrik seems to be anti-stimulus but what he says here makes sense as well (emphais mine):
And if I am right on the remaining source of disagreement, we can say two things. First, there is in fact a reasonable consensus about the economics of the situation (as described by both Cochrane and Krugman, although they do use different words). And second, the remaining disagreements are largely philosophical, political, and practical--revolving around the role of government, the extent of rent-seeking and public-choice concerns in government programs, and the right mixture of prudence and boldness that the situation requires.
It wouldn't be the first time that economists are discussing such questions--for which their PhDs have done little to qualify them--in the guise of discussing economics. But it would be too bad if disagreements on the second score obscure the apparent convergence on the former.

My argument against Cochrane's piece:
We are experiencing a strong portfolio and precautionary demand for government debt, along with a credit crunch. People want to hold less private debt and they want to save, and they want to hold Treasuries, money, or government-guaranteed debt.

Is this an assertion, assumption or something based on evidence? It sounds plausible but if there is any movement by economics toward 'evidence-base' this is not one of its finer moments. See also Brad Delong's claim that Cochrane is making "an elementary, freshman mistake."

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