Friday, August 19, 2011

Why Americans Hate Economics

Stephen Moore's column with this title in today's WSJ is hopelessly wrong. He ridicules the "witchcraft" of Keynesian macroeconomics, and insists that fiscal stimulus has to result in dollar-for-dollar crowding out. I have to say that our old friend Todd Steen, quoted in an earlier post by Steve, makes pretty much the same mistake.

When there are unemployed resources in an economy, a fiscal stimulus does not crowd out anything. To the extent that it increases aggregate demand (and is not offset by tax increases, say), it employs resources that would otherwise be idle. It therefore crowds IN economic activity, and has no burden on the economy. The first thing we teach students is opportunity cost. What is the opportunity cost of fiscal stimulus? To the extent that it employs otherwise idle resources, its cost is NOTHING.

The canonical model is not relevant in this situation. The model has no explanation for an economic depression, and hence can not be expected to predict results accurately in a situation of persistently depressed economic conditions. It is only relevant when the economy is in a full-employment equilibrium situation. That is not the case now. It is for times like this that Keynesian economics was developed.

Why do our students hate economics? Because they come to us expecting to learn about the real economy, not some fantasy economy that exists only in economists' heads.


Steven McMullen said...


I think you assume too much in your statement about fiscal stimulus employing otherwise idle resources.

First, what percentage of resources employed by the government in a stimulus program are really idle? To the extent that they are not, or would not be, there will be some (not complete) crowding out.

Second, stimulus spending, like all spending, must be weighed against the cost of getting the cash in the first place, which will always come from either taxes now or later. It is right to take that opportunity cost into account, even in a recession.

The result is, there are times, even when there are unemployed or under-employed resources in the economy, that a stimulus will not be justified because of costs, which take the form of crowding out.

Now, that crowding out will not be dollar for dollar, but I don't think Todd implies that, so I would argue that your implied criticism of his essay is just wrong.

John Tiemstra said...

My argument assumes (and states the assumption) that current taxes are not raised. Future taxes when the recession is past will not create a macro cost, especially if they simply redistribute the revenue to domestic bond holders. There is no reduction in GDP or employment (apart from the deadweight burden of the tax, which is a second-order small effect). Think of Keynes's example: print money, bury it, and have the unemployed dig it up. There's no cost to this. Of course, there are more constructive things that could be done, things that would increase the stock of public capital.

My apologies to Todd. I don't think any apologies are due to Stephen Moore.