Tuesday, January 29, 2008

Economist Smackdown

In Sunday's Washington Post, economist Steven Landsburg explained "Why the Stimulus Shouldn't Stimulate You" -
As a general rule, economic policies command bipartisan support only when they're incoherent. Take, for example, the fiscal stimulus package now bulldozing its way through the legislative process. It's poorly conceived, it's unlikely to work, and it's sure to do a lot of collateral damage.

The idea, we're told, is to stave off an all-out recession by stimulating both investment (through tax cuts for businesses) and consumption (through tax rebates to individuals). But hold it right there.

Investment and consumption are natural rivals.

Investment means converting resources into machines and factories; consumption means converting those same resources into TV sets and motorboats. In anything but the very short run, more of one means less of the other.

Ah, say the package's more honest proponents, that's exactly what we care about -- the very short run. And in the very short run, we can have more of everything if only we put more people to work.

Fine, but what makes you think that this package will put anyone to work? The idea behind the stimulus deal is to give people tax cuts so they'll feel richer and spend more. But government can't make people richer on average; all it can do is shuffle wealth around. To pay Peter, you must tax Paul (or at least promise to tax Paul in the future, when your debts come due). Peter spends more, but Paul spends less.

Landsburg's argument seems to be based on classical economic theory, which holds that changes in aggregate demand do not affect the level of output. That was prevailing economic wisdom 80 years ago, but we've figured some things out since then, as Paul Krugman explains:

The understanding that Say’s Law doesn’t work in the short run — that a fall in consumption doesn’t automatically translate into a rise in investment, but can lead to a fall in output and employment instead — is the central insight of Keynes’s General Theory. (My introduction to the new edition is here.) And we’re having a serious debate about economic policy that hinges on that insight.

Yet here we have an opinion piece published in a major newspaper 70 years after that profound insight, supposedly informing readers about economics, by someone who obviously just doesn’t get it.

Brad DeLong thinks its the "stupidest thing published by the Washington Post so far this year," and Mark Thoma is also critical.

Landsburg and Jason Furman are debating the stimulus in the LA Times (Hat tip: Greg Mankiw).

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