The graph at John Taylor’s blog explains stimulus failure. (I wrote about the Cogan-Taylor work earlier, but it bears repeating.)
Everyone, including Keynesians, agrees that if Ricardian equivalence holds, then stimulus does not work. Ricardian equivalence means that the folks receiving the funds that the government borrows use the funds to save rather than to spend.
The Taylor-Cogan story is that in the case of the 2009 stimulus, a lot of the funds went to state and local governments, which promptly saved them (or, equivalently, reduced borrowing). The stimulus was not an increase in spending. Instead, it was a transfer between bank accounts. In other words, there was no stimulus. All the econometric modelers that applied their multipliers to estimate the effects of the stimulus are making bogus claims, because there was nothing to multiply.
If Taylor and Cogan are right (and I have not checked their work), then CBO, Blinder-Zandi, et al, ought to climb down from their claims that the stimulus saved umpty-ump jobs. That might be embarrassing for them, but it would show a willingness to be grounded in reality,
READER COMMENTS
Sam
Dec 9 2010 at 9:53am
Correct link is http://johnbtaylorsblog.blogspot.com/2010/12/stimulus-math-many-multiples-of-nothing.html
Joey Donuts
Dec 9 2010 at 10:35am
Can someone explain why the data in Taylor’s article (see link from Sam above) is so different from the data here.
http://www.federalreserve.gov/releases/z1/current/z1r-2.pdf
B.B.
Dec 9 2010 at 10:53am
Actually, no.
Is the misnamed Ricardian equivalence about expectations or about reality?
Krugman has made this point repeatedly, as have others. Suppose a block of households find that they are in debt, must make monthly debt payments, but find that their access to more credit has been denied. They cannot increase leverage, but they must deleverage. Such households are liquidity constrained.
They do save some because they are forced to. But after taxes and debt payments, they spend their net cash flow. It is the Keynesian consumption function. If they get a tax cut, they will spend it because the extra cash relaxes a credit constraint, even if they rationally expect their future taxes to go up.
So there is a role for aggregate demand policy using tax cuts.
Also lower interest rates would reduce the burden of deleverage for those with debt.
Joseph K
Dec 9 2010 at 11:44am
Responding to B.B., I’m gathering your argument is that Keynesian stimulus can still work when people just use the additional money to increase their savings, because they’ll spend it later (presumably once they increased their savings to a more comfortable level). If this is what you’re saying, it doesn’t seem to make sense to me. If you stimulate using taxes, then you’ve taken money from one sector, reduced their savings and spending (reducing their future spending) to give it to another sector. If you stimulate using debt then you’re just increasing one sectors saving at the expense of another, increasing one’s future spending and decreasing the other’s. In the aggregate it just seems like zero net benefit.
Lord
Dec 9 2010 at 1:01pm
Believers in Ricardian Equivalence should also oppose the current tax proposal, but I don’t hear any saying so. That might interfere with their prejudices. No, I don’t believe states simply saved it; they would have cut spending much more without the funds. Politically money does have to be given to those not needing it to provide for those that do but that is politics. That says however it was not stimulus in a positive sense but in a negative sense; the economy would have been worse without it, but it did not improve it over its prior level.
Hyena
Dec 9 2010 at 8:51pm
Why would Ricardian equivalence suggest that, though?
If Ricardian equivalence does hold and debts are denominated in that country’s own currency, then people would internalize the indebtedness less the expected value of future inflation to pay for those debts.
Given that it’s the expected value of future inflation that drives Keynesianism of all kinds, that would seem to keep the two out of contradiction.
But why would we expect Ricardian equivalence anyhow? Doesn’t it require there to be no discount rate? Even a rational one?
Miguel Madeira
Dec 10 2010 at 10:27pm
“Everyone, including Keynesians, agrees that if Ricardian equivalence holds, then stimulus does not work.”
No, they don’t
http://krugman.blogs.nytimes.com/2009/04/06/one-more-time/
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