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Tuesday, May 25, 2021
Lars P. Syll — Functional finance and Ricardian equivalence
Abba Lerner and John Maynard Keynes against Robert Barro. Who wins?
Paul Krugman did a brilliant takedown of Ricardian Equivalence... by pretending it was true. Even then he notes, stimulus would still be effective. Here's the last part of the article:
I’ve tried to explain why Lucas and those with similar views are all wrong several times, for example here. But it just occurred to me that there may be an even more intuitive way to see just how wrong this is: think about what happens when a family buys a house with a 30-year mortgage.
Suppose that the family takes out a $100,000 home loan (I know, it’s hard to find houses that cheap, but I just want a round number). If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.
But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.
Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.
How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong? And yet as far as I can tell almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.
Joseph Stiglitz did a somewhat briefer take down of Ricardian Equivalence than Krugman. As Stiglitz put it, "Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense."
re: Ricardian Equivalence
ReplyDeletePaul Krugman did a brilliant takedown of Ricardian Equivalence... by pretending it was true. Even then he notes, stimulus would still be effective. Here's the last part of the article:
I’ve tried to explain why Lucas and those with similar views are all wrong several times, for example here. But it just occurred to me that there may be an even more intuitive way to see just how wrong this is: think about what happens when a family buys a house with a 30-year mortgage.
Suppose that the family takes out a $100,000 home loan (I know, it’s hard to find houses that cheap, but I just want a round number). If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.
But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.
Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.
How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong? And yet as far as I can tell almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.
A Note On The Ricardian Equivalence Argument Against Stimulus (Slightly Wonkish)
Joseph Stiglitz did a somewhat briefer take down of Ricardian Equivalence than Krugman. As Stiglitz put it, "Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense."
ReplyDelete“ Who wins?”
ReplyDeleteNobody it results in some sort of synthesis of the two opposing theses... Socrates 101...
Which is in contrast to scientific process which seeks optimization thru testing and adjustment...