There’s a rather angry exchange going on in econ-blog land. Eugene Fama, noted financial economist, wrote skeptically of fiscal stimulus as the solution to the economy’s problems:
Even when there are lots of idle workers, government bailouts and stimulus plans are not likely to add to employment. The reason is that bailouts and stimulus plans must be financed. The additional government debt means that existing current resources just move from one use to another, from private investment to government investment or from investment to consumption, with no effect on total current resources in the system or on total employment. And stimulus plans only enhance future incomes when they move current resources from less productive private uses to more productive government uses – a daunting challenge, to say the least.
Brad DeLong doesn’t so much refute Fama’s observations as to deride them:
Fama’s claim that “‘stimulus spending must be financed which means it displaces other current uses of the same funds…” rests on Fama’s implicitly making one of two assumptions: either that stimulus spending does not lead to any surprise reduction in inventories, or that a surprise fall in inventories does not lead to any change in the flow of saving. Make either of these assumptions, and Fama’s argument goes through.
But why should you make either assumption? Why would you ever assume that there can’t be unwanted growth in inventories? Why would you ever assume that household incomes and saving must remain unchanged as firms’ stocks of unwanted inventories grow ever larger?
The answer is that you never would–but that Fama does not know enough national income accounting to know that that is what he is assuming. He does not understand the identity he deploys as equation (1). He thinks that “investment” means “growth in the value of the capital stock.” He simply does not understand what the NIPA investment concept is, or that what he thinks of as “investment” is not in general equal to savings.
All of this is part of the undergraduate sophomore economics curriculum.
It isn’t just Fama’s ideological opponents who are critical of his observations. Arnold Kling notes:
Basically, Fama says that national savings equals national investment. So, if the government deficit goes up and private saving is unchanged, then investment must go down. Therefore, the argument runs, a government deficit crowds out private investment and does not raise output.
That story holds for an economy that is always at full employment. However, if the economy were always at full employment, then hardly anyone would have heard of a fellow named John Maynard Keynes, and we would not be talking about the issue of an economic stimulus.
In the Keynesian story, if investment declines (due to a drop in “animal spirits”), saving declines to match investment. They re-equate at a low level of total output, at which there is unemployment.
The Keynesian story is not without its problems. As David Henderson has pointed out in a couple of recent posts here, and as I pointed out at greater length in my lectures on macroeconomics, the simple Keynesian model is “priceless” in that it acts as if the usual economic adjustment mechanism, most notably the response to prices, does not work.
If Fama wants to make these sorts of criticisms, or add his own criticisms, that would be fine. But to just pretend that full-employment economics is the only economics and ignore Keynes completely contributes nothing to our understanding.
I’m no economist (as I’ve demonstrated here time and again). My own caution about the massive fiscal stimulus package that’s being planned derives more from my skepticism that the money will be used efficiently than from doubting that fiscal stimulus can be effective in the abstract. The numbers matter. If a small stimulus can be produced in the very best case and the best case will definitely never be realized, does the remaining effect make any sense given the inevitable adverse secondary effects? I’ve seen some numbers but, frankly, they looked like handwaving to me.
There’s one more thing that I think bears mentioning: there will be a stimulus package. Regardless of its economic merits its politically necessary. Under the circumstances I think that it makes less sense to invest the money in some mayor or governor’s pet project that hasn’t been able to secure funding because local people don’t think it’s worth spending their money on than to invest in projects that are grand enough that they’re seen as being too risky to find private financing.
