Government Spending and What’s Wrong with Economics

I can’t stop thinking about this statement,  in Project Syndicate, by Joseph Stiglitz, a Nobel prize winner:

The near-global stagnation witnessed in 2014 is man-made. It is the result of politics and policies in several major economies – politics and policies that choked off demand. In the absence of demand, investment and jobs will fail to materialize. It is that simple.

This brings us back to politics and policies. Demand is what the world needs most. The private sector – even with the generous support of monetary authorities – will not supply it. But fiscal policy can. We have an ample choice of public investments that would yield high returns – far higher than the real cost of capital – and that would strengthen the balance sheets of the countries undertaking them.

The big problem facing the world in 2015 is not economic. We know how to escape our current malaise. The problem is our stupid politics.

But is it that simple?  Really?  It is that simple?

Brad DeLong conveniently has re-posted his defense of basically any government spending, with this equation proving how it is mathematically always a net positive, given a bunch of assumptions:

Following DeLong and Summers (2012), let the parameters for an economy at the zero lower bound of nominal interest rates and with anchored inflation expectations be:

  • μ, the multiplier—and a depressed-economy zero-lower-bound multiplier, not a monetary- offset multiplier;
  • η, the hysteresis coefficient: the shadow cast on potential output by today’s downturn;
  • τ, the marginal tax-and-transfer share: 1/3;
  • ξ, the deadweight loss from having to raise a dollar of extra tax revenue to service the debt;
  • r, the real government borrowing rate (and the social rate of time discount); and
  • g, the growth rate of potential GDP: 2.5%/year

Then for each extra dollar of government spending today the present value of total economic output now and in the future changes by:


Both Stiglitz and DeLong are defending Keynesian theories, which basically state that in order to stop and reverse a recession, the government should spend as much as it takes to stop and reverse the recession.

On the other hand, Austrian theories argue that in order to spend during recessions, governments must take on debt, and too much government debt causes permanent slowdown in economic growth later.  There is research published on this topic as well.  In addition, Austrians would argue that Keynesians are just plain wrong to begin with.  Here is Scott Sumner:

During the course of 2013, real GDP growth was almost twice as fast as during 2012, and nominal GDP growth also accelerated. Today some Keynesian like to minimize the austerity program of 2013, acting like nothing of importance happened. Let’s look at the record, starting with what Keynesians were saying in late 2012:

Responding to a letter by 80 CEOs published in the Wall Street Journal calling for budget cuts to reduce the deficit, 350 economists published a letter calling for job stimulus and growth instead.

That letter included this warning:

At the end of the year, we face a congressionally-created “fiscal cliff,” with automatic “sequestration” spending cuts everyone agrees should be stopped to prevent a double-dip recession.

Only about 6 weeks later Congress raised the payroll tax by 2 percentage points. Income taxes were raised at the same time. A few months later spending was slashed under the “sequester.” By April 2013, Keynesians like Mike Konczal and Paul Krugman were calling the austerity a “test” of the market monetarist proposition that fiscal austerity would be offset by monetary stimulus.

But the double-dip recession never happened; indeed growth sped up in 2013.

That seems kind of silly; obviously more government spending will lead to an increase in immediate economic growth, all else equal.

To me, all of this comes down to the point of Bob Higgs’ comments, posted by Don Boudreaux:

I am thinking that you may well share my view, which I have held for a very long time, that the scarcest ability among economists (and others who purport to have expertise about economic matters) is good judgment. Many economists are obviously very smart, in the sense that they are good at math and can wheel and deal with pretty complex mathematical models and econometric exercises. But this sort of technical ability may — and sad to say, usually does — have little or nothing to do with actually understanding how the world works.

Prof. Boudreaux adds:

The economics profession is chock-full of high-IQ people who would be great engineers; the economics profession is sadly short on wise, insightful, and historically informed people who are good economists.

The bottom line of all of this is, What is the Purpose of Economics?  It seems to me that Prof. Higgs is interested more in understanding how the world works, while many others, especially including most of the Keynesians, are interested in figuring out how the economy can be handled or controlled or smoothed by the government.

The viewpoints on the actions of the Fed are also very telling in this regard.  A quasi-government organization with monumental power, the Fed has a “dual mandate:” to control inflation, and to maximize employment.  Personally, I hate this.  They control the supply of money, somewhat indirectly.  They can strongly and immediately impact interest rates, and that is a big driver of inflation.  But I don’t see how they can or should be tasked with employment.  They can have a negative impact, by shocking the economy, but the positive loop there is a lot more complex, especially if you are more of an Austrian, or like David Stockman, don’t even agree with the inflation part:

Who cares about the nonsensical and completely arbitrary 2% inflation target? What’s so great about debasing money’s purchasing power at this rate anyway?

There can be no question that savers are in fact “punished” by these policies and incidentally, their declining incomes actually exert a negative influence on their demand, the very thing Draghi purportedly seeks to revive.

People manifestly do not “stop buying things because prices are falling”. This is an utterly absurd contention. Have falling prices for computers and smart phones kept anyone from buying these items? How is it possible that these are booming growth industries, when the prices of their products are continually declining? Unless Draghi and others making such assertions don’t explain convincingly why this seemingly magical exception to their theory exists, they have no leg to stand on.

Will people stop eating when the price of food is expected to fall? Will they postpone life saving operations because they might cost less next year? Again, the idea that people will stop consuming if consumer prices trend down is neither theoretically nor empirically provable.

So, then, what is the purpose of government in regards to the greater economy?  Do Americans want the economy to be manipulated like this?  What do people want when a recession occurs?  It seems to me that the responsibility of the government is to:

  1. Be certain that laws and regulations ensure transparent and open markets, where no participants can gain and keep unfair advantages.  This would include things like financial and trading regulations, banking laws, real estate laws, health care regulations, etc.  An indicator of a problem in this area is when large firms dominate a market, and there are measurements for that.  This ensures that as an economy recovers, the recovery is more likely to be broad and shared.  In addition, this part has to include pricing in externalities, either through taxes or regulation.
  2. Enforce those laws.  If the recession was caused by fraud and wrong doing, like the last one, then be sure the offending institutions and individuals bear the full brunt of their actions.  That is, poor management must result in bankruptcy (complete reorganization, with new management) for insolvent firms, and illegal activity must involve punishment ( even jail time) for the individuals.
  3. Provide a safety net for individuals.  Obviously this is something like UC.  But maybe it’s more than that, and sometimes the government does more than that.  Structural unemployment requires individuals to get new skills, and sometimes to relocate.

Why is it the job of the government to try to grow GDP at some specific rate?  Shouldn’t the government just set up fair rules, and stay the heck out of it except to help those who are inevitably harmed?  Are there any economists studying that?






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