Tyler Cowen describes the debate on the merits of fiscal stimulus so far,
This exchange is a good micro-cosm of how the stimulus debate has proceeded. A highly respected anti-stimulus economist puts up some anti-stimulus evidence in a highly imperfect test (in Barro’s defense, he did cover more than just WWII). The anti-stimulus economist is attacked by pro-stimulus economists. But the pro-stimulus proponents are focused on attack. They are not putting up comparable empirical evidence of their own for the efficacy of fiscal policy and there is a reason for that, namely that the evidence isn’t really there.
Arnold Kling suggested this would be the case,
Overall, on close examination, the case for the large fiscal stimulus, like the case for the Paulson rescue plan, is really quite weak. However, the same elite groupthink that made passage of the Paulson plan inevitable probably also makes the passage of the stimulus package inevitable. Opponents of the stimulus plan will be mocked and vilified in the media, even though they may very well have logic on their side.
And no, it isn’t that the case for fiscal stimulus is rock solid and thus the other side doesn’t have to present any evidence. As Greg Mankiw notes here,
The puzzle is that, taken together, these findings are inconsistent with the conventional Keynesian model. According to that model, taught even in my favorite textbook, spending multipliers necessarily exceed tax multipliers.
How can these empirical results be reconciled? One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment–a mechanism absent in the textbook Keynesian model.
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My advice to Team Obama: Do not be intellectually bound by the textbook Keynesian model. Be prepared to recognize that the world is vastly more complicated than the one we describe in ec 10. In particular, empirical studies that do not impose the restrictions of Keynesian theory suggest that you might get more bang for the buck with tax cuts than spending hikes.
But there are people who are arguing for at least some caution with regards to fiscal policy. Take for example Professor Edward Leamer’s postion,
It is more accurate and more intellectually healthy to think of ourselves as trading greater prosperity in the next year or two for less prosperity later on. Let’s proceed with handouts and bailouts that greatly reduce the severity of the current recession at the lowest possible future cost. But let’s top throwing cash at anything that doesn’t move, as if being hit with money would get it moving again.
This is in response to Krugman’s “boneheaded” mistake (Leamer calls it an undergraduate level mistake) that increasing the deficit is not big deal since we largely owe the money to ourselves.
Leamer is certainly correct though. We don’t live in a closed economy and we depend on foreign investors to fund at least a portion of our deficits. Krugman’s view that there is nothing to worry about the sky’s the limit on the deficit, the assumption is that foreigners are essential an endless source of money with which we can fund our deficits.
When borrowing takes place it transfer consumption from the future to the present. In short, it reduces future well being. For an individual the issue is a personal one: are you happier knowing that your future consumption and well being will be lower, but that your consumption and well being will be higher today. But when you are talking about a government you are not talking about inter-generational transfers of wealth. Apparently it is okay to take money from say our children (most of whom don’t even have jobs yet) and consume it now. It strikes me as rather odious when we use that future consumption to reward people who have behaved in an irresponsible manner (invested recklessly, purchased a large expensive house without having the income to justify such a purchase, etc.).
Then there is Alan Auerbach who also voices some reasons to be cautious.
Undertaking expansionary fiscal measures now while showing no interest in dealing with our long-term fiscal problem could lead investors to question our ability to confront that problem later, and that loss of confidence could have an immediate impact.
In other words, reckless and unbridled expansionary fiscal policy is not an option. We have the problem with Medicare for one. That huge fiscal imbalance combined with taking a veiw that we can borrow as much as we want might induce foreigners not to buy U.S. government bonds. And as both Gary Burtless and Isabel Sawhill note much of the current U.S. government debt is held by foreigners. If they stop buying we’ll have to offer the debt at a higher interest rate and that is not a good thing.
It seems to me there is plenty of room to disagree on how much fiscal stimulus there should be and what shape it will take. The evidence in favor of fiscal stimulus is not so clear cut. There are reasons why we might not want to just throw money at the problem. Calling people who voice concern or raise objections to various proposals stupid and such is childish.
