Friedman’s response to Romer & Romer

29 February, 2016 at 18:27 | Posted in Economics | 3 Comments

As yours truly wrote the other day, reading the different reactions, critiques and ‘analyses’ of Gerald Friedman’s calculations on the long term effects of implementing the Sanders’ program, the whole issue seems to basically burn down to if the Verdoorn law is operative or not.

In Friedman’s response to Romer & Romer today this is made even clearer than in the original Friedman analysis:

The Romers … would acknowledge that following a negative shock, government stimulus spending may accelerate the recovery somewhat …They deny, however, that stimulus spending could change the permanent level of output … Like mosquitos on an otherwise delightful summer afternoon, slow growth is unfortunate but there is little that can safely be done about it.

slide_40Or maybe we can find safe pesticides. Here I agree with John Maynard Keynes that the economy can have a low-employment equilibrium because of a lack of effective demand, and I agree with Nicholas Kaldor and Petrus Verdoorn that productivity and the growth rate of capacity can be increased by policies that push the economy to a higher level of employment … I see an economy at low-employment equilibrium where discouraged workers have abandoned the labor market and firms have had little incentive to innovate or to raise productivity. In this situation, additional stimulus can not only temporarily raise output but by priming the pump and encouraging additional private spending and investment, it can push the economy upwards towards capacity. And, beyond because at higher levels of employment, more people will look for work, more businesses will invest, and employment will grow faster and productivity will rise pushing up the growth rate in capacity. That is why I see lasting effects from a government stimulus when, as now, the economy is in a low-employment equilibrium.

3 Comments »

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  1. Thank you for posting this. It is nice to hear from an optimistic economist like Friedman. I really can’t believe that something like Verdoorn’s Law would not be considered in standard economics. It seems so obvious to me that increasing cost and demand of labor would lead to increasing productivity, even if only through better management of that higher cost labor.

    The Romers seem to be saying something similar to this- we assume military technology increases at a standard rate every year regardless for the demand for military hardware. Therefore wars do not lead to any increased capacity to kill people except by increasing the size of armies. Therefore, at the end of WWII, after demobilization, the technical capabilities of the U.S. military were only slightly higher than at the start of the war. Any perceived increase is illusory and had nothing to do with the war. Is this a fair analogy of the Romers’ understanding of demand stimulus?

    • Jerry the Romer approach is a-historical; ie ignore ground-up documented historical analysis. High growth rates that were maintained for decades after 1945 were initially a result of large capital injections (ie the Marshall Plan) for post-war reconstruction. This led to an investment boom that led to further rounds of investment in manufacturing that took Europe and Japan far beyond reconstruction itself with positive effects on the world economy as a whole. This cycle was kicked off by extraordinary levels of demand for which funds were made available for capital investment. This was largely about demand.

      • Thanks Nanicore. I agree with you, I just don’t know why the Romers use a model that does not accord with historical facts.


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