How to cure the recession …

2 June, 2016 at 08:04 | Posted in Economics | 4 Comments

 

(h/t Gabriel)

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  1. Mark Blyth is actually making this shit up.
    .
    Ricardian equivalence refers to the following situation: Suppose you have $100 in income and pays $20 in taxes (such as your disposable income is $80). Then if the government would say, “you know what, those $20 in taxes is not taxes anymore, it’s government bonds, but you are just not allowed to sell and cash them in now (so your disposable income is unchanged at the moment). But at some future date you will be allowed to sell those bonds and cash in, but unfortunately that’s also the date at which we are going to tax you $20 plus whatever interest those bonds have accrued (so you’re disposable income is not going to be any higher in the future either).”
    .
    Ricardian equivalence says that the above semantic shift in taxes/debt will not influence individuals spending decisions. The reason is that disposable income has not changed neither in the present nor in the future.
    .
    BUT having said that, there is plenty of research showing — both theoretically and empirically — that an increase in government spending can have profound effects on economic activity. But those effects do not rely on Ricardian equivalence being false (although they sure can).

    • Maybe that’s what you teach your students in Cambridge, Pontus, but that’s actually not all what is meant by Ricardian equivalence among economists todays.

      Ricardian equivalence — built on absolutely ridiculous assumptions — basically means that (fiscal) expansionary policies are ineffectual and that e.g. financing government expenditures through taxes or debts is equivalent, since debt financing must be repaid with interest, and agents — equipped with rational expectations — would only increase savings in order to be able to pay the higher taxes in the future, thus leaving total expenditures unchanged.

      And there is, of course, no reason for us to believe in that fairy-tale. Ricardo himself didn’t believe in Ricardian equivalence!

      And as one ‘Nobel Prize’ laureate in economics had it:

      “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.”

      So I absolutely think Blyth is in his right to criticise using Ricardian Equivalence as an underpinning of neoliberal wet dreams of Alesina-type ‘expansionary austerity’.

      Shit is shit even if wrapped up in a fancy looking package.

    • Nope, that is what Ricardian equivalence says. It is a proposition that takes all policies apart from tax/debt-shifting as given, and is therefore silent of the effect of other policies. I know you guys love to attach the most absurd caricatures of economics, and perhaps it has good entertainment value, but it is not correct.
      .
      I’m not writing these things to you — it’s hard to teach old dogs new tricks — but rather to set the record straight. People do not deserve to be misled by these imaginary views of what economists claim and so not claim.

      • Pontus’s definition of Ricardian Equivalence is good enough, but completely misses the point of Blyth’s rant. Blyth’s complaint is not against Ricardian Equivalence as a concept or about whether or how RE obtains, but rather about a chain of abstract reasoning stringing together Ricardian Equivalence with several other dubious concepts, including rational expectations, a permanent income hypothesis, time and debt inconsistency, in order to provide a fanciful theoretical explanation, all expressed in esoteric math, for how business confidence can make policies of deficit reduction (aka austerity), especially by reductions in public spending, expansionary, .
        .
        Alesina and Ardagna’s Large Changes in Fiscal Policy: Taxes versus Spending is freely available as a 2009 NBER working paper, if anyone cares to see “what economists claim” regarding the potential of expansionary austerity. This paper purports to generalize from case studies, and takes its theory to be given as follows:
        .

        “On the demand side, a fiscal adjustment may be expansionary if agents believe that the fiscal tightening generates a change in regime that “eliminates the need for larger, maybe much more disruptive adjustments in the future” (Blanchard (1990)). Current increases in taxes and/or spending cuts perceived as permanent, by removing the danger of sharper and more costly fiscal adjustments in the future, generate a positive wealth effect. Consumers anticipate a permanent increase in their lifetime disposable income and this may induce an increase in current private consumption and in aggregate demand. The size of the increase in private consumption would depend, however, on the presence or absence of “liquidity constrained” consumers. An additional channel through which current fiscal policy can influence the economy via its effect on agents’ expectations is the interest rate. If agents believe that the stabilization is credible and avoids a default on government debt, they can ask for a lower premium on government bonds. Private demand components sensitive to the real interest rate can increase if the reduction in the interest rate paid on government bonds leads to a reduction in the real interest rate charged to consumers and firms. The decrease in interest rate can also lead to the appreciation of stocks and bonds, increasing agents’ financial wealth, and triggering a consumption/investment boom.”

        .
        Alesina and Ardagna complement their demand side theory with a supply side argument that cutting wage rates increases “profits, investment and
        competitiveness.”
        .
        The Alesina and Ardagna paper, published or presented in various places in 2009-10 and coming as the culmination of a longer research program of similar arguments and projects, was influential, but seems like hackwork to me. It is pretty typical of a style of argument, that dumbs down economics with highly stylized concepts and econometric “facts” while employing a rhetoric of naïve pragmatism (“what works”) and serving the cause of a purely reactionary ideology supportive of the business interests of the very rich.


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