The ‘tiny little problem’ with Chicago economics

7 November, 2017 at 17:25 | Posted in Economics | 3 Comments

14-john-cochrane.w710.h473.2x Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions.

John Cochrane

And the tiny little problem? It’s utterly and completely wrong!

What Cochrane is reiterating here is nothing but Say’s law, basically saying that savings are equal to investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. As some of my Swedish forerunners — Gunnar Myrdal and Erik Lindahl — stressed more than 80 years ago, it’s really a question of ex-ante and ex-post adjustments. And as further stressed by a famous English economist about the same time, what happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

Government borrowing is supposed to “crowd out” private investment.

william-vickrey-1914-1996The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey

In a lecture on the US recession, Robert Lucas gave an outline of what the new classical school of macroeconomics today thinks on the latest downturns in the US economy and its future prospects.

lucLucas starts by showing that real US GDP has grown at an average yearly rate of 3 percent since 1870, with one big dip during the Depression of the 1930s and a big – but smaller – dip in the recent recession.

After stating his view that the US recession that started in 2008 was basically caused by a run for liquidity, Lucas then goes on to discuss the prospect of recovery from where the US economy is today, maintaining that past experience would suggest an “automatic” recovery, if the free market system is left to repair itself to equilibrium unimpeded by social welfare activities of the government.

As could be expected there is no room for any Keynesian type considerations on eventual shortages of aggregate demand discouraging the recovery of the economy. No, as usual in the new classical macroeconomic school’s explanations and prescriptions, the blame game points to the government and its lack of supply-side policies.

Lucas is convinced that what might arrest the recovery are higher taxes on the rich, greater government involvement in the medical sector and tougher regulations of the financial sector. But – if left to run its course unimpeded by European type welfare state activities -the free market will fix it all.

In a rather cavalier manner – without a hint of argument or presentation of empirical facts – Lucas dismisses even the possibility of a shortfall of demand. For someone who already 30 years ago proclaimed Keynesianism dead – “people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle to one another” – this is of course only what could be expected. Demand considerations are simply ruled out on whimsical theoretical-ideological grounds, much like we have seen other neo-liberal economists do over and over again in their attempts to explain away the fact that the latest economic crises show how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be the government.

Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich. Trying to explain business cycles in terms of rational expectations has failed blatantly. Maybe it would be asking too much of freshwater economists like Lucas and Cochrane to concede that, but it’s still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one in economics will know who Robert Lucas or John Cochrane was. John Maynard Keynes, on the other hand, will still be known as one of the masters of economics.

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3 Comments

  1. “My rational expectation is that 30 years from now, no one in economics will know who Robert Lucas or John Cochrane was. John Maynard Keynes, on the other hand, will still be known as one of the masters of economics.” RIGHT!!

  2. I think both the Chicago school and keyns idea about liquidity in the Economy should be forgotten. Both are from an age of paper money where more sales in a firm results in larger demand of paper money. In the modern age of computing there is no reason why an increase in sales should increase demand for money.

  3. God all mighty!!Lucas, Milton F et !!!Chicago Uni.Once up on a time the home of people like Carl Sandburg and John Dewey! What a a decline it´s sad, and “Swedens next largest town” there nearly half of all swedish immigrants found their home.

    CHICAGO-Carl Sandburg

    HOG Butcher for the World,
    Tool Maker, Stacker of Wheat,
    Player with Railroads and the Nation’s Freight Handler;
    Stormy, husky, brawling,
    City of the Big Shoulders:

    They tell me you are wicked and I believe them, for I
    have seen your painted women under the gas lamps
    luring the farm boys.
    And they tell me you are crooked and I answer: Yes, it
    is true I have seen the gunman kill and go free to
    kill again.
    And they tell me you are brutal and my reply is: On the
    faces of women and children I have seen the marks
    of wanton hunger.
    And having answered so I turn once more to those who
    sneer at this my city, and I give them back the sneer
    and say to them:
    Come and show me another city with lifted head singing
    so proud to be alive and coarse and strong and cunning.
    Flinging magnetic curses amid the toil of piling job on
    job, here is a tall bold slugger set vivid against the
    little soft cities;

    Fierce as a dog with tongue lapping for action, cunning
    as a savage pitted against the wilderness,
    Bareheaded,
    Shoveling,
    Wrecking,
    Planning,
    Building, breaking, rebuilding,
    Under the smoke, dust all over his mouth, laughing with
    white teeth,
    Under the terrible burden of destiny laughing as a young
    man laughs,
    Laughing even as an ignorant fighter laughs who has
    never lost a battle,
    Bragging and laughing that under his wrist is the pulse.
    and under his ribs the heart of the people,
    Laughing!
    Laughing the stormy, husky, brawling laughter of
    Youth, half-naked, sweating, proud to be Hog
    Butcher, Tool Maker, Stacker of Wheat, Player with
    Railroads and Freight Handler to the Nation.


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