Chicago economics — garbage in, gospel out

18 May, 2019 at 15:10 | Posted in Economics | 4 Comments

Savings-and-InvestmentsEvery 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

The problem with this view is, of course, that it is utter and complete nonsense!

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!

william-vickrey-1914-1996As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly … 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 Fifteen Fatal Fallacies of Financial Fundamentalism

As could be expected there is no room in Chicago economics 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.

Robert Lucas and other Chicago economists have again and again dismissed 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 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 is still a fact that ought to be embarrassing. My rational expectation is that 30 years from now, no one will know who Robert Lucas or John Cochrane was. John Maynard Keynes and William Vickrey, on the other hand, will still be known as two of the masters of economics.


  1. If you ask an Austrian Economist then Say’s law means that “you cannot consume something you have not produced”. What economic school is saying that Say’s law is an accounting identity?

  2. “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.”
    MMT denies this reasoning, saying that financial capital must all net to zero therefore someone’s saving depends on the government already having spent that dollar as deficit spending, or perhaps printed it.
    I would up Vickrey’s “two or more” to “ten or more”.

  3. Lucas did launch various appalling attacks against Keynesianism.
    However, his view that “people don’t take Keynesian theorizing seriously anymore” might have the support of Leijonhufvud who, in his same era (1979) paper (The Wicksell Connection) , claimed that (p.53):
    “There obviously was an American school in the days of Alvin Hansen’s famous Harvard seminar and for some time thereafter. One cannot off-hand date its demise. But it is doubtful that anyone who has gained prominence in the profession and is now under the age of 40 would accept the label “Keynesian” for himself. So we know the school is done for.”

  4. The quotation from Cochrane is so stupid that I clicked thru to read the whole piece, where it just gets worse and worse. What is wrong with mainstream economics that this moron can publicly tout an argument so fallacious, so ill-conceived without losing his academic position or credentials?

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