New School Economic Review

Previous Post: Free Pictures of ’29 Recession, FDR & WWII   Next Post: Samuelson: “Look to History”

Chicago and Macro goes the way of the Dodo

by Benjamin on June 18, 2009

Alright then, has everyone now heard the argument that more debt funded government spending will crowd out an equal and opposite private investment or consumption? I’m sure it sounds familiar, because there is something about that story, especially as it is sold by Chicago’s Eugene Fama and John Cochrane very recently.

The story excludes the current circumstance of the economy (recession), it assumes – in its classic form – that the economy is not credit driven, and as Paul Krugman complains: “What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship”. In fairness Krugman is only responding to Brad DeLong who goes a little further in lambasting the Chicago guys:

Milton Friedman knew this. Irving Fisher knew this. Simon Newcomb knew this. David Hume knew this. John Cochrane does not know this: does not know that the velocity of circulation is an economic variable rather than a technological constant. I do want to pound my head against the wall. I do not know what else to do…

And here is where the dark ages come in. The Dark ages were dark, because so much knowledge had been lost, and so much more was misunderstood. Some of us might argue that the misunderstandings have been going on for a while, it’s just now that the rest of the profession are catching up. Rudi von Arnim points to a recent article by Benn Steil (director of the Council of Foreign Affairs) who does violence to Keynes and macro through a microeconomic allocation of labour and capital concluding that government spending will only confuse the price mechanism in an otherwise functioning equilibrium. Never mind the macro or the economy, von Arnim worries that

The lack of understanding of ‘depression economics’ is truly, truly depressing. As an aside: No wonder this piece was first published in Forbes. The Econ-guys from Forbes are special buddies of CNN’s Ali Velshi, who is going to run business and economics reporting there in the ground.

And what are all these predictions based on? Empirical estimates of the current crisis? No. Economic History looking at the last great depression? No. How about the evidence from the WWII borrowing to spend budgets which gave us the highest government debt figures as a % of GDP ever? No. This is all based on an assumption, or in Krugman’s words the “ineluctable implication of an accounting identity”. If they had bothered with data they might have found evidence for borrowing ones way out of a recession with the loans paying for themselves in the resulting growth period (as was the case post WWII, and the argument Keynes made at the time), or maybe it might work (which seems to be a consensus on the ’29 crisis)… A Dark Age indeed

Tags: Academica, Benn Steil, Brad DeLong, Chicago, Economics, Macroeconomics, mainstream, Paul Krugman, Rudi von Arnim