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The tiny little problem with Chicago economics

from Lars Syll

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 Fifteen Fatal Fallacies of Financial Fundamentalism

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.

Lucas starts by showing that real US GDP has grown at an average yearly rate of 3 per cent 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 shows how the markets have failed to deliver. If there is a problem with the economy, the true cause has to be 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 to 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 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.

  1. June 2, 2016 at 2:46 pm

    It is really rather simple. The govt first spends money into the economy and then, to maintain price stability, must destructively extract some of the money they spent. We call it taxes. Then the govt can spend more, each time taking back a part of the previous spending. This results in a natural “debt” by bookkeeping and that so called debt is the same as the money in the economy! It is a very simple and accurate concept. .

  2. June 2, 2016 at 10:55 pm

    “Chicago economics is a dangerous pseudo-scientific zombie ideology that ultimately relies on the poor having to pay for the mistakes of the rich.”

    Austerity is an old and stable form of wealth centralization. But the basic milieu has changed. Now increased economic growth via increased demand is a prescription for global climate collapse. This is an entirely new ball game.

  3. June 3, 2016 at 7:48 am

    The way that the poor pay for the existence of the rich has not yet been explained. Basically it is due to the way land can be owned and not shared, but its value speculated in, driving up utilization costs and reducing its availability for its proper use. This makes good and proper use and accommodation on it more costly–it limits the chances for entrepreneurs to compete with big organizations and for these smaller producers to provide more employment. Land ownership is monopolization of the opportunities to produce and to have a home on a small site.

    The solution to this problem is to legalize the collection of the land rent by the government in lieu of a tax, on what is not being available for everybody’s use. This subject has been called Land Value Taxation (LVT), which strictly speaking it is not. It is a revenue for the right to withhold opportunity. When LVT is in place, other kinds of villainously enforced taxation can be scrapped with considerable benefits for almost all the community, except those who would exploit land values for selfish reasons.


    • June 3, 2016 at 9:35 pm

      I think it is rather obvious why inequality has evolved. The primary driver has been tax policy. When we had a 95% marginal rate paying large salaries was just not done with only 5% getting to the payee. The reduction of marginal rates has enabled paying grotesque salaries in many venues.

    • Max
      June 4, 2016 at 2:08 am

      Then the rich buy something else. The problem is that the system is geared towards the rich being able to fund themselves very cheaply while the poor can only save the little bit they have in a bank account that pays no interest while at the same time inflation keeps on eating up their fiat savings. So you tax land, they buy companies or commodities or whatever it is. Taxing land is trying to treat the symptoms. You need to solve the problem at the root, which is central bank policy.

      • June 4, 2016 at 7:47 pm

        Max, its not money but land which is the real problem. Money was involved only after speculation in land values drove up the price of land and allowed the landlords and their buddies the banks to get deeply involved and for their bubble to eventually burst. Money control will not stop speculation in land values and it is more fundamental. By taxing land values, there will no longer be any advantage in withholding useful sites from use and speculation in its value will cease. Then the banks will have to encourage the investors to place their bets on something that can really help the economy forward–namely durable capital goods.

  4. Max
    June 3, 2016 at 10:28 am

    Regardless what Chicago economics might be, nobody can deny anymore that keynsian economics has led to “the poor having to pay for …..the rich.” What keynes misunderstood is that the savers are the haves and the borrowers are the have nots. Obviously the opposite is true. The poor have no access to credit. The richer you are, the more access you have. Keynsian economics has led to the perverse situation where the richest can borrow almost infinitely at no cost, then use the funds to purchase assets which then are driven up in price by the same keynsian inspired central bank policies. Whether or not Chicago economics also lead to wealth transfer from the poor to.the rich is irrelevant as chicago economics play no role in todays world. Keynes has won, that is why the rich become richer and the poor poorer.

  5. charlie
    June 4, 2016 at 4:28 am

    anyone who has read at Piketty (me) suspects that Max is 180 deg from reality I hope to get a copy of Fullbrook and Morgan to see if my reading is consistent ..

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