Home > Uncategorized > The ‘tiny little problem’ with Chicago economics

The ‘tiny little problem’ with Chicago economics

from Lars Syll

14-john-cochrane.w710.h473.2xEvery 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.

  1. November 11, 2017 at 8:44 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.”
    My father, who possessed a masters in economics from the University of Chicago, would have agreed with this statement, as I do. My best undergrad economics teacher, the late Art Leigh, his PhD from the University of Chicago Economics Department, disagreed in almost every way with the Chicago Boys ideology. My best grad school teacher, the late Irv Hoch, got his PhD from Friedman’s Chicago school and was a freemarket fundamentalist throughout his career. Irv and Lucas were contemporaries at Chicago. I loved Irv as a human being, thought him a great and creative teacher, and disagreed with him on almost all ideological issues. His true belief mystifies me to this day, as he had too good a mind to be caught in the grip of this dangerous zombiness.

  2. November 11, 2017 at 10:32 pm

    “Every dollar of increased government spending must correspond to one less dollar of private spending.”

    Wrong, for a government that issues its own currency (directly or through its central bank). The Modern Money Theory people have disentangled the complexities and extracted this:

    FIRST the government issues money into circulation, THEN it removes money by taxation. The two do not have to balance, i.e. there can and should be a net amount of government fiat money in circulation. A government ‘deficit’ ADDS to the total money supply.

    So there is a different accounting identity, attributed to Wynne Godley:

    Domestic private sector balance + Domestic government sector balance + Foreign sector balance = 0

    It means a government deficit enables private savings.

    Ultimately if there were not government debt there would be no money.

    See J. D. Alt here http://neweconomicperspectives.org/2017/11/wouldnt-great-america-fiat-money-system.html and in The Millennials Money https://www.amazon.com/Millennials-Money-Generation-Afford-Better/dp/1457545128/ref=sr_1_1?s=books&ie=UTF8&qid=1510439268&sr=1-1&keywords=J.+D.+Alt .

    This does not apply to governments that can’t issue money, e.g. states, provinces and Euro countries. But it still applies to their national/supranational authorities.

  3. November 12, 2017 at 1:39 am

    Sometimes good minds come with weak consciences. There are a million people dead in Iraq, killed by the economists who advised W and L Paul Bremer on economics policy in 2003. A moment of silence for the widows and orphans of these fatalities, please.

    • charlie
      November 16, 2017 at 5:29 am

      and three trillion dollars of debt … should we thank them for the debt? or curse them for their offspring …

  4. Risk Analyst
    November 12, 2017 at 1:44 am

    The forecast that 30 years from now students will know Keynes but not Lucas is suspect. Today I went to an open house of a second or third tier college and stopped by the economics stand to ask what they were teaching. They start with the Krugman book said the professor who was standing next to the guy with the “Chairman” label on his jacket. When pressed about alternative views, they said they offered some Keynes readings in the history of economics classes but that it was not really important or stressed because Keynes was difficult to read. There might be some socialist readings in that history class also admitted the professor. They were very enthusiastic about the mathematics and econometrics classes and how they were next year teaming up with the computer science department for programming classes for economics students. On a related subject, it is also quite difficult to get crabgrass out of your lawn once it has invaded.

  5. robert locke
    November 12, 2017 at 9:18 am

    How long has Says law been in dispute? Then why are we still disputing it?

  6. November 12, 2017 at 9:42 am

    R. E. Lucas. In the 2003 presidential address to the American Economic Association, Robert E. Lucas, Jnr of the University of Chicago said:
    “My thesis in this lecture is that macroeconomics in this original sense has succeeded: Its central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

  7. November 12, 2017 at 9:45 am

    ‘Lucas on “foxhole Keynesianism”:reply
    Mr. Lucas believes Ben Bernanke acted properly to prop up the system. He doesn’t even find fault with Mr. Obama’s first stimulus plan. “If you think Bernanke did a great job tossing out a trillion dollars, why is it a bad idea for the executive to toss out a trillion dollars? It’s not an inappropriate thing in a recession to push money out there and trying to keep spending from falling too much, and we did that.”
    It’s interesting that this position would be contradicted by Lucas’ own preferred macro models. I guess this just goes to show how deep the intuitive sympathy for Keynesian ideas runs, even among the titans of neoclassical macro. ‘

  8. November 12, 2017 at 9:47 am

    What Cochrane is reiterating here is nothing but the assumption of no involuntary unemployment. i.e. that all unemployment is voluntary!

  9. November 12, 2017 at 12:36 pm

    Again, not all worthy employment is paid nor paid employment worth having …

    “Let other folk make money faster;
    In the air of darkened towns;
    I don’t dread a peevish master.
    Though no man may heed my frowns
    I be free to go abroad,
    Or take again my home-ward road,
    To where, for me,
    The apple tree
    Do lean down low in Linden Lea”.

  10. November 12, 2017 at 4:18 pm

    Here is a recent analysis of the effects of government monetary and fiscal policy: http://necsi.edu/research/economics/econuniversal

  11. November 12, 2017 at 8:57 pm

    Of course one should read things charitably. But there is a danger of always reading too charitably, for life is finite. With enough work anything whatsoever can be made to “make sense”. A time to pause is when the reader’s (the haruspex’s?) work in “interpreting” far outweighs that of the writer. This goes for Cochrane’s words or other interpretations of them considering “involuntary” unemployment (as if there were any other kind!), Say’s Law or “an accounting identity”. OK, which identity? according to which definitions? in which book?. I can sorta guess, I guess, but precisely how is what he is saying any of these? I am stupid. Connect the dots for me, and show me just how that cloud is a camel, not a weasel or a whale.

    For reading Cochrane’s words as ordinary English, they are not any of the above. They are insane raving from an academic madman in authority. It is doubtful that there has ever been any situation in human history to which they apply.

    Note: “Nothing to say about … it” & “totally uninteresting” are signs that the whole matter is here being evaded. So everything else BUT such a “nudge-nudge” may be safely skipped.

    • November 13, 2017 at 9:33 pm

      “Connect the dots for me, and show me just how that cloud is a camel, not a weasel or a whale [and] Cochrane’s words … are insane raving from an academic madman in authority.”
      I agree with this last statement. I constantly hope to connect dots these days, and the camel/weasel/whale is only comprehensible to me in terms of the emperor’s new clothes.

      At the risk of sounding like a broken record, I can only comprehend and connect dots when the elephant in the room — imperial acquisitive predatory corporate capitalism — is fully acknowledged, its pernicious role recognized, and its inherent qualities of instability, inequality, unsustainability, anti-democracy and anti-life made transparent. Neoclassical economics must be seen for what it is: the intellectual cover — the design, manufacture, and donning of the elephant-emperor’s clothes — to hide the essential nature of this capitalism. All sorts of logical absurdities can be comprehended this way: the bloodless cipher that is “economic man; the quasi-religious sanctity of private property; the insanely inventive concept of goodness that is Pareto efficiency. As Rob Urie states in his book, Zen Economics: “Either the premises make sense or the theoretical frame of Western capitalism is rendered unintelligible.”

      • Risk Analyst
        November 13, 2017 at 10:25 pm

        “Smoking kills. If you’re killed, you’ve lost an important part of your life.” Brooke Shields

        And I might point out that Ms. Shields likely has more money, fame and exposure than the sum total of everyone here. Being right and being successful frequently have nothing to do with each other. Dislodging the neoclassical view is not going to be done by showing them they are wrong. They don’t care.

      • robert locke
        November 14, 2017 at 2:26 pm

        What is to be Done. Con’t analyze the world, change it. Serious people have always known that the issue is getting rid of neoclassical economic’s stranglehold on the subject. I think it can be done only by opposing the neoclassical economics system in its weakest link. Outside the US and the UK.

      • November 14, 2017 at 3:34 pm

        If by “them” Riskanalyst means such as Cochrane, I completely agree. But my communication is not for them; I have nothing to say to true-believer ideologues such as Cochrane. Nor is my purpose to show someone “they’re wrong”.

        My purpose is to suggest that, since we live in an increasingly unregulated predatory corporate capitalist context, most of our reform proposals may amount to mere tinkering, if they are achievable at all. With the commonweal threatened by unlimited cash for political campaigns, this context may be unmediated by “democracy” as well.

        Although it certainly is debatable, context is extremely important. Predatory corporate capitalist context is central to every important public policy I can think of. Without understanding this dominant context, I believe that changes in the economic and political orthodoxies are mere tinkering and that reforms will continue to fail.

        And “Serious people have always known that the issue is getting rid of neoclassical economic’s stranglehold on the subject”? I know many “serious people” and they appear to me to know nothing of the sort. They continue to believe in Samuelson’s version of Keynes and in supply and demand “natural” law. Their knowledge of the subject provided by the one class they had called “Econ 101”.

  12. robert locke
    November 15, 2017 at 10:26 am

    IF “Predatory corporate capitalist context is central to every important public policy [you] can think of, THEN, why would you call those who …ncontinue to believe in Samuelson’s version of Keynes and in supply and demand ‘natural law” “serious people.” I took Econ 101 in the 1950s using Samuelson’s version of Keynes as text, and decided to study history. Historians make lousy ideologues.

    • November 15, 2017 at 11:02 pm

      I was responding to your use of the term “serious people” without fully understanding your use of the term. I’m referring to people who are my friends and acquaintances, and some family members. By the standards of our shared culture, they had successful work lives (we all are retired). All are well-educated, many with masters, some with PhDs in their fields. They are thoughtful, considerate people, and not highly neurotic. True believers in objectivity and rationality. Believers in science. 40% are retired teachers. Comfortable middle class and above. I take them seriously as I feel I must consider anyone who is fully adult.

      But I find most of them clueless about political power and citizen power, as none of them had the activist career I had. I am the only one trained in the field of economics. All claim to have taken some economics in college. About three years ago some of them asked me to lead a discussion about Piketty’s book, which I did. To prepare, I needed to immerse myself in a discipline I had discarded a half-century ago, as I had become averse to the idea of economics as a career.

      For some reason, many of these intelligent, critical-thinking people accept orthodox economics and cannot seem to connect the dots between their deep concerns about the environment and inequality, on the one hand, and the fact that the dominant ideology that shapes our economic lives is global inperial financialized predatory corporate capitalism.
      I resist being too critical, simply choosing to keep presenting how I now connect the dots. I must choose a bit of humility, because it took me a long time to connect the dots. My years of orthodox economics training left their mark, even though I now am a harsh critic. When I decided to leave the field, my intellect was not in tune with my emotions and my intuitions. The latter told me something was wrong. My intellect was too distracted to figure it out then. And I pursued an unrelated career.

      I’m not sure why my friends are so slow to get it. Perhaps they need more time (even as we feel we’re running out of time). Perhaps it’s a form of denial. Perhaps they feel a deep sense of despair. Perhaps they don’t connect the dots because it might threaten their comfort level. Perhaps they just take it all for granted because of corporate power. Our culture is steeped in conventions and perhaps this is one I’ve been lucky to escape.

      I find that most of my friends, and it seems much of the white culture of the United States, have trouble with the idea that America is exceptional only in its imperialism. Perhaps it is because they found their niches in their native culture that blinds them. I don’t know.
      What I can say is this: my friends are serious people, but they are not serious students of economics, nor do they claim to be.

      I hope this clarifies. Sorry for going on a bit. By the way, in school I hated history. After retiring I spent some time on the subject and now I love it.

      • robert locke
        November 16, 2017 at 7:40 am

        In 1954, I was fired from my summer job for being a soviet sympathizer. That was the result of my studying history as an undergraduate (UCLA) where I learned that the German army in WWII was defeated primarily by the Soviet Union. I told this to my co-workers on the summer job; they accused me of being a soviet sympathizer, and I was physically threatened. I was right; but it lost me my job during the McCarthy hysteria in the US. I ended up leaving the country because of the brain washing Americans went through made me an alien in my own land. Been that way ever sense. But at least, living decades outside the US, I developed a different perspective on things. Just as I did when I was required to teach World Civilization in Hawaii. Most people have trouble thinking outside the box of their own world, but any good history department in US universities offers a variety of courses that helps people do it. Economics closed itself off from perspective varieties in postwar US and the UK.

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