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Paul Krugman clarifies his point about temporary versus permanent spending:

Tyler's latest on temporary versus permanent government consumption clarifies what the confusion is over my very simple point. I don't think Tyler understands what I (and everybody else) means by government spending. I don't mean the government handing someone a rebate check; I mean the government actually, you know, buying something -- say, building a bridge.

When Tyler says

The Keynesian boost to aggregate demand arises because people consider the resulting bonds to be "net wealth" even when they are not,

the only way that makes sense is if he's thinking of a rebate check. If the government builds a bridge, the boost to aggregate demand comes not because people are "tricked" into feeling wealthier but because the government is building a bridge. The question then is how much of that direct increase in government demand is offset by a fall in private consumption because people expect their future taxes to be higher; obviously that offset is smaller if they think the bridge is a one-time expense than if they think there will be a bridge built every year. That's why temporary government spending has a bigger effect.

OK, I guess there's an alternative theory of what Tyler is talking about -- maybe he doesn't consider the wages of the bridge-builders count, that only what they do with those wages matters. But that's not the way either employment numbers or GDP are calculated: bridge construction is part of GDP.

I quake to take on a Nobel-Prize winning economist, so perhaps I should call these my misunderstandings of, rather than my problems with, the post.


As a lowly MBA, I do not think of spending money to build the bridge as a net increase in the country's wealth.  We exchanged money for a bridge worth the money we spent (or so we light-heartedly hope).  One could argue that the bridge would generate more economic value than it cost in taxes and deadweight loss; one could also argue that it will generate less (and Japan has quite a few bridges of this description).  But this is an argument for the bridge, not for bridge-as-stimulus.

The second thing I don't understand is the way that he is doing the discounted cash flow (DCF), which economists know as DPV.  Leaving aside the objects acquired with the money and the relative amazingness of the objects versus other possible uses of the money, public or private, as I see it, the cash flows on the single bridge are +$100 billion year zero, and (-$100 billion)(1 + [real rate of interest]) in years 1-10.   If I were a single taxpayer (and the various gains and losses should, in my highly theoretical model with no frictions, net out so that it is appropriate to view us as The American Taxpayer), then I should rationally set all the money I gain in bridge-building income aside in order to cover the later taxes that will be required to repay the principal and interest.  After all, I will not be earning that money again in the future, so unless I want to take a sizeable hit to my consumption later, I'd better save it.

Assuming that the real interest rate approximates the time preference of said American Taxpayer, and that the bridge is worth exactly what we paid for it, the net economic benefit is zero.

Now, say that I know with perfect certainty that we are going to build an extra bridge every single year.  This tells me that my taxes in the future will go up $100 billion a year.  But it also tells me that my future income will go up $100 billion a year.  The net economic effect is again zero.  Perhaps there is some reason to believe that taxpayers pay more attention to future taxes than spending, but I'm not sure I understand this assumption.

Now, in the real world, people are not perfectly forward looking, do not have great certainty about the future path of government spending, the benefits of spending do not fall on people with identical time preference to those from whom the taxes are taken, and so forth.  But the efficacy of spending in generating a net economic benefit--a positive shock to Keynes' "animal spirits"--does seem to rest on people not believing that the bridge will cost them as much as it is costing the government, or else failing to act on the belief that it will.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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