I mentioned in my last blog entry three recent articles in the Economist magazine that criticize macroeconomists and finance theorists for their inadequate performance in regard to the current financial and economic crisis. The articles rely heavily on criticisms from within economics itself, notably from Joseph Stiglitz, Paul Krugman, and Bradford DeLong.
But here is what is notable about those criticisms: the economist critics do not themselves have a firm grasp on the crisis. You can tell this from their views on the stimulus. The "stimulus" is the $787 billion dollar program of deficit spending that Congress at the urging of the Obama Administration enacted in February. The stimulus is criticized by some conservative economists, such as Robert Barro, Eugene Fama, and John Cochrane, as incapable of increasing employment. Their argument is that because government expenditures must be paid for one way or another, a dollar of deficit spending subtracts a dollar from private investment, and so there is no net increase in output. The argument is unconvincing. If private demand falls, investment geared to production of goods and services for private consumption will fall. People's savings (other than cash savings) will be invested, but in assets such as Treasury securities and money-market accounts that do not generate productive activity, or much such activity. Even investments in equities and commercial bonds have only an indirect, and often long-delayed, effect on production. In contrast, if government hires private firms (road contractors, for example) to produce goods and services that they would not otherwise produce because private demand is insufficient, there is an immediate effect on output and therefore on employment--immediate, at least, when the private firms begin to hire and produce.
That word "immediate" brings me to the centrist criticism of the $787 billion stimulus, which is that it was poorly designed and is being lackadaisically executed. Too much of it has taken the form of tax and other benefits, much of which may be saved rather than spent--and even that needlessly feeble form of stimulus is on a slow track. Too little is going to the states, to enable them to avoid tax increases and layoffs necessitated by the sharp depression-induced reduction in tax revenues and the states' limited borrowing power (and they can't create money--"monetize the debt"--as the federal government can do). The public-works part of the stimulus package is not targeted on areas of the countries, and industries, with the greatest unemployment. Forms of stimulus, including increasing the investment-tax credit and replacing military equipment inventories depeleted by the Iraqi and Afghan wars, have been overlooked. And the Administration has failed to appoint an official who would act as the expediter of the program, cutting the red tape that is delaying execution.
The left criticism of the stimulus--the criticism made by economists such as Stiglitz, Krugman, and DeLong--is that the stimulus is too small. They want a second stimulus. They have not named a number, but from their criticisms it seems that they would want $1 trillion or more. They may be right that the $787 stimulus is inadequate, but its inadequacy may be due less to its size than to its poor design and sluggish implementation. It will probably be spent over three years, for an average of $250 billion a year, and that is less than 2 percent of the Gross Domestic Product.
But without analysis and explanation that the left economists have not furnished, the idea of enacting another stimulus package of the same or larger size is irresponsible. With the national debt soaring, the question whether the nation can afford another $1 trillion or so of debt is acute. And what would the money be used for? And when would it come on line? And how would it be deformed as it wended its way through Congress en route to enactment? The states appear to be facing a budget shortfall of $100 billion, and there is an argument for a federal loan of that amount. But the other $900 billion? Could it be spent in the near term, or would it not be spent until 2011 and 2012, at which time it could have a strong inflationary effect?
I am not saying that there is no case for a further stimulus. But I haven't seen the case made. To make it effectively would require a knowledge of the economy that macroeconomists appear not to possess.
One begins to wonder whether the current crop of economists has made or will make an original contribution to fighting the economic crisis. It is not as if such weapons as easy money (the Federal Reserve's expansion of the money supply to drive down interest rates), bailouts of banks and other financial institutions, and deficit spending were inventions of modern economists. They were well known in times past (for financial crises are nothing new) to bankers and other businessmen and to economists such as Walter Bagehot (a nineteenth-century journalist rather than a professional economist), Irving Fisher, and John Maynard Keynes. Keynes in particular seems the best guide to digging our way out of our current economic crisis, even though he has been dead for 63 years and his great work The General Theory of Employment, Interest and Money (1936) has been neglected rather completely for the last 30 years or so.