I spoke with Robert Barro of Harvard yesterday about the stimulus bill, fiscal policy, and related issues in macroeconomics.
I wanted to speak with Professor Barro after reading his piece in the Wall Street Journal about the multiplier on government spending. The piece, which argued that the multiplier has historically been much lower than the Obama administration hopes, produced a tremendous amount of response -- from Paul Krugman, Brad DeLong, Greg Mankiw, Matt Yglesias, and Tyler Cowen (some of them several times). And that response was notable, in part, because it turned into a reflection on the "standards" of the stimulus debate itself. I was interested to hear what Barro thought about his critics this debate.
He was admirably patient with my questions:
Conor Clarke: What I am trying to do is sort of apply a barometer to
modern macroeconomics and see where the profession is, because I am
sort of confused by a lot of things.
Robert Barro: [laughs] Probably the fault of the profession.
Well, one thing I am confused by is where all of this resurgent interest and fiscal policy came from. That's very broad. But where do you think it came from? When I took macroeconomics in college there was not a lot about fiscal policy.
It came from the crisis and memories of the Great Depression and the fact that monetary policy seems to have done not a tremendous amount, and conventional stuff doesn't look like its going to work anymore. And it's about grasping at straws to try and find something else.
And I take it from the Wall Street Journal piece you wrote last week... well, the piece is just specifically about measuring multipliers, but I take it that you are fairly skeptical in general that fiscal policy will boost aggregate demand.
Right. There's a big difference between tax rate changes and things that look just like throwing money at people. Tax rate changes have actual incentive effects. And we have some experience with those actually working.
What would you say is the best empirical evidence there?
Well, you know, it worked to expand GDP for example in '63 and '64 with the Kennedy/Johnson cuts. And then Reagan twice in '81 and '83 and then in '86. And then the Bush 2003 tax-cutting program. Those all worked in the sense of promoting economic growth in a short time frame.
I'm the middle of a study where I am trying to estimate this overall, going back to 1913 -- sort of constructing some measure of the overall effect of the tax rate at the margin, at the moment. I'm just looking at that now, actually...
You're talking about the multiplier on a dollar of...
Well both things, but here I'm talking about the tax rate stuff. Get some measure of the effect of marginal tax rate that comes from the government -- federal, state, local. And then you can see what it looks like going down or going up and how the economy responds. And then, in addition to that, the government might be spending more or less money on either military stuff or not on military stuff. And we can estimate that at the same time. With the government spending stuff, the clearest evidence is in wartime. It's not that it's the most pertinent, but it's the clearest in terms of evidence because it's the dominating evidence at those times, especially during the world wars.
Do you read Paul Krugman's blog?
Just when he writes nasty individual comments that people forward.
Oh, well he wrote a series of posts saying he thought the World War II spending evidence was not good, for a variety of reasons, but I guess...
He said elsewhere that it was good and that it was what got us out of the depression. He just says whatever is convenient for his political argument. He doesn't behave like an economist. And the guy has never done any work in Keynesian macroeconomics, which I actually did. He has never even done any work on that. His work is in trade stuff. He did excellent work, but it has nothing to do with what he's writing about.
I'm not in a position to...
No, of course not.
I'm not in a position to know things like the degree to which Paul Krugman counts as a relevant expert on new Keynesian economics.
He hasn't done any work on that. Greg Mankiw has worked in that area.
Greg Mankiw is, I guess, skeptical of spending for the same reasons
that you are: he says that there's some empirical evidence -- I think
he cites the Christina Romer study from 15 years ago -- that a dollar of tax cutting has a larger impact than...
The Romer evidence is very recent actually. It's an ongoing project.
I thought it's from 1993 or something like that. Maybe that's something else.
They have a current thing that's going to be presented at Brookings at the next meeting, where they have some estimates of how the economy responds to tax changes. It's not really looking at tax rates. It's looking at tax revenue, which is not the same thing. That's mostly what Greg was referring to, which is going to be presented in a few months.
I would need to go back and check. But one question, and I think Greg Mankiw raises this question as well, is, Why does this set of evidence depart from what seems like the standard Keynesian theory that a dollar of spending would have a larger multiplier than a dollar of tax cutting?
I don't think it is really confusing at all, because when you cut taxes there are two different effects. One is that you cut tax rates, and therefore give people incentives to do things like work and produce more and pay more -- maybe, depending on what kind of taxes. And then you also maybe give people more income. This income effect is the one that's related to this Keynesian multiplier argument, where it's usually argued that government spending should have a bigger effect. So that's the income effect. But the tax-rate effect, inducing people to do things like work and produce more and invest more, is a whole separate effect, and that could easily be much bigger than the multiplier thing, than the income thing.
This might just be my confusion, but the inducement to work, is separate from the idea of boosting aggregate demand and consumption in the short run.
Oh it's exceptionally different. But the experiment is that the government is doing something by changing the tax system to lower its collections -- by, for example, a tax cut. The response of the economy to that is not going just to isolate this business of giving people money. It's also going to have these incentive effects, more than tax rebates, on economic activity. It's going to be a combination of those two things -- income effects and incentive effects. One piece looks like this sort of multiplier stuff, which is analogous to government spending -- probably because the government spending has a first-round effect where it comes in and directly affects the aggregate demand -- and then in the second round it sort of looks like a tax cut. That's why the government spending thing is bigger in textbooks: because it has this first round in addition to all these subsequent ones.
But all that is just income responses -- people having more or less income, or the government keeping the money and then that shows up as people's income. None of that is about responses in terms of incentives -- incentives changing in response to lower or higher tax rates. And the evidence that Romer and Romer look at is combining the tax rate stuff with the income stuff. I didn't know it was possible to do that but, hey, you get different viewpoints form different people. But the study I am doing now is intended to include all these things together in one framework.
And when does this study come out?
Who knows. I mean, it's a big project, we've been working on it for a while. Part of it is just measuring, back since 1913, the effect of the tax rate that the federal government or the total government is levying on people. Measuring that was a big project. But we've sort of finished that.
I just have two more questions, quickly. One is that you've mentioned that monetary policies sort of seem to be stuck. And I guess there have been a couple of people -- Robert Lucas is one that comes to mind and maybe Greg Mankiw too -- who say there are other kinds of monetary policy that can still be pursued.
Oh I agree with that. There are things that they can still do. The sort of standard stuff. They drove the nominal rates on the usual government paper down to zero, and they drove down the federal funds rate, so they don't have any more leeway on that. But there is plenty of other stuff that they can do and that they are doing.
And what is that?
The Federal Reserve is buying up all kinds of other assets, like long-term government bonds. But they are also buying a lot of private stuff, and that will presumably have a substantial impact. I mean there's a downside to doing all this, but it should certainly have effects. So in that sense they haven't run out of ammunition. I agree with that.
The last thing is just about the stimulus bills as it stands. Two things here. One thing is what do you think about the ratio of spending to tax relief in the bill. And the second is, if you judge it by Larry Summers standard -- that stimulus be temporary, timely and targeted -- does it clear the bar?
This is probably the worst bill that has been put forward since the 1930s. I don't know what to say. I mean it's wasting a tremendous amount of money. It has some simplistic theory that I don't think will work, so I don't think the expenditure stuff is going to have the intended effect. I don't think it will expand the economy. And the tax cutting isn't really geared toward incentives. It's not really geared to lowering tax rates; it's more along the lines of throwing money at people. On both sides I think it's garbage. So in terms of balance between the two it doesn't really matter that much.
Well, presumably Larry Summers is not an idiot.
[laughs] That is another conversation. I have known him for 25 years, and I have opinions about that.
Well, presumably Christina Romer is not an idiot if you're...
They've brought in some reasonable people in terms of economic advisors. I don't know what impact they're having, and I suppose they have different views on Keynesian macroeconomics than I have. But I'm giving you my opinion about it.
I think Geithner is a good appointment. I think he's going to focus on what really matters, which is the financial system and the housing market. That's where they should be putting their efforts. That's where the problems came from.
Fixing the credit market, you mean?
was the main problem in the Great Depression, too. Though then it was
concentrated on commercial banks which were the main credit vehicle.
That was the main problem in the depression and fixing that was the
main thing that ended the depression.
Well since you brought it up... I have no idea what your views are on financial economics, but it seems like there's going to be another round of TARP-like bailouts. Do you have an opinion on how that should be structured?
That's a hard problem. I mean, they're basically floundering around -- the crew of the previous administration more than the current one. But I admit they're having a good effect by putting more resources into assistance. The exact way to do it is pretty tricky. It's not clear what the best thing to do is. Larry Summers did bring in Jeremy Stein, who is probably one of the best people in the area. I think he's going to have a lot of impact on that design. I hope so. That's another person they hired recently.
Yeah, he's a Harvard economics department person. He's in the White House. Summers brought him in to advise particularly on the financial and housing issues, the design of the new regulations structure. That was an excellent appointment. That's the stuff that's really going to count. Not this spending thing. I mean democrats were waiting with all these ridiculous projects, and now they've got an excuse to bring it through politically.
Just one last thing. I think Joe Biden and a couple other people have said there's a fairly wide consensus among economists that fiscal stimulus in the form of a large spending bill is the way to go, and...
He said first that every economist thought that.
Well, that's Joe Biden hyperbole. But what is the lay of the land there? Presumably there are economists out there that take this seriously. And then there are economists out there who think there's a one-for-one crowding out with any government spending. And I guess, where does the profession fall on that spectrum?
Most economists haven't really been thinking about this issue, they haven't really focused on it. It's not their specialty. Most economists today, they haven't really been thinking about this kind of multiplier issue. Which goes back to that first question you asked about how come now we're so worried about this. I don't think most economists are focused on this, or that they're familiar with the empirical evidence. I don't think they've really worked on the theory. So I don't know, maybe they have some opinion that they got from graduate school or something.
I think my sense is that the sentiment has been moving against this kind of approach both within the economics profession and more broadly. I think the initial view was that "yeah, this is a terrible situation" -- which I agree with -- "and we've got to do something about this, and maybe this will work." I think there was support in that sense.
Are there any conditions under which you might think spending could have a positive effect on output or is it always going to be the case that as a relative matter that tax cuts are going to be better?
Tax cuts are bound to be better. I think the best evidence for expanding GDP comes from the temporary military spending that usually accompanies wars -- wars that don't destroy a lot of stuff, at least in the US experience. Even there I don't think it's one for one, so if you don't value the war itself it's not a good idea. You know, attacking Iran is a shovel-ready project. But I wouldn't recommend it.