Saturday, January 16, 2010

Did the stimulus work? Make sure your priors are consistent

Lots of people have criticized the stimulus package and it’s hard for me to know whether the type of stimulus package we saw was likely to have helped us in the recent financial crisis.  But I have seen a couple of arguments pretty frequently that I think are inconsistent with one another.  And it seems to me, although I’m not positive, that these two arguments are made by the same types of critics. Of course, given that support of the stimulus (outside of those like Krugman who argued it should be larger) fell largely along liberal/conservative lines, it's not surprising that criticisms would come from one side of the aisle:

  1. The stimulus package couldn’t have been successful because the bulk of it hasn’t even been spent yet.  (Perhaps represented by this type of article:
  2. The Ricardian equivalence argument that every dollar of stimulus spent by the government dissuades a dollar of private investment because people rationally believe that the government’s spending will necessitate future tax increases. That anticipation causes people to save more to finance the future spending.  (This seems in line with John Cochrane in his recent New Yorker interview, here:

I don’t know if people rationally anticipate future inflows and outflows or if they don’t. The cheap answer (but one that’s probably right) is that they do sometimes or to some degree.  But if you’re trying to make a logical economic argument for why the stimulus couldn't have worked (rather than an empirical stab at measuring whether it *did* work), it’s a cheap argument to say that people sometimes anticipate the future and sometimes don’t.  If you have to hold or drop your belief about rationality depending on how well the implications fit your priors, that’s a bad sign.

So to be clear, if you believe that the stimulus couldn’t have worked because the bulk of spending hasn’t occurred yet, it seems that you don’t believe people anticipate the net present value of future stimulus, and act accordingly.  That is, they only change their current consumption and investment decisions when they receive the stimulus funds (e.g., as a worker or supplier).  Until they cash the check, they remain hunkered down in a state of capital preservation.

If you believe that stimulus perfectly crowds out private investment/consumption because of the expected future taxation, it seems you do believe that people anticipate future inflows/outflows and change their current behavior appropriately.  The second seems in line with the idea of people adjusting their behavior in line with changes in the anticipated permanent income.

Although I don’t have a quick example off-hand, I feel like I’ve seen both of these arguments coming out of the same corner.

No comments:

Post a Comment