Saturday, 31 January 2009

The Treasury View

Eugene Fama, a very distinguished finance specialist at Chicago, has been arguing that government spending cannot stimulate output as a matter of logical necessity (see the subsection of his article "The Sad Logic of a Fiscal Stimulus")

Like the auto bailout, government infrastructure investments must be financed -- more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount [...]Stimulus" spending must be financed, which means it displaces other current uses of the same funds, and so does not help the economy today.
John Cochrane, also of Chicago, has arguably made a similar point here.

Certainly he is sceptical about traditional fiscal stimulus:
The central question is whether fiscal stimulus can do anything to raise the
level of output. The question is not whether the “multiplier” exceeds one –
whether deficit spending raises output by more than the value of that spending.
The baseline question is whether the multiplier exceeds zero.

These arguments esentially repeat what was known as the Treasury View during the Great Depression. With the help of Keynes and others, this was shown to be a fallacy. What people like Paul Krugman and Brad DeLong are scratching their heads about, is how can this fallacy still exist as a serious argument?

It is worth reading Krugman's response, as it nicely describes why this argument makes the mistake of interpreting an accounting identity as a behavioural relationship, or equally Brad DeLong discusses the Treasury View here, and gives an example to explain the fallacy here (although this may be hard to follow).

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