Evidence, logic and reason cannot explain conservative beliefs--ie about economics. Tribal myth-making can. This is a case in point
My previous diary, "GOP denial of reality complete: House adopts rules of fiscal madness", dealt with Paul Krugman's op-ed, "The New Voodoo", which warned of the institutionalized fiscal madness that House Republicans have now committed themselves to, the ice-cream-pizza-and-beer diet "fiscal discipline by cutting taxes." Most ominously, Krugman wrote:
How did Republican leaders reconcile their purported deep concern about budget deficits with their advocacy of large tax cuts? Was it that old voodoo economics - the belief, refuted by study after study, that tax cuts pay for themselves - making a comeback? No, it was something new and worse.To be sure, there were renewed claims that tax cuts lead to higher revenue. But 2010 marked the emergence of a new, even more profound level of magical thinking: the belief that deficits created by tax cuts just don't matter. For example, Senator Jon Kyl of Arizona - who had denounced President Obama for running deficits - declared that "you should never have to offset the cost of a deliberate decision to reduce tax rates on Americans."
It's an easy position to ridicule. After all, if you never have to offset the cost of tax cuts, why not just eliminate taxes altogether?
The GOP madness is so transparent, and Krugman's platform so high that he just had to be attacked for saying this out loud. But there's nothing to attack him for. The GOP position is pure madness. So if there's nothing to attack him for, the solution is simple: just (1) make shit up and (2) ridicule him. It's Third Grade Bullying 101.
Take for example, Tom Maguire, whom Brad DeLong focused on over the week-end. DeLong used Maguire's feeble effort to go after bigger game: top Republicans silently signed on to this madness. But I'm happy enough to focus on Maguire himself, because he shows how entire mythologies get created with layer upon layer of BS to justify their biggest lies, lies such as "We have a spending problem, not a revenue problem." Or "tax cuts don't matter for the deficit." Here's DeLong:
Tom Maguire Says That All the Republicans Who Have Been Claiming to Worry About the Deficit Over the Past Two Years Are LiarsTom:
JustOneMinute: One Day, When The Times Has An Economist As A Columnist...: The idea that deficits created by tax cuts don't matter is hardly new or magical, except perhaps to Krugman and any Times readers who lean on him for economic insight. IF YOU CAN'T TRUST FOX ON THIS:? Per Fox, the Republican message has been that we have a spending problem, not a revenue problem.? Very Ricardian, and how did Krugman miss it? SO WHO HAS ALZHEIMERS NOW, MR. SMARTY-MOUTH?
Seems like Tom is a bit harsh on his fellow Republicans to me. I think a bunch of them--people like Alan Greenspan, Paul O'Neill, etc., etc.--do worry about the deficit, but have been told to fall in line and be quiet for a while.
The most prominent feature here is trash-talking Krugman--in ALL CAPS, NO LESS! It drives conservatives crazy that the guy has a Nobel Prize and a prominent media platform, so trash-talking him helps build their group identity, and this group identity sustains them in the lack of any coherent set of facts, principles or ideology--the lack of which Krugman has just explosed. To actually discredit Krugman and his argument, Maguire would have to show that it's not delusional/magical thinking to diet on pizza, beer and ice cream cut deficits by cutting taxes.
But he can't do that, because it is magical thinking. So he does the best that he can: He tries to ridicule Krugman by pretending that the idea isn't new--that in fact it's well over 100 years olds, and associated with a venerable classical economist whom most conservative true believers probably never even heard of--David Ricardo--but it will make a really cool cover story, if they can all just get their stories straight.
But he can't do that, because Ricardo never said that tax cuts don't matter for deficits. So Maguire does the next best thing: he pretends that Ricardo said that tax cuts don't matter for deficits by implicitly equating it with what's known as "Ricardian equivalence" (hence "hardly new or magical" as Ricardo was early 19th Century) and he pretends that Krugman was just too obtuse to see it, even though Krugman had actually written about it before. (Hence the reference to ALZHEIMERS... MR. SMARTY-MOUTH!)
Unfortunately for Maguire, though, one of the things Krugman had written, which Maguire had missed, was the totally on-target prebuttal, "One more time" in which Krugman took aim at those who do "not understand the implications of their own model", in this case, Ricardian equivalence. In that prebuttal, Krugman had utterly demolished the basis of Maguire's "argument" if it can be called such, since Maguire's misunderstanding is even farther off the mark. But Krugman certainly demolished the authority of conservative economists on which Maguire relies.
This may all seem a bit overwhelming for non-economists, but split into bit-sized pieces, it turns out to be pretty easy to follow....
What is Ricardian equivalence?
What is Ricardian equivalence? It's the proposition that shifting taxes around in time makes no difference in terms of aggregate macro-economic behavior: if taxes are cut now, they'll have to be raised later, and because of that, cutting taxes to stimulate the economy won't actually do any good. The same argument is also raised against government spending. Wikipedia introduces the concept thus:
The Ricardian equivalence proposition (also known as the Barro-Ricardo equivalence theorem[1]) is an economic theory that suggests consumers internalise the government's budget constraint and thus the timing of any tax change does not affect their change in spending. Consequently, Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy being the same.
And in his prebuttal, Krugman further clarifies what this means, making the unrealistic assumptions needed to make the proposition work:
Here's what we agree on: if consumers have perfect foresight, live forever, have perfect access to capital markets, etc., then they will take into account the expected future burden of taxes to pay for government spending. If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.
What's wrong with Ricardian equivalence?
The first things wrong with Ricardian equivalence is that no one actually believes in it. The assumptions needed to make it work--"if consumers have perfect foresight, live forever, have perfect access to capital markets, etc."--are wildly unrealistic. So the real question isn't whether it's true--it's not. It's whether it's close enough to being true to make it a useful approximation. That's what knowledgable economists disagree over.
Unless they get all confused--say by mixing up permanent tax-cuts or spending increases with short-term ones. And that's what Krugman was writing about. That's a second problem, and Krugman explained:
But suppose that the increase in government spending is temporary, not permanent - that it will increase spending by $100 billion per year for only 1 or 2 years [a typical Keyensian stimulus], not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.
Which is why Krugman introduced this brief post like this:
Brad DeLong is, rightly, horrified at the great Ricardian equivalence misunderstanding. It's one thing to have an argument about whether consumers are perfectly rational and have perfect access to the capital markets; it's another to have the big advocates of all that perfection not understand the implications of their own model.
Maguire, as we shall see, only compounds the misunderstanding with a whole new level of confusion.
The third problem, closely tied to what Krugman wrote here, is that Ricardo wrote 100 years before Keyenes invented macro-economics, which takes into account profound cyclical processess that Ricardo had no way of knowing about. Keyensian economics works by stimulating the economy when it's depressed--either by government spending (preferrably) or tax cuts (more problematic)--and then restoring the balance when the economy is going great guns, cooling it off a bit by either raising taxes (particularly if they've been cut before) or cutting spending (or at least slowing its growth below the growth in revenues).
Thus, the Keyensian approach differs from Ricardo's vision in three ways: (1) It's not burdened by totally unrealistic expectations. (2) It deals with temporary, not permanent, changes in levels of taxation and/or government deficit spending. (3) It changes the levels of taxing and/or spending dynamically in response to what's happening in the business cycle.
Given this approach, it's still an interesting question how good an approximation Ricardo's unrealistic model provides (1), but it's no longer necessarily a very crucial one, given (2) and (3) above.
What's wrong with Maguire? Part 1
Now, with all that backround out of the way, we're finally ready to take a look at Maguire's post in something more like its full form, in order to assess what's wrong with it:
One Day, When The Times Has An Economist As A Columnist...
Paul Krugman closes the year with misdirection and deception.? His topic is tax cuts (bad!) and Evil Republicans (what else?).? My emphasis:How did Republican leaders reconcile their purported deep concern about budget deficits with their advocacy of large tax cuts? Was it that old voodoo economics - the belief, refuted by study after study, that tax cuts pay for themselves - making a comeback? No, it was something new and worse.
To be sure, there were renewed claims that tax cuts lead to higher revenue. But 2010 marked the emergence of a new, even more profound level of magical thinking: the belief that deficits created by tax cuts just don't matter. For example, Senator Jon Kyl of Arizona - who had denounced President Obama for running deficits - declared that "you should never have to offset the cost of a deliberate decision to reduce tax rates on Americans."
New and magical?? Everything old is new again!? As an alternative to Keynes, the Ricardian theory is that it is primarily the level of government spending that matters, rather than whether it is financed by taxes or borrowing. (A very accessible summary is here.)
But, of course, as we've just seen, that's not what Ricardian theory says. To the extent that Ricardian theory can be considered an alternative to Keyenes, it (a) fails to account for cyclical changes in the economy, which alter people's options as well as their outlooks, and (b) only tells us about permanent changes in taxing and spending, not temporary ones. It's like saying that a horse and carriage is an alternative to a jet plane. Not if you want to get from New York to London, it's not.
Maguire's "Expert" Summary Unmasked
Just to make this last point perfectly clear, let's go look at that link Maguire proffers as "A very accessible summary":
GOVERNMENT SPENDING, DEFICITS AND OPTIMAL FINANCIAL POLICY
Charles I. Plosser*
William E. Simon Graduate School of Business Administration
University of Rochester
Shadow Open Market Committee
November 2003....Budget Deficits-The Conventional Wisdom
The conventional view of budget deficits is found in many Keynesian textbooks and widely accepted among policymakers. The basic premise of this standard view is the assumption that a deficit-financed tax cut leads to an expansion of aggregate consumer demand. This expansion comes about because individuals or households in the economy are fooled into thinking that a deficit-financed tax cut makes them wealthier. The argument is that the deficit means households must hold more government bonds as assets but there is no off-setting liability, hence they feel wealthier and aggregate demand rises. In fact, if government spending is held fixed, deficits today mean higher taxes in the long-run which offset the government bonds on household balance sheets. If households feel wealthier, private saving rises less than the amount of the tax cut (if at all) so that real interest rates have to rise to restore a balance between saving and investment demand. The higher real interest rate "crowds-out" private sector investment resulting in a lower capital stock in the long run. Thus, the new government debt is a burden on future generations in that they inherit a smaller capital stock.
The standard view does not specifically provide policy advice on how the government should decide when to run deficits and how much government debt is too much. However, because deficits have an unambiguous positive impact on aggregate demand in this framework, it is often thought that deficit spending is an appropriate and effective stabilization tool. Indeed, this is one of the key messages of Keynesian fiscal policy.
Now, I'm not an economist, but I do know enough as a journalist to know that this account is badly skewed, to say the least. The central idea of Keyensian fiscal policy is to smooth out the business cycle so that vast productive capacity is not laid to waste in terrible depressions. It is high-employment economics. It is also explicitly counter-cyclical: Government demand is used during downturns to substitute for the lack of private demand, and the accumulated government debt that results is then paid down when the economy heats up again. (The "Keyensian" argument for tax cuts is actually a derative hybrid, using private spending of tax cuts to stimulate demand, instead of government spending.) Thus, the standard Keyensian view most certainly does "specifically provide policy advice on how the government should decide when to run deficits" and when to pay them off. All the rest that follows in this paper is essentially misleading at best, or intentionally dishonest at worst, because it is based on the false claim Keyensians have no concern or plan for dealing with the consequences of government debt incurred during downturns to keep the economy functioning at relatively high levels of productivity and employment.
What, then does the paper go on to say? First of all, on the false premise that Keyensians neither know nor care about the full consequences of government debt--and the additional false premise that tax-cutting, rather than government defecit spending is the core focus of Keynsian arguments--the previous misleading picture of the Keyensian view is dishonestly attacked for being based on deception:
Budget Deficits-The Alternative ViewEconomists have long been skeptical of theories and policy advice that rely on the government fooling the public in some systematic or repeated way or where consumers are viewed as myopic and limited in their view of the world. The argument is both a practical and a philosophical one. As a practical matter economists ask if such theories make sense and are the implications believable or predictable. At a philosophical level, some economists ask whether government should undertake policies that rely on duping the public into doing something it would not otherwise choose to do.
The conventional wisdom, at noted above, relies on the public incorrectly believing they are wealthier when in fact they are not.
Of course this last statement is utter balderdash. It depends on a fantasy version of Keyensian theory that bears no resemblance to the genuine thing.
Next, the high ground is claimed:
A more appealing baseline case for thinking about the government's financing decisions is one where households have full knowledge of the environment and are not fooled by a government policy nor are they myopic in their outlook. In this environment the choices between debt and taxes do not matter. This view is often referred to as Ricardian equivalence in honor of the 19th century economist David Ricardo who first articulated the proposition.1 Sufficient conditions for this invariance result to hold are lump-sum taxes; certainty about future levels of income, public spending, and interest rates; infinitely-lived households (or households with a bequest motive); and perfect capital markets. Under these conditions, the present value of taxes must equal the known present value of spending. By issuing debt the government can change the timing of taxes, but not the present value.More importantly, the conditions imply that households only care about the present value of taxes. This means that a deficit-financed tax cut does not change consumer wealth or the present value of the taxes owed (as long as the present value of government spending is unchanged). Since consumer wealth is unchanged, it follows that the tax cut does not affect consumer demand, raise interest rates, or crowd-out investment. Households simply use the extra dollars from the tax cut to buy the new government debt and nothing else changes. Put another way, the dissaving by the government is matched by an equivalent amount of new saving by households.
In this framework, what matters for consumer wealth is the present value of spending. Higher government spending today means that the present value of spending rises unless it is offset in the future in a manner that leaves the present value unchanged. Thus, higher government spending tends to reduce private sector wealth, "crowding-out" private sector consumption and investment. Deficit-financed tax cuts holding spending fixed has no effect on wealth or demand.
In this Ricardian environment it makes no difference how the government chooses to finance it[s] spending. Neither the form nor the quantity of public debt is relevant for any economic variable of interest. Of course, no one believes that Ricardian equivalence holds exactly. Nevertheless, like a lot of useful theoretical frameworks it guides us in a search for what does matter and how to evaluate departures from the baseline case.
You'll note that part near the very end that I bolded, where it's admitted that Ricardian equivalence doesn't actually hold in the real world. Ooops! Well, don't say I didn't warn you. But the rest of the argument presented here is exactly the sort of irrelevancy that Krugman warned against: It has nothing to do with the real world of Keyensian economics where changes are temporary, not permanent, and are shaped and timed in accord with the business cycle.
What's wrong with Maguire? Part 2
In short, the previous section showed at great length that even Maguire's designated "expert" could not conjure up the sort of rationale Maguire thought he could. Instead, he fell directly into the sort of trap that Krugman described far more economically.
Blissfully unaware that his link actually undermines his argument with the cognoscenti, Maguire continues:
Could it be that Krugman has Klein-itis and can't understand Ricardo because he is more than one hundred years old?? Maybe!? Or maybe we are witnessing early onset Alzheimers - Krugman seemed well aware of Ricardian models back in the late 1990's when he was writing on Japan:In a fully Ricardian setup the multiplier on government consumption will be exactly 1: the income generated by the purchases will not lead to higher consumption, because it will be matched by the present value of future tax liabilities.
Well, he certainly is snarky enough, but he's got the wrong link. The right one ("Thinking About the Liquidity Trap") leads to the full context, which shows not only that Krugman was well aware of the Ricardian model, but also of its limitations--it's not what's causing him concern:
You might suspect that we are about to talk about Ricardian equivalence here. But that is not the crucial issue. True, if consumers have long time horizons, access to capital markets, and rational expectations tax cuts will not stimulate spending. However, real purchases of goods and services will still create employment, albeit perhaps with a low multiplier. (In a fully Ricardian setup the multiplier on government consumption will be exactly 1: the income generated by the purchases will not lead to higher consumption, because it will be matched by the present value of future tax liabilities). The problem instead is that deficit spending does lead to a large government debt, which will if large enough start to raise questions about solvency.
In short, Krugman knew then what he knows now: Ricardian equivalence is an interesting theory that can shed some light on certain factors worth considering, but it doesn't tell the whole story, and doesn't even necessarily tell you what you should really be looking out for. But that's got nothing at all to do with the GOP mantra that Maguire is trying to justify. And nothing that follows does anything to address that lack of connection, either:
Well, that pre-dates the Florida recount and the Iraq War, so perhaps Krugman's mighty mind has been swamped with new information and the whole Ricardo/Barro rational expectations debate has gone out the back door.? Krugman may disagree with the model, or think its application is not appropriate in the current context, but there have been serious econmists on the other side of that debate for quite a while.? The idea that deficits created by tax cuts don't matter is hardly new or magical, except perhaps to Krugman and any Times readers who lean on him for economic insight.
But, of course, Krugman's prebuttal clearly shows that he hasn't gone addle-headed, and that the Barro's updating of Ricardo is irrelevant to how Keyensian economics actually instructs us to act.
More importantly, however, it must be stated once again that none of this has anything to do with the claim that "We have a spending problem, not a revenue problem," which is the whole point of Maguire's post: to ridicule Krugman for missing the supposed Ricardian foundations of this claim. Simply asserting that there is a connection is not enough. You actually have to explain what it is and present an argument for why that connection is valid.
But this is utterly lacking from Maguire's post. Nowhere has Maguire explained why he thinks that Ricardian equivalence provides a foundation for that claim. He doesn't even seem to realize that he's left anything out. As such, it's both a classic example of a non-sequiter fallacy and of anosognosia. This is rather stunning omission, given that the whole point of this diary was supposedly to embarrass Krugman for not seeing the connection--a connection that Maguire himself does not even try to establish. Anosognosia's a bitch.
Moral
Less snark. More focus.
A moral that's utterly lost on an anosognosic.
p.s. Maguire's cluelessness does not exist in a vacuum. The Wikipedia entry on "Ricardian equivalence" contains this line under "critiques":
In 2009, Paul Krugman ignited a debate among notable blogging economists and financial journalists when he grouped Barro with "first-rate economists [who] keep making truly boneheaded arguments against [organizing Keynesian stimulus]".[13][7][14][15]
But Krugman's post, "War and non-remembrance", had nothing to do with Ricardian equivalence, and thus didn't belong in that entry at all. Just to be clear, here's how Krugman's brief post begins:
As I've already pointed out,the prospect of a Keynesian stimulus is having a weird effect on conservative economists, as first-rate economists keep making truly boneheaded arguments against the effort.The latest entry: Robert Barro argues that the multiplier on government spending is low because real GDP during World War II rose by less than military spending.
Actually, I've already taken that one on. But just to say it again: there was a war on. Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort.
Oh, and the economy was at full employment - and then some. Rosie the Riveter, anyone?
See? Neither hide nor hair of David Ricardo or his proposal. This is associational thinking run amok, just where critical thinking is needed most.
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