Barro on Keynes Barro and Grossman

Robert Waldmann

Robert Barro wrote an op-ed in The Wall Street Journal. The substance of the op-ed is to report an estimate of the Fiscal multiplier 0.8 which is less than one. Thus, according to Barro, a stimulus will partially crowd out of investment, consumption or net exports and not just reduced leisure. Paul Krugman took Barro to task for using the huge WWII stimulus in his estimates, since the economy was at full employment during WWII. So have Matthew Yglesias using his Harvard BA in philosophy from Harvard and Kevin Drum using his BA in Communications from The California State University in Long Beach.

I might want to reassess Long Beach State, but I think the reason that Yglesias and Drum immediately make the same argument is Krugman is that Yglesias and Drum don’t know about modern econometrics. Barro is using an instrumental variables regression in which wartime military spending is considered to be an exogenous variable which is correlated with government consumption. The implicit assumption is that we can safely assume that the fiscal multiplier today is identical to the fiscal multiplier during World War II, because the economy is basically similar. Without training in modern econometrics it is simply impossible to assume something that stupid.

There is also a severe gap in economic theory, at least as remembered by Robert Barro. Wouldn’t one think that there must be some model in which correlations vary depending on the general conditions of the economy — say like whether at current prices there is excess demand for goods or excess supply of goods.

Of course, no one could expect Barro to know that there is a vaguely Keynesian model, which differs from the neoclassical model only because of rigid nominal wages and prices, in which the economy can be in one of three different regimes, Keynsian (with insufficient aggregate demand), Classical (firms can sell as much as they want but real wages are too high so workers are unemployed) and repressed inflation (excess supply of labor and goods).

I’m mean who’s ever heard of the Barro-Grossman model (A General Disequilibrium Model of Income and Employment Barro, Robert J.; Grossman, Herschel I.; American Economic Review, March 1971, v. 61, iss. 1, pp. 82-93 [stable JSTOR link added for those with access])? Certainly not Robert Barro.

The passage quoted by Krugman about what Keynes thought is inconsistent with The General Theory. However, it can be corrected easily. The accurate description of the history of economic thought is “John Maynard Keynes Robert Barro and Herschel Grossman thought that the problem lay with wages and prices … will mean that wages and prices do not have to fall.”

Look I sympathise. Like Barro, when I was young and reckless I did embarrassing things which I have tried to cancel from my memory. I really wish I could do that as well as he has.

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