Really Implausible Economic Arguments

Robert Waldmann

is still wondering why eminent economists have been making such implausible arguments.

Eugene Fama’s mad predictions based on an accounting identity (and forgetting that the value of goods which firms produce but can’t sell is counted as inventory investment). Then Eugene Fama asserted that the velocity of available funds or something is constant.

John Cochrane made the same constant velocity argument.

William Poole asserted that if there is Ricardian equivalence, then government spending must crowd out consumption.

The odd thing is that these are all demand side arguments — all arguments that the stimulus plan will not cause increased aggregate demand.

Historically the fresh water school focused on aggregate supply. In particular their natural argument is that output can not be greater than aggregate supply and the stimulus won’t affect aggregate supply. As far as I know no one is making this argument against the stimulus. If I’m right about that, why not ?

My attempt to answer after the jump

First is anyone making the argument ? Itis Greg Mankiw’s very charitable interpretation of Fama’s argument (an interpretation which is clearly inconsistent with the text of Fama’s argument). But Greg Mankiw doesn’t say he agrees with the view that he ascribes to Fama.

It is odd that no one is making the argument. It has two steps. First some dynamic stochastic general equilibrium (DSGE) models, employment is equal to labor supply. Workers will not work more unless there is a higher real wage or a higher real interest rate. On the other hand firms are unwilling to produce and sell any more unless there is a lower real wage or a lower interest rate. Under standard assumptions there is no way you can both convince more workers to work and firms to hire more of them — ever.

Now note I said some DSGE models. There are DSGE models of all sorts. However, models with the properties described in the paragraph above have been taken very seriously for decades by macro-economists.

So why doesn’t one of them make the argument ?

I think it is because, while it may be a bit embarrassing to derive predictions from an identity or assert that the velocity of money is constant when it is rapidly falling, it would be crazy to tell policy makers or the public that there are no workers willing and able to work at current wages and prices (for example at the wage they had last month before they were laid off) or to tell them that firms are unwilling to fill any more orders at current wages and prices and that if the government demands more from them they will turn private sector buyers away empty handed.

That is the assumptions which are often made in macroeconomics (for example by Robert Waldmann) have to be kept secret. If the public found out that our research involves such assumptions they would cut off the little research funding we have.

Now it could be that general equilibrium arguments aren’t made because economists fear that the public and policy makers wouldn’t understand them. To me they have always seemed fairly simple and the problem is that the public and policy makers would consider them absurd.

The really implausible economic arguments are those to be found, here

Alessandra Pelloni and Robert Waldmann (1998) “Stability Properties of a growth Model,” Economics Letters, vol. 61 pp 55-60.

(that’s a model of how labor supply moves around in response to a sunspot and that is the business cycle)

Please don’t tell my co-author I wrote this blog post.