The Great Ricardian Equivalence Debate of 2011: Do Mainstream Economists Agree on Anything?
Krugman started it, in response to Lucas. Everyone piles on. Plutocracy Files has the list of links. (Plus don’t miss Nick Rowe’s, which includes a long comment thread.)
Here’s what wows me: all these world-classical economists are accusing each other of contradicting “textbook economics,” and circling through extraordinary contortions in their efforts to reconcile that school of economics with some version of reality.
There is no consensus. None.
Every one of these folks is bought into classical assumptions, or at least into the Keynesian/classical “synthesis” that’s embodied in the IS-LM model (a model that was created explicitly to render Keynes classical, i.e. without the the Keynes, and was later disavowed by its own creator, John Hicks, as nothing more than a “classroom gadget”).
And they’re all trying to do intergenerational macro in their heads, as a bunch of stylized and simplified thought experiments.
I just finished re-reading Lucretius, and the methodological similarities are striking.
Given that several of the world’s most notable “textbook” economists can’t agree on how to define what in physics would be the equivalent of angular momentum, some of us have to wonder if the whole discipline as taught today offers any useful macro-level insight or modeling utility at all.
I think it’s significant that an authoritative MMT voice has yet to weigh in (I think they all probably think it’s silly — or would be if it didn’t reveal such dysfunction), aside from a passing shot by Mike Norman.
Cross-posted at Asymptosis.
It’s not quite that bad.
Most of it is a debate over what Lucas might have meant when he said what he said. I stayed out of that one.
But that we are having a debate over the burden of the debt is suprising. I thought this was all basically settled 30 years ago (except for a few Old Keynesians who haven’t got past Abba Lerner). And that there were 3 possibilities:
1. Mainstream: debt is a burden. It’s the future taxes, plus distortions from future taxes.
2. Barro: Debt is not a burden (except for tax distortions) because Ricardian Equivalence is (roughly) true and people offset that burden.
3. Samuelson 1958? Exact Consumption Loan model: debt is not a burden if the rate of interest is permanently below the growth rate so Ponzi finance is sustainable.
I agree with Mankiw, as far as I can see.
i weighed in on this at plutocracy files, steve; unfortunately, i had read several of those posts….the bottom line on my comments was that “the richardian-equivalence arguments are still a waste of valuable cyberspace”…
This post sounds a lot like Steve Keen (my interview with him coming shortly).
1. Trying to create fundamental “laws of physics” to predict human behavior is a fool’s errand to begin with. Macroeconomics has its purposes, but many who study it become lost in it.
2. With regards to economics as a science, even if the “laws” were firm, it’s as if these “laws of physics” only apply themselves once every generation or two. It’s as if I throw a ball today and maybe it will fall down in 40 or 50 years, 60 if it’s kept afloat by the populace’s general beliefs. In the subsequent generations, more than a few students will refuse to believe that the ball will ever fall.
3. Beyond that, so much changes in between, and so much of it is predicated on humanity, that the laws will drift. When the force of gravity shifts between experiments, that means that even if the study could be useful as a descriptive model, it’s pretty useless as a predictive model.
However as we have dugger deeper and deeper burrows of specialization and lost sight of the real world in favor of mathematical models, what should be a usefule social science for describing human behavior and loosely recommending policy has devolved into something more resembling a fractured religious cult: on one side are those convinced that the ball will ball at the same speed as last time, and on the other side are those that are convinced that the ball won’t fall at all.
The truth is that no one knows, but that’s not an acceptible answer because politicians on both sides are relying on these cults to feed them their scripts, and because you don’t get tenure by being humble.
Is Samuelson 1958 old Keynesianism? It sounds exactly like what Galbraith is saying today. A Lerner slave? (As you’ve mentioned in the past, some of those earlier economists have figured out things that are forgotten today — ‘nominal” demand/supply, for instance.)
IANAE, but I weighed in on the Ricardian Equivalence/Rational Expectations argument against gov’t stimulus on DeLong’s blog in ’09. I made two points, which nobody has convinced me are wrong. First, even if we grant the argument that tax payers will save the amount of stimulus money in anticipation of future taxes, that only means that we should give stimulus money to peopl who will not save it, such as poor people. Later stats indicated that the most effective stimulus came, not from stimulus programs enacted in ’08 and ’09, but from unemployment insurance. I think that that supports my case. Second, I think that anybody who is over the age of 30 who believes that gov’ts will pay off their debts is irrational. Their beliefs fail what Freud called reality testing. Adam Smith pointed out, back in the days when most money was backed by silver or gold, that gov’ts do not pay off their debt. IIUC, MMTers say that gov’ts with their debts in their own fiat currency never have to pay off their debts, although there may be a danger of inflation. Nick Rowe pretty well excluded MMTers by eliminating money from his scenario.
No, it’s the original overlapping generations model, and it’s not been forgotten. Most grad students study OLG models. Full employment, so not Keynesian, but with something that Samuelson calls “money”, but could also be interpreted as an unfunded pension plan. It was the theory behind the US SS system, AFAIK.
“I think that anybody who is over the age of 30 who believes that gov’ts will pay off their debts is irrational.”
How about: “anyone who is under the age of 400…”
http://www.angrybearblog.com/2011/12/meme-that-refuses-to-die-government.html
But the issue here is really whether debt or taxes is increased, and the future effects of those, right?
And of course whether real IRs exceed growth.
The only reason people think that governments (barring a government that let’s its self print money way beyond all reaon) is because they think in terms of their own mortality. I know I can and will die and you are like me, thus if I loan you money, I want it back before you drop dead.
So, unless you believe that the goverment and thus the nation will die, as in cease to funtion in any form (the US becomes a couple paragraph of memorial in a school text book) there is no reason to even consider this silly question.
The only reason people think that governments need to be concerned about paying back their debt (barring a government that let’s its self print money way beyond all reaon) is because they think in terms of their own mortality. I know I can and will die and you are like me, thus if I loan you money, I want it back before you drop dead.
So, unless you believe that the goverment and thus the nation will die, as in cease to funtion in any form (the US becomes a couple paragraph of memorial in a school text book) there is no reason to even consider this silly question.
Steve Roth: “But the issue here is really whether debt or taxes is increased, and the future effects of those, right?”
If we accept the proposition that gov’ts do not have to pay off their debt (which is not the same as paying for some of the debt), then what does it matter if the gov’t already has debt that it will not pay off when we add new debt?
Also, to answer something said by Nick Rowe, when the question of the burden of debt on future generations comes up in political discourse, it is always a question of the net burden. If the debt is used to build a school that will benefit future generations, then it is wrong to ignore that benefit in the politico-economic debate. If the debt is used to give the parents of the future generation jobs which benefit not only them but their children (through them) then those benefits are relevant.
Steve Roth: “And of course whether real IRs exceed growth.”
Indeed. Nick Rowe did a service to show that when the gov’t lends persistently at rates that exceed growth plus inflation, the debt becomes unsustainable. That’s one reason why the debt should be in money, the interest rate should be nominal and the gov’t should engineer enough inflation. It is also an argument for just printing money under certain circumstances.
If sustainability is considered a burden on future generations, that is a crock.
Steve: take the model (OK, story) in my post, and make one change. I assumed that the government increased taxes enough to pay off the debt, so cohort C paid the full burden. Change that assumption. Assume instead that the government increases taxes just enough to pay the interest on the debt, so the debt stops growing. Then the burden is shared between cohorts C, D, E, etc. The present value of the burden is exactly the same, but the debt is never paid off. Now change the assumption again, so the economy is growing (but the growth rate is less than the interest rate). And assume the government raises taxes on C and all subsequent cohorts just enough to keep the debt/GDP ratio constant (so it’s sustainable). The present value of the burden is still exactly the same, even though the debt keeps growing. (I would rather not do the math to prove that, but I did it once 😉 )
It doesn’t matter if the debt is never paid off. What matters is the r>g assumption.
Min: “ That’s one reason why the debt should be in money, the interest rate should be nominal and the gov’t should engineer enough inflation.”
But if people anticipate the government will engineer inflation, the nominal interest rate will have to rise one-for-one with the expected inflation rate, which doesn’t help sustainability at all, because the government is right back where it started.
Min: “Nick Rowe pretty well excluded MMTers by eliminating money from his scenario.”
Towards the end of that very long comment thread, in response to JKH putting forward the MMT position, I did address this question, and showed you get the same results.
Daniel: that is incorrect. Even with an infinitely lived government (which is what we normally assume, for simplicity) the present value of taxes must equal the existing debt plus the present value of government spending (assuming r>g) and you get exactly the same results.
huh? how does that address what DB said? ie, that governments dont need to be concerned about paying back their debt (which steve has showed the US doesnt in a previous post)
i dont doubt that what youre saying is true, i just dont see how it’s germane…
And thus my caveat: (barring a government that let’s its self print money way beyond all reaon)
I understand that one has to be aware of the debt load as it should not pace faster than the ability to afford it (earn enough in income and wealth). But then again, if we were all so concerned, we would also be concerned about the top 1% doubling their income faster than the nation’s GDP doubles. This is the “present value of taxes” concern.
Create debt consistantly faster than your income or wealth or pocket the money faster than your enterprise produces it gets you to the same place. Let those who are taking faster than the producing determine the conversation and policy and suddenly debt becomes the issue and not their taking.
You’d think that after 70 years, much less 400 years, people would put down their textbooks and look out the window and see what happens in the real world.
i won’t go much further into this, because in a conversation of experts no one would know, or care, what i was talking about.
much further: SS doesn’t have much, if anything, to do with “debt.”
no more than saving enough from your friday paycheck to cover sunday’s dinner.
“pay as you go” allows the worker to save enough from his paycheck this year to pay for dinner forty years from now without worrying about inflation, or “returns on investment.”
oh, well, a little further
“debt” is something you acquire in order to do something today with money that you decide is worth the price of repaying the debt. you don’t have to come out “ahead” or even “even” to justify it.
the people who lend the money know they are taking a risk. it seems to me that all of the models and theories discussed here are trying to fit “debt” into the concepts appropriate to a banker… and that is just not broad or fundamental enough to make sense when you are talking about national debt or even personal debt.
presumably you got your money’s worth, so paying it back is not a “burden.” if you didn’t and it is, well, that’s the way it goes sometimes.
basically Erik is right.
money is worth what you get for it, or give for it, at the time of the transaction. insisting on some universal and moral equivalence between the money you pay for a truck today and for a wheelchair tomorrow is to worship an illusion.
Excellent
Thanks, Nick! Happy New Year!
But Nick, I showed sustainability. You are arguing that people will oppose sustainability, which means that they really do not care about future generations, and all the talk about the burden of debt on future generations is BS.
Nick Rowe: “Assume instead that the government increases taxes just enough to pay the interest on the debt, so the debt stops growing. Then the burden is shared between cohorts C, D, E, etc.”
Really? That sounds like the return to conditions before Generation A, in terms of lifetime consumption. That is, each generation consumes what they produce. How is that a burden? In fact, as Adam P pointed out on WCI, people might actually prefer the new arrangement, because they spread out their consumption more evenly during their lifetimes. 🙂
To put it another way: If we assume an infinite duration for the gov’t (which you later say that you do), and each generation shares the burden equally, then the burden for each generation is infinitesimal.
(Those are not my assumptions, but for the sake of the argument. . . . ;))
Nick: “What matters is the r>g assumption.”
Right. I *think* that’s exactly what Galbraith says:
http://www.levyinstitute.org/publications/?docid=1379
Is it reasonable to expect g>r over the long term? Given the distributional effects of such a regime (or its reverse), it’s pretty much a political/power prediction question, no?
One side (roughly: the relative small group of creditors) would have it that such a regime constitutes “economic repression.” The other side (roughly: the relatively large group of debtors) would say that its the only way to compensate for exactly the same thing (but in the opposite direction and without the quotation marks).
There are many more debtors, but the creditors’ interests are much more concentrated, as are their means for effecting their interests. Back to Mancur Olson…
This will be a long comment. I think that the problem isn’t as symmetric as it is presented in this post. Ricardian equivalence has a precise agreed definition in the literature. John Ochrane is simply wrong. The phrase was introduced by Robert Barro who explained it clearly
http://economistsview.typepad.com/economistsview/2012/01/more-ricardianoid-equivalence-.html
Note that Barro is a fresh water economist even though he works at Harvard. It isn’t as if physicists didn’t have an agreed definition of angular momentum. It is as if a physicist with tenure in a top department and a ton of cites just said it was the energy due to spin or mass times velocity or a newly discovered elementary particle or something.
Lucas, for example, did not use the plainly wrong definition of Ricardian equivalence. His error was to assert that in the IS-mode all multipliers are the “same”. This too is an amazing error (he is old enough to have been taught the IS-LM model — I don’t know how he managed to suppress the memory). But it has nothing to do with Ricardian equivalence.
More alarmingly, Cochrane’s gross elementary error was in Wikipedia. A professor teaching elementary macro figured out that something funny was going on when half of the students in his class made Cochrane’s error on an exam. Wikipedia has been corrected. I don’t have th elinks, but this definitely happened.
I don’t think Cochrane is getting his beliefs about macroeconomic theory from Wikipedia (I think he is making them up as he goes along). But his elementary error was commonly made in the blogosphere.
My point (if any) is that while macroeconomic theory has gigantic problems and extremely limited achievements, the current problem is a problem with John Cochrane who doesn’t know elementary macroeconomic theory and not with the field as a whole.
OK now Hicks. First I contest the interpretation of “Mr. Keynes and the “Classics”; A Suggested Interpretation.” I see no b asis whatsoever for the claim that it is an effort to reconcile Keynes and the classics. I think it was a successful effort to clarify exactly how Mr Keynes disagreed with those he called classical economists (now called neo classical economists). I am willing to be convinced that you are right and I am totally confused, but only by quotations from the article.
Also I think we are well past pretending that there was a neoclassical Keynesian synthesis. There was a Principles textbook by Samuelson which presented Keynesian macro and neoclassical micro, but it was a “binding together in the same volume” not a synthesis. In any case, the idea that one could be Keynsian, neoclassical and not named Paul Samuelson was abandoned about 38 years ago. Samuelson could claim he had synthesized, because of his gigantic status based on his gigantic contributions to economic theory* — he could claim anything. But no one has taken his claim seriously for decades.
* rejecting Samuelson is basically rejecting economic theory. I personally reject economic theory.
as a molecular biologist, some one who regularly does experiments, i was astonished to read thu this mess, and see almost no discussion of the data..one would think that after more then 100 years, there would be some ref text on the data for against RE
Cinnamon Colbert: “i was astonished to read thu this mess, and see almost no discussion of the data”
We don’t need no stinking data.
😉
Min
economics is not molecular biology. data itself is subject to very serious doubts about it’s reality let alone its relevance. this may be inescapable… that is, it is not the fault of “economists” that their field is highly subjective.
it is their fault that they pretend it is not.
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