Dark Age of Macroeconomics (Wonkish) -- Paul

¶ … Dark Age of Macroeconomics (wonkish) -- Paul Krugman

Paul Krugman's column in The New York Times zeros in on the good and the bad that goes with government debt financing. He references economists Brand DeLong, Eugene Fama, and John Cochrane, all of whom claim that debt-financed government spending "…necessarily crowds out an equal amount of private spending" (Krugman, 2001). The economists that Krugman references believe that private spending is being blocked not based on some empirical model, but on simple accounting. In other words, because so much money is financed through debt dynamics, those with capital are being pushed out of the opportunity to invest. But Krugman begs to differ, and that is the sum and substance of this article in the Times.

Meantime while other economists try to read more into Cochrane and Fama than is actually contained within their narrative, Krugman asserts that it's not that complicated. Krugman offers a quote from Fama: "…bailouts and stimulus plans" are financed by putting the government deeper in dept, and that additional debt "absorbs savings that would otherwise go to private investment" (Krugman, 1). Debit financing isn't a matter of adding to present resources, Fama continues, that strategy just moves "resources from one use to another" (Krugman, 1).

Cochrane puts it very simply: "Every dollar of increased government spending must correspond to one less dollar of private spending… [And] jobs that were created by government stimulus spending "…are offset by jobs lost from the decline in private spending" (Krugman, p. 1). Cochrane goes on to critique the stimulus concept (which President Obama and the Congress put in place in 2009 to prevent the country from falling into a deep depression), saying that those who advocate for the use of stimulus strategies want that money to be spent on "consumption, not saved." Past stimulus plans have been evaluated on how much people spent, Cochrane notes, not on how much of it was saved. The economy, in any event, doesn't care if a person buys a car or lends the stimulus money to a company "that buys a forklift" (Krugman, p. 1).

Krugman takes issue with Cochrane and Fama, asserting that their assessments are "mind-boggling" due to the "basic [economic] fallacies" they project in their logic. Krugman insists that the two economists are "interpreting an accounting identity as a behavioral relationship" (p. 1). The columnist takes the position that while indeed, savings need to equal investment, but it doesn't just "mystically" take place; any discrepancy between the "desired savings and desired savings causes something to happen that brings the two in line" (p. 1).

In a more direct approach to rebutting Cochrane and Fama, Krugman believes that after a change in one's savings or investment activities, when interest rates are fixed, the accounting identity holds firm. That is, the Gross Domestic Product (DGP) "…changes to make S (savings) and I (investment) equal (Krugman, p. 2).

Cochrane and Fama believe, according to Krugman, that savings plus taxes equal investment plus government spending equals faulty fiscal policy. "But it doesn't," the columnist insists. Krugman believes that anyone doing a simple evaluation of the relationship between savings and investment should be able to see that it doesn't prove "…anything about the effectiveness of fiscal policy" (p. 2).