Readers of this blog may have guessed by now that I am not a fan of The Wall Street Journal editorial page. (Actually that is not entirely true. The Journal editorial page is my go-to source of material whenever I am looking for something to write about on the blog. So the truth is that I am deeply indebted and eternally grateful to the Journal.) But I have to admit that even I was not quite prepared for Robert Barro’s offering in today’s Journal. You don’t have to be a Keynesian economist – and I have never counted myself as one – to find Barro’s piece, well, let’s just say, strange.
Barro is certainly more sophisticated than Stephen Moore who, having discovered, 75 years after Keynes wrote the General Theory, that Keynesian economics defies common sense, tried and failed to apply the coup de grace to Keynesian economics. Employing a variation on Moore’s theme, Barro, with a good deal more sophistication than Moore, draws the contrast not between Keynesian economics and common sense but between Keynesian economics and regular economics.
Regular economics is the economics of scarcity and tradeoffs in which there is no such thing as a free lunch, in which to get something you have to give up something else. Keynesian economics on the other hand is the economics of the multiplier in which government spending not only doesn’t come at the expense of private sector spending, amazingly it increases private sector spending. Barro throws up his hands in astonishment:
If [the Keynesian multiplier were] valid, this result would be truly miraculous. The recipients of food stamps get, say, $1 billion but they are not the only ones who benefit. Another $1 billion appears that can make the rest of society better off. Unlike the trade-off in regular economics, that extra $1 billion is the ultimate free lunch.
Quickly composing himself, Barro continues:
How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people? Keynes in his “General Theory” (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.
Nice rhetorical touch, that bit of faux self-deprecation, referring to his own fruitless youthful efforts. But the real message is: “I’m older and wiser now, so trust me, the multiplier is a scam.”
But wait a second. What does Barro mean by his query: “Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?” Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure? Or does Professor Barro, like many real-business cycle theorists (say, Charles Plosser, for instance?), believe that fluctuations in output and employment are optimal adjustments to productivity shocks involving intertemporal substitution of leisure for labor during periods of relatively low productivity?
Perhaps that is what Barro thinks now, which would be interesting to know if it were the case, but about two and a half years ago, writing another op-ed piece for the Journal, Barro had a slightly different take on what is going on during a depression.
[A] simple Keynesian macroeconomic model implicitly assumes that the government is better than the private market at marshalling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.
John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.
So in January 2009, Barro was at least willing to entertain the possibility that some kind of obstacle to necessary price and wage reductions might be responsible for the failure of markets to generate a spontaneous recovery from a recession, so that a sufficient monetary expansion could provide a cure for this problem by making wage-and-price reductions unnecessary. But if that is what Barro believed (and perhaps still believes), it would be interesting to know if he thinks that monetary expansion, which, after all, can be accomplished at very little cost in terms of resources or foregone output is not somehow inconsistent with his conception of regular economics. I mean you print up worthless peices of paper and, poof, all of a sudden all that output that private markets couldn’t produce gets produced, and all those workers that private markets couldn’t employ get employed. In Professor Barro’s own words, How can that be right?
But let us assume that Professor Barro, obviously a very, very clever fellow, has an answer to that question, so that trying to increase output and employment by printing up and distributing worthless pieces of paper is not at odds with regular economics, while trying to do so by government spending – quintessential Keynesian economics – must therefore contradict regular economics. Well, then, let’s ask ourselves how is it that monetary expansion works according to regular economics? People get additional pieces of paper; they have already been holding pieces of paper, and don’t want to hold any more paper. Instead they start spending to get rid of the the extra pieces of paper, but what one person spends another person receives, so in the aggregate they cannot reduce their holdings of paper as intended until the total amount of spending has increased sufficiently to raise prices or incomes to the point where everyone is content to hold the amount of paper in existence. So the mechanism by which monetary expansion works is by creating an excess supply of money over the demand.
Well, let’s now think about how government spending works. What happens when the government spends money in a depression? It borrows money from people who are holding a lot money but are willing to part with it for a bond promising a very low interest rate. When the interest rate is that low, people with a lot cash are essentially indifferent between holding cash and holding government bonds. The government turns around and spends the money buying stuff from or just giving it to people. As opposed to the people from whom the government borrowed the money, a lot of the people who now receive the money will not want to just hold the money. So the government borrowing and spending can be thought of as a way to take cash from people who were willing to hold all the money that they held (or more) giving the money to people already holding as much money as they want and would spend any additional money that they received. In other words, i.e., in terms of the demand to hold money versus the supply of money, the government is cleverly shifting money away from people who are indifferent between holding money and bonds and giving the money to people who are already holding as much money as they want to. So without actually printing additional money, the government is creating an excess supply of money, thereby increasing spending, a process that continues until income and spending rise to a level at which the public is once again willing to hold the amount of money in existence.
Now I am not saying that the two approaches, monetary expansion via printing money and government spending by borrowing, are exactly equivalent. But I am saying that they are close enough so that if restoring full employment by printing money does not contradict regular economics, I have trouble seeing why restoring full employment by borrowing and government spending does contradict regular economics. But I am sure that Professor Barro, very, very clever fellow that he is, will clear all this up for us in due course, perhaps in a future op-ed in my go-to paper.