Ricardian Equivalance Heat

Here's the latest word from Paul Krugman on Ricardian equivalence. First Lucas doesn't understand it. Now, not only does David Andolfatto not understand it, he can't read either. What's the world coming to? Who taught that idiot Andolfatto anyway? Send him back to Surrey for reading lessons. Maybe he should consider going back to drywalling.

Here's what Krugman says:

I accused Lucas of not understanding Ricardian equivalence. Here’s Lucas’s argument:

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash. It has no first-starter effect. There’s no reason to expect any stimulation. And, in some sense, there’s nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn’t going to help, we know that.

That’s saying that the spending response to expected future taxes leads to a fall in consumption that exactly offsets the expansionary fiscal policy. If that’s not a Ricardian equivalence argument, what is it?

What's Lucas saying? There's a bridge, it's funded by increasing taxes. Lucas says it doesn't make any difference that the government does this. He also says the answer doesn't change if the taxes that pay for the bridge are current taxes or future taxes. The last part of that is Ricardian equivalence. So what is wrong with that argument? It could be the spending actually matters, regardless of how it is financed, and we could argue about that. It could be that Ricardian equivalence does not hold in practice, and we could argue about that. Does Lucas somehow indicate in that line of reasoning that he doesn't understand Ricardian equivalence? Absolutely not. I was telling people that I thought Krugman had to understand Ricardian equivalence. My undergraduates get it. Why can't he? I don't want to be accusing the poor man of lack of understanding or poor eyesight. Maybe he can clear this up?

Here's another puzzler for you:

Then Andolfatto says that Lucas was arguing that it matters how government spending is financed. No, he wasn’t. Right there, he argues that government spending doesn’t matter at all:

If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that’s just a monetary policy. We don’t need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that’s stimulating is the monetary part.

So he was saying that government spending can’t raise aggregate demand. Period.

Figure that one out and I'll give you a prize. Krugman starts off by tellling us he's going to show us that Andolfatto was wrong. But put this Lucas quote together with the previous one, and Andolfatto's interpretation seems to be exactly what Lucas said. Lucas told us in the first quote that the government spending won't matter if it's paid for through taxation (present or future). Then, in the second quote, he says that it will matter if the Treasury issues debt to finance the expenditure, and the Fed buys the debt. What Krugman says to summarize, i.e. "so he was saying the government spending can't raise aggregate demand," is essentially correct, but that is not in contradiction to what Andolfatto said. I would not use the words "aggregate demand" in relation to what Lucas was talking about, but we'll let that one go.

Here's where Krugman heads for the gutter:

Look, I know people want to defend Lucas and hit at me, but what Lucas said there betrayed a fundamental failure to understand the implications of debt-financed spending — followed by an outright smear against Christy Romer.

A fundamental failure to understand...? That's not the problem here at all. One could construct a coherent set of debating points, based on theory and empirical work, to counter what Lucas is saying, but there's no fundamental failure to understand something. I think it would be fun to have that debate, and I'm sure Lucas would be game. On Christy Romer, it helps to read the whole transcript of Lucas's talk, which is available here. The earlier quotes were taken from the main talk, which apparently was never written down. It looks like Lucas is making it up on the spot, presumably from notes. The Christy Romer stuff is in the Q&A at the end. Here's the relevant part:

QUESTIONER: Ben Steel, Council on Foreign Relations. Bob, I edit a journal called International Finance and I get a lot of submissions from people who build big models -- big economic models -- and the shortest referee reports I get back condemn these submissions by saying this model is subject to the Lucas critique. In the last session, we had quite an animated discussion which spilled over into the lunch about models on fiscal multipliers, what they are.

On the one extreme, we have models by people like Mark Zandi at Moody's who say that the fiscal multiplier for the spending initiatives we're discussing are on the order of 1.5. On the other hand, we have people like Robert Barro at Harvard who say there's zero or negative. How would you go about applying the Lucas critique to these types of models to sort of educate us in how we should think about the validity of these models?

LUCAS: Do I need the Lucas critique for -- I'm with Barro is the short answer. (Laughter.) The Moody's model that Christina Romer -- here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this -- in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.

So she scrambled and came up with these multipliers and now they're kind of -- I don't know. So I don't think anyone really believes. These models have never been discussed or debated in a way that that say -- Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics.

Maybe there is some multiplier out there that we could measure well but that's not what that paper does. I think it's a very naked rationalization for policies that were already, you know, decided on for other reasons. I don't -- I'd like to talk about the Lucas critique but I don't -- I don't think we can -- (chuckles) -- deal with that issue.

The question is about models and multipliers. Lucas tells us a story about how he imagines Christy Romer does her job. In fact, you can see how she does it in this speech from February 2009. She talks about how she and Jared Bernstein used some "very conventional macroeconomic models" to come up with a multiplier of 1.6, which she thinks is on the low side. As Lucas says, he thinks exercises like that are "schlock economics," and he's right. The "very conventional macroeconomic models" Romer is talking about are large-scale macroeconometric models which are fundamentally the same as the ones constructed in the 1960s and early 1970s - the FRB/MIT/Penn model for example. Those were the models Lucas criticized when he wrote this paper, which is part of what the question was about. It's not a smear to question someone's methods. Sorry, Paul.

Here's the finishing paragraph, and it's a winner:

Ever since I started writing about the failures of modern macro, I’ve been attacked by people claiming that I just don’t understand the depth of their thought. Each time it turns out that they either are making basic errors or simply can’t manage to read what I and others actually wrote. And here we have another example.

You have to pity the poor man who wrote that. Viciously attacked by arrogant failures who just can't get it right.

Well, give me a break. What does Paul Krugman want exactly? If you go around badmouthing the cumulative work over 40 years of many macroeconomists - work that has been vetted by mainstream economic journals, hashed over in many hours of seminars and conferences, and awarded many prizes, including several Nobels - do you want a pat on the back, or what? The smearing isn't being done by Bob Lucas here.