Bryan Caplan  

Fiscal Futility: Helping Brad Understand

Department of Double Standards... The Wonder of Economic Freedom...
Brad DeLong pleads perplexity:

I simply do not understand their arguments that government spending cannot boost the economy. As far as I can tell, they are simply burying their heads in the sand.

At the start of 1996, the US unemployment rate was 5.6%. Then America's businesses and investors discovered the Internet. Over the next four years, annual US spending on information technology equipment and software roared upward, from $281 billion to $446 billion, the US unemployment rate dropped from 5.6% to 4%, and the economy grew at a 4.3% real annual rate...

Back at the start of 2004, America's banks discovered that they could borrow money cheaply from Asia... or so they thought. Over the next two years, annual US spending on residential construction roared upward, from $624 billion to $798 billion, the US unemployment rate dropped from 5.7% to 4.6%, and the economy grew at a 3.1% real annual rate.

...[Y]ou cannot argue that these groups did not increase their spending, and that their increased spending did not pull large numbers of Americans - roughly two million in each case - into productive and valued employment.

The government's money is as good as anybody else's. If businesses' enthusiasm for spending on high-tech gadgetry and new homeowners' enthusiasm for spending on three-bedroom houses can boost employment and production, then what argument can Harvey, Fama, Barro, Steil, and company make that government spending will not? I simply do not see it.

If all we're trying to do is raise nominal GDP, then I agree that "the government's money is as good as anybody else's."  Unfortunately, nobody's money is very good.  To see why, we need to ask a question inspired by Bastiat: If X had not spent money on Y, what would have happened instead?  We can pose this question to both the private sector and the government. 

Suppose X is the private sector, and Y is the Internet.  Brad seems to think that if the private sector hadn't poured money into the Internet, that spending would simply never have existed.  This doesn't make sense to me.  If the Internet boom never happened, I say that the private sector would have spent on something else, or lent it out to someone else to spend on something else.

OK, suppose X is the government, and Y is the bail-out.  Again, Brad seems to think that if the government doesn't spend Y, no one will.  This doesn't make sense to me either, and for the same reasons: The money has to come from somewhere. 

No doubt Brad is eager to meet Bastiat's challenge head-on and say: "Wrong!  If X had not spent money on Y, total spending would have been less."  But there are only two escape hatches that allow this response.* 

The first is the interest-elasticity of money demand - when interest rates go up, people will respond by reducing their cash holdings.  To me, this seems only slightly less fanciful than inter-temporal elasticity of labor supply.  I've never reduced my cash holdings when interest rates went up, and I know the model!

The other escape hatch is endogenous monetary policy - when the government borrows more, the Fed has to print more money to keep interest rates from rising.  To me, this seems entirely real.  But once you admit that fiscal policy increases nominal GDP by inducing more expansionary monetary policy, why not just cut out the middle man of fiscal policy and make monetary policy more expansionary?

Admittedly, "Harvey, Fama, Barro, Steil, and company" may not share my view that the LM view is roughly vertical.  All I can do is help Brad understand my own reasoning.  Maybe I'm wrong; but am I really so hard to understand?

*Or maybe three, if you count a "beggar-thy-neighbor" devaluation to siphon demand from other countries.

Comments and Sharing

COMMENTS (22 to date)
Grant writes:

Why even answer DeLong? The last time I posted a comment on his blog, it was deleted and I was unable to comment again. It was a polite and civil comment, but a point-by-point refutation of his argument.

Has Brad ever run any sort of a business, or ever tried to hire anyone? Does he realize how difficult it is to productively employ people? Sure any moron can spend, but doing so in a manner that actually produces profit isn't very easy at all.

Brad Warbiany writes:

There's another question to be answered here...

Is the goal increased GDP & employment or is it a more productive economy?

I'd say that the internet boom was a productivity boom. The improvement in computing and communication technologies will have long-lasting effects in increasing the standard of living globally. Yes, there was certainly overinvestment and a boom, but after the correction the world was a changed (and more productive) place.

The real estate boom? Not so much. Yes, it boosted employment and production, but it was fake (i.e. unsustainably-leveraged) money and the long term productivity of our economy was not improved. We spent the money, and people were employed for a while, but at the end of the day we didn't really make any big changes. Then the fake money dried up, and all those people were out of work.

So can government money improve the productivity of our economy? Maybe. If the money is spent on make-work programs, not so much. If it's spent in the hopes of getting temporary spending increases, not so much. In short, if it's just intended to get people buying "things" so that they put people to work, the actual gains of the spent money will not be long-term improvements to our economy.

Could government spend it on productivity improvements? Yes, but they probably won't. So it's better -- as Bryan points out -- to keep that money in private hands where it at least has SOME hope of being spent wisely.

Bob Smith - Fort Worth writes:

Dr. Kling,
Did I miss something? It was my understanding that the government didn't have any money (I should say extra money) of its own. That additional spending came from an increase in taxes or through debasing the currency.
So, wouldn't that mean that the Government's extra money isn't as good as private money because their money reduced the wealth of society as a whole - with most of this burden being borne by the poor and lower middle class if this is done through inflation, while private investment increased private the wealth of society.
Did I miss a class?

Barkley Rosser writes:


The answer here is very garden variety. You are assuming that Say's Law holds. Supply creates its own demand, and if money is not spent on one thing it must be spent on something else. Why?

Amusingly, even Say did not believe his "own" law, although he did indeed assert it in a number of places quite eloquently (leaving it to James Mill and others to call it "his" law). However, in several places in his main work he recognizes that it might not hold. An example he gives, something that public choice people should appreciate, involved the Ottoman Empire, where people were taxed on the appearance of their properties and could even face confiscation if their properties were too lavish. Result? People would hoard money and not spend it, at least that is what Jean-Baptiste Say had to say, and he had some other similar examples.

Greg Ransom writes:

Barkley, you horde money, the purchasing power of my money goes up. What am I missing here -- can you put the argument in the form which would persuade a blog reader?

Lord writes:

If not spent, it would be saved, but what would there to be to invest in as rates and returns approached zero? They may not wish to spend even then if they expect they will need it in the future and may not have an income then. More expansionary monetary policy would help, but it is hard to push on a string.

Arthur_500 writes:

The problem is not that government spending cannot induce positive change in the economy, rather the question is what government spending.
Government spending on government is, to paraphrase Winston Churchill, like trying to pull yourself up in a bucket while standing in in.
Government spending in private business and industry provides jobs, investment, money velocity and a tax base that begins to support that government spending.

Bill writes:

"...[Y]ou cannot argue that these groups did not increase their spending, and that their increased spending did not pull large numbers of Americans - roughly two million in each case - into productive and valued employment."

I can easily make that argument, but I don't really need to. The market has made that argument for me. Bad Fed policy lead to artificially low interest rates, which in turn reduced the cost of capital, which inflated valuations. In both examples (tech and housing booms), easy money was chasing bad investments that the market has since determined were neither valued nor productive - not to the levels in which they were originally invested in. Much capital was flushed down the toilet.

Of course, to believe this, you have to realize that real prosperity comes from real capital accumulation, not credit and debt. I'm sure Delong would disagree.

Can I tell you where that capital would have otherwise gone? No I can't - no one can with any degree of certainty. But it would have gone somewhere, and I can say we wouldn't be facing this current crisis. Heck, maybe I'd have my flying car by now.

The new bubble seems to be in arrogant economists who foolishly think they can design and run an economy. I can't wait for that immoral and evil bubble to pop.

Barkley Rosser writes:


During the Great Depression, businesses "hoarded money" and did not carry out capital investments. Prices fell, thereby increasing the purchasing power of those who had money. But then, the nominal money supply was collapsing much more rapidly than was the price level, indubitably reducing peoples' real wealth, as banks failed widely with no FDIC around. Do you dispute these facts?

TomB writes:

I agree with Brad W. It wasn't mere spending on information technology - it was investment in a growing industry. If, during the 90s, the government had invested in roads and a basket of random projects, can anyone doubt that we would not have seen the record growth that we did?* Spending is not what fueled employment, but technological growth. Not only were the advances in computers and technology valuable in and of themselves, but the growth of information technology increased efficiency of workers across a variety of sectors (I am assuming).

So all spending is not equal. Investment in a growth or productivity enhancing industry is better than investment in an ordinary industry. Investment in the next big idea is better than investment in yesterday's idea. Identifying the next big idea is not simple either - venture capitalists fail many times for every time they win big (I do not have data in front me). Some may think that green technology is the next big thing, but people have been investing in it for years. No new developments in technology or changes in social values have happened to indicate that green technology will hit it big anytime soon.

As for the housing industry, given what we know now, the growth in the real estate sector did not pull people into "productive and valuable employment." The housing growth misallocated resources and inefficiently employed people in an overvalued sector.

*Perhaps DeLong thinks Clinton's fiscal responsibility, expansion of free trade, and other social policies in combination with spending were the driving force behind the growth of the 90s. I am not sure how that would help his argument though.

Jayson Virissimo writes:

"The answer here is very garden variety. You are assuming that Say's Law holds. Supply creates its own demand, and if money is not spent on one thing it must be spent on something else. Why?"
-Barkley Rosser

Why is it that people who don't believe Say's Law holds never state Say's Law the same way that people that believe Say's Law holds do? My intuition tells me that there is a straw man at work here.

fmb writes:

Brad has been clear numerous times that he thinks (and thinks it's widely accepted) the interest elasticity of money demand is not 0.

One recent representative post:

James writes:


Bryan is wrong but not for any reason related to Say's law. He doesn't appear to be assuming it, though he seems to think that there was some marginal business expenditure foregone in order to fund the investment associated with the internet boom. Maybe that's wrong?

Anyway, here's the real reason why you are right: If you have decided to save more and spend less, then anyone willing to increase your future financial obligations, whether a credit card thief or the federal government, can increase GDP in the current accounting period by running up debts that you must pay in later periods.

The mistake Brad makes is in assuming that something special happens when the party running up debts in someone else's name is a government.

If I swiped your credit card and charged a lot of purchases on it, that too would increase GDP. But it would make you worse off. If the law were changed to make credit card theft legal and banks were not allowed to do anything about compromised accounts, I could swipe everyone's credit card and charge a lot of purchases on them. That would increase GDP but it would make all of the cardholders worse off.

Would the consequences be any different if I called myself a government and called my actions a stimulus package?

simon writes:


I agree. Brad is not worth taking seriously. He is not honest nor open to ideas that differ from his own. He plays the role of demigod.

James A. Donald writes:

Assume that creating value is easy, any brainless fool can do it, even the brainless fools at Washington Mutual. It is then immediately obvious that the government can make everything lovely by printing money and giving it to the morally worthy. Are car production lines shut down while unemployed workers idle? Just print money and give it to bureaucrats in government schools, or other similarly wise and worthy people, and lo and behold, those car production lines will start up again, and all will be well.

If, on the other hand, producing value is hard, then falling nominal GDP may well reflect the discovery that we were producing less value than we thought - that we were providing houses to people who were not in fact willing to pay for them, and building cars that were not in fact the cars that people wanted, in which case issuing enough money to stimulate the economy may well stimulate inflation, rather than the production of real wealth.

This brings us to Japan: Did Japan lose a decade because it refused to allow the free market to remove the power over assets held by incompetent people, or because it failed to run a big enough deficit?

Those who believe Japan failed to run a big enough deficit may well now get the chance to put their theory to the test in the US. If spending enough borrowed money to keep the incompetent running businesses stimulates the economy, then they will have proven themselves right.

Andy writes:

DeLong and his pal Krugman are clearly disingenuous in dismissing and being baffled by any opposing arguments.

Dezakin writes:

"More expansionary monetary policy would help, but it is hard to push on a string."

There's a third option between standard monetary policy, and fiscal policy. We can make more string and just pull. After seeing what Japan went through, we may well want to engage in quantitative easing: printing money.

Jacob Oost writes:

I'm mystified that Delong is stumped on this. I've never even taken a class in economics and I have no trouble understanding this.

The thing is that economic growth depends on individuals engaging in voluntary trade in which both parties benefit.

When the government spends money merely to spend money and boost the economy, it is not engaging in trade in which two parties benefit, because the first party in this case is actually the tax-payers, NOT the government. They have no say here (beyond the ballot box, but see public choice theory on that).

When I buy bagels, it is because I know that I like bagels and that I value the bagels more than I value my $2.29. If the government buys bagels, it does not know whether the tax-payers truly value bagels or not, or (and this is very important!) at what price they say "no" to buying more bagels. Put simply, the government doesn't have enough information to make wise spending decisions.

Why do governments have to invest in boondoggle shopping centers and other showy projects? Because private investors, whose own money is on the line, didn't think it was a good ROI. But the government spends on what *it* wants to spend and assumes that "it will be good for the economy," create jobs, etc.

Economic growth depends on peoples' incentives being coordinated by the price system to produce things that other people want, at a price they are willing to pay. Because spending money is a part of this process, one-dimensional thinkers can easily be duped into thinking that spending money *equates* to economic growth. But it ignores the important points that the government does not know and cannot possibly know what things to buy OR at what price they should buy them.

Randy writes:

re; "The government's money is as good as anybody else's."

Technically true. When the government seizes dollars from others, be it current or future taxpayers, the value of each dollar is still the same when spent. When the government prints more dollars everyone's dollars are devalued the same. But the fact that this is technically true is not a justification for doing it, because the fact does not resolve the moral issues.

Larry Peoples, Sr. writes:

I think the "Troubled Asset Relief Program" should be re-named "Cash Ready Assistance Plan."

h-dawg writes:

Grant is right. I don't know why intelligent economists like Bryan even waste time with an "economist" like DeLong who doesn't understand the difference between spending and investment.

Mr. Econotarian writes:

I'm glad to hear the government is good at investing, that way they can invest, make a profit, and stop taxing us.

Oh wait, government has turned a profit how often in the last 20 years?

Is government investment (above basic services) more likely to create or destroy wealth?

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