Tuesday, December 10, 2013

Krugman is wrong and MMT is right.

Further to Paul Krugman’s recent claimthat aggregate demand cannot be raised, he now claimsthere is a big obstacle in the way of raising demand, namely that in order to do that, government (in his words) has “to credibly promise to be irresponsible”.
What he means by that is a claim made by David Beckworth(who Krugman actually cites) namely that if government does a helicopter drop, there’ll be no effect unless everyone  thinks the resulting money supply increase is permanent. In short, Krugman is invoking Ricardianism: that’s the idea that households and firms devote big efforts to PREDICTING future government actions and policy, and adjusting their behaviour accordingly.
So the Beckworth / Krugman argument is that households and firms on receiving the helicopter windfall won’t spend it because they’ll reckon that eventually government will withdraw the money supply increase via extra tax.
Well this is straight out of cloud cuckoo land isn't it? What does your common sense tell you that the average household or small firm does on noticing that their income and bank balance has expanded? A significant proportion will increase their expenditure, won’t they?
Or do you seriously buy the B&K idea that every household keeps a close eye on the deficit, the national debt, the monetary base, inflation etc etc and decides to hoard cash as per B&K’s theory? I suggest the average household hasn’t the faintest idea as to where to even look up figures on what’s happening to the debt, the base, inflation, etc.
Bill Mitchellsaid that Ricardianism was an idea from “la-la land”, and I agree. Joseph Stiglitzsaid that “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.” I agree.
Moreover, the empirical evidence backs the above common sense guess. That is, the evidence is that when households come by a windfall, they spend very roughly half of it within a year and save very roughly half. See here, here, here, here, hereand here.
Some of the latter studies do not relate DIRECTLY to helicopter drops: they look at the effects of windfalls in the form of tax rebates. But it’s abundantly clear from that evidence that households are not what might be called “100% income smoothers”. For example, someone who receives an $X windfall and who thinks they have 30 years to live, will not split the $X into $X/30 portions and spend $X/30 each year for the next 30 years. Quite the contrary: they’ll do what your common sense tells you they’d do. That is, spend a significant chunk of the $X within a year or so.

Promise to be irresponsible?
Now let’s examine Krugman’s bizarre claim that government has to “to credibly promise to be irresponsible”.
What he means by that is that given a deficit funded by new monetary base (i.e. a helicopter drop), government has to commit to leaving the extra money out there in private hands, else the private sector will “go all Ricardian” and hoard the money instead of spending it.
Well that would be irresponsible if the result was excess inflation. If not it wouldn’t. Or have I missed something? In short, the sensible / “responsible” / common sense policy is for government to run a deficit funded by new monetary base AS LONG AS THAT IS NEEDED in order to get unemployment down.
And if for some reason the private sector goes into irrational exuberance mode (which it’s bound to do at some point in the future), and aggregate demand becomes excessive, then the “responsible” thing for government to do is to put the whole process into reverse: i.e. raise taxes and start WITHDRAWING helicopter money.

And what do you know? That's exactly what Modern Monetary Theory prescribes!! 

And finally, David Beckworth in the comments section after his blog post actually concedes the latter point about helicopter money being left in the private sector “if needed” (to quote him). See the comment by Bob Rawlings.
Perhaps Paul Krugman could now do an article pointing out that MMTers have been right all along on the helicopter point.

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