The state of economics

September 23, 2009

The debates stimulated (pun intended) by Krugman’s recent article in the NY Times Magazine are incredible.  Here’s Krugman’s sensible article; here’s Cochrane’s rebuttal.  And here is Brad Delong ripping into some incredible comments of “freshwater” economists.

I find the freshwater economists slavish dedication to so-called Ricardian Equivalence particularly disturbing. Here’s Cochrane:

In economics, stimulus spending ran aground on Robert Barro’s Ricardian equivalence theorem. This theorem says that debt-financed spending can’t have any effect because people, seeing the higher future taxes that must pay off the debt, will simply save more.

And here’s a graph showing US  government debt:

US National Debt-GDP

And here’s a graph showing US savings:

US Savings Annual

Something wrong?  The relationship seems to hold during WWII, although saving was appparently enforced as government policy during the war, but for the last 30 or so years Ricardian Equivalence seems to have been forgotten: government debt has increased signficantly while savings has declined. This trend is likely to change in the near future, as government debt increases, but surely this is due to households repairing severely over-leveraged household balance sheets rather than expectations of future taxes.

I really think it’s a fascinating time to begin a PhD, as for me the crisis has helped me to understand systems and policies that were previously taken for granted.  That said, I think there’s been some over reactions–that the crisis marks the death of capitalism.  I think what is more at stake (again) is a certain form of neo-classical, deregulated, laissez faire capitalism–which many thought was finished in 1929!

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