The Fiscal Multiplier Wrestling Marathon

Welcome to the academic wrestling match of the recent years. In the left corner, Paul Krugman (with assistance from Bradford DeLong)! In the right corner, John Cochrane (with assistance from Eugene Fama)! They will fight over the size of the Fiscal Multiplier in a match where any trick may, can, and will be used. Both are heavyweights in the economics profession with one of them even with a Nobel Prize to his credit! This is a match not to miss.

Well, this is actually not funny at all. But one of the most important questions in macroeconomics, how effective is expansionary fiscal policy in a recession, have recently been subject to such heated debates among leading American economists that a tired sports analogy does not seem that much off the mark. Interestingly, the main contesters are not particularly known for their research in macroeconomics (but rather, trade theory and finance, respectively). But never mind about that – they are smarter than the average economists, so what they have to offer should be of interest.

Not only in the US, but in all other countries where the financial crisis has taken its recessionary tolls. In such a situation, knowing the size of the fiscal multiplier is actually quite important, if you as a responsible policymaker wants to counteract the immediate negative effects of the recession while still keeping an eye on a horizon where an aging population is looming (not in the dark as many wants to believe in my part of the world, but in the bright daylight).  Unfortunately, what could have been the time for modern macroeconomics to shine as providing relevant tools for policy advice, has been overshadowed by the (mud-) wrestling going on between very influential economists. Like it or not, in my part of the world nearly all advocates of fiscal stimulus refer to “Nobel Laureate Paul Krugman” as a backup for their arguments.

I definitely wouldn’t do that. His public arguments with John Cochrane are a bit embarrassing for the profession from an academic perspective, as they convey economists as frivolous and self-righteous persons who are only driven by a purely ideologically-based agenda. For what it’s worth, Krugman probably made the feud draw worldwide attention with his controversial New York Times Magazine article in September 2009, “How Did Economists Get It So Wrong?” There, he presented a caricature of macroeconomics as consisting of good, but naïve, guys (saltwater economists) and bad guys (freshwater economists), and he spiced it up with a lot of quite hateful outbursts against particular economists. It was a disturbing read, and everybody who hated macroeconomics loved it. The policy advice that came along with the article was essentially that since nobody got it right, there was nothing left to do than going back to Keynes. And apparently he meant going way back. John Cochrane wrote a response, “How did Paul Krugman get it so wrong?” trying his best to keep his composure in addressing all the attacks. Since then, the fight has been on.

Disagreements bring on exchange of ideas which can help a science evolve, but what is going on here on this serious topic is ludicrous. No policymaker gets any sensible advice, but they can pick the economist that suits their ideology to back up any policy. Cochrane essentially advocates a zero multiplier based on the Ricardian equivalence theorem, and Krugman essentially advocates a Keynesian multiplier through a figure of a Keynesian cross. So evidently, Krugman is indeed going all the way back to simple Keynes as we have learned it in undergraduate courses: Static graphical arguments, which may not be the best ones when dealing with an intrinsically dynamic issue. Cochrane is at least up front when he makes his points, as he cites modern macroeconomic literature and even acknowledges that some models can produce very large multipliers (in that direction, I would recommend Michael Woodford: “Simple Analytics of the Government Expenditure Multiplier” American Economic Journal: Macroeconomics, 2011).

Even though I actually side mostly with Krugman and Delong in terms of policy advice, I would never cite any of them in this situation. Their writings appear as resulting from a local (i.e., U.S.-based) spitting contest and not from sound academics. Therefore, when it comes to presenting clear academic arguments for one’s positions Cochrane is a clear winner of the match. Helped immensely by Krugman’s peculiar insistence on dumbing down his own position beyond comprehension. But picking a winner is not a remedy against the irreparable damage to macroeconomics caused by this marathon match. Even in academic wars there are no winners.

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