Assault of Thoughts, Special Stimulus Edition - 7/15/2010

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" -JMK

- David Henderson ably explains why it's hard to make definitive statements about the effect of the stimulus because of our inability to identify a counterfactual, and then goes on to make definitive statements about the stimulus despite his inability to identify a counterfactual. See my comments in the comment section - it's the first one. [UPDATE: David Henderson grants the point in the comment section of his blog, which is not surprising at all because he clearly employed the logic w.r.t. the CEA, he clearly understands the logic, and he clearly is a genuine guy that is more than happy to apply the logic to himself. It was a momentary oversight that happens a lot in quick blogging. I just found the stark juxtaposition between what he was dishing out and what he was claiming surprising. I agree with Henderson probably the least of the three Econlog bloggers, but it's not my intent to critique him for the sake of critiquing him. Sorry for the delay in updating this, David! Thanks for visiting the blog.]

- Greg Mankiw has a better critique of the same issue (Henderson cites Mankiw - he should have said "Mankiw's dun' good" and left it at that). All we have available to us is to try to understand how fiscal and monetary policy effect the macroeconomy under given circumstances and then apply what we learn or think we've learned. We can't point to one policy and one downturn and say "this is what happened". We can infer what happened based on what we know about fiscal and monetary policy, but ultimately that's all it ever is, and we've just gotta be straightforward about that. It doesn't mean you can't have a firm sense of what policy will do - that's fine to have. Just don't defend that on the basis of a single event for which you have no counter-factual.

- Brad DeLong shares some of Jean-Baptiste Say, and suggests that Say "gives what is the first thorough explanation I have ever seen of irrational exuberance, overtrading, excessive leverage, disappointment, panic, flight to quality, excess demand for high-quality and liquid assets producing excess supply of goods and services and labor, falls in incomes, and the fall in incomes causing the initial problem to snowball...". I have to take his word for it, because fancy-pants DeLong quotes Say in French. Nevertheless, I've seen English selections before too that confirm this view of Say. DeLong concludes that Keynes was ultimately unfair to Say. I don't think this is exactly new news. I personally view Keynes's version of Say's Law as a heuristic device rather than a probing history of economic thought. In that sense, the fact that Keynes's Say's Law was a strawman has never bothered me that much. It was - but it was also a mindset that the Classical School slipped into or was at risk of slipping into. In that sense, it was still an important backdrop for the General Theory - it was a way of saying "insofar as I am different, these are the grounds on which I'm different", even if the Classics didn't conform exactly to what has been called the "strong version" of Say's Law. If Keynes were presenting a review of Say's works, it would obviously be inappropriate, but I think you have to consider the context.

- David Indiviglio makes an important observation: the administration's forecast of inflation may have been way off, but it's forecast of GDP was pretty much on target. What does this mean? Well, it may mean that Keynesians have the relationship between stimulus and output right (which is pretty good, since that's the primary mechanism through which stimulus works!), but that the underlying relationship between GDP and unemployment is behaving unpredictable. Harry Holzer, of Georgetown University and the Urban Institute, makes this point a lot - that Okuns Law is not functioning as we expect it to. This is an important point for guys like David Henderson who point to that unemployment forecast, forget everything they just cautioned us about when it comes to counter-factuals, and claim the stimulus didn't work. What is the stimulus designed to impact? Demand. And how does that work on the economy? Through output and prices. The impact on output followed predictably (I talk about why nothing surprised me about the performance of output in response to stimulus here). But something is breaking the expected link between output and employment. This is actually a very important critique that Hayek made of Keynes - that he didn't spend enough time on the link between output and employment. Recent events seem to suggest that that relationship is worth a closer look.