Wednesday, May 9, 2012

Jonathan Catalan on Chris Edwards and Keynesian time inconsistency


A lot of good thoughts here. He's not impressed by Edwards either. I do think the time-inconsistency problem is a little tougher than Jonathan suggests. He seems to present it (and I could be wrong) as "Keynesians always reach for fiscal stimulus", which he does a good job pointing out is not true in any particularly activist sense (we think it's nice that there are automatic stabilizers in place, but aside from that the reaction to 2008 was very different than the reaction to other situations, as Jonathan points out).

But time-inconsistency is more than that. The point of time inconsistency is a question of whether you can credibly commit now to decisions in the future. In other words, if you responde every time with fiscal stimulus that's fine as long as you reel it back in in boom years. Edwards argues that Keynesians don't demonstrate an ability to commit to that. That's why I highlighted all the discussion of the Bush tax cuts. That was a great (recent) example of Keynesians making a current commitment to long-term deficit reduction while others were the ones that made the bad decision (at least in terms of closing the long-term debt problem). Keynesians committed, many others didn't - and Keynesians committed and across the board specifically cited the long-term debt as the reason for their decision.

I do have to say, though, I found this point from Jonathan bizarre:

"Something I note that most of these quoted economists have in common is that they do not support the Bush tax cuts."

Right! I specifically looked for quotes where they opposed the Bush tax cuts which also specified why they opposed it! Let's read on:

"While there may certainly be a case that the Bush tax cuts were ineffective because of how they targeted different income levels and how this may have distorted their effect, this is not what these economists seem to be arguing.  Rather, they seem to be claiming that in the face high (even rising) long-term costs of the entitlement programs and defense spending, we should increase spending."

WHAT?!?!? No! The entitlement programs are the increased spending that is going to happen. The argument isn't that we should increase spending! The argument is that because there is a long-term debt problem casued by the entitlements we should increase revenue! Read on:

"This, to me, seems like a bad (possibly mildly contradictory) argument.  Long-term debt ought to be reduced by annual budget surpluses or by increase in real tax revenue from an increase in real income, not by an increase in the tax burden."

And now I feel like I'm taking crazy pills. Yes, we should run a surplus or at least a smaller deficit. You do that two ways: (1.) reduce spending, (2.) raise revenue. Lots of Keynesians like Obamacare because they think it will "bend the cost curve" and reduce Medicare spending. People who know Medicare like the back of their hand think this too, so I'm inclined to at least entertain the idea that it will work.

But the other key is raising revenue, and the Keynesians have shown that on precisely this issue they are not the ones that have the time inconsistency problem. They are willing to do things in the short term that are painful in order to deal with long-term problems. That is the very definition of not having a time-inconsistency problem.

Two points I meant to raise in the initial post, but didn't:

1. It's important to note that the real problems with the long-term debt are not the result of Keynesian policy at all: they're the result of Medicare and to a tremendously lesser extent, Social Security.

2. A few times... in the Edwards post, in Henderson's post, and now in Jonathan's post, there is this sense that we have to run surpluses in good times and deficits in bad times. That's actually not true. We could sustainably run deficits from now until the end of the world, so long as the economy keeps growing. They just need to be smaller in boom times and bigger in recessions. But there's no obligation to run a surplus. If things are going really well, of course it would be nice to run a surplus and pay off the debt even faster. But there's no reason why we have to.


  1. Where I write, "Rather, they seem to be claiming that in the face high (even rising) long-term costs of the entitlement programs and defense spending, we should increase spending," I made a typo. I meant taxes, not spending (although, I suppose spending also makes sense, since an increase in long-term costs is synonymous with an increase in spending). My point was that they weren't targeting the Bush tax cuts because they were poorly designed, but for the sake of increasing revenue.

    I consider this "mildly contradictory," because increasing the tax burden is the same as increasing the proportion of private income that can no longer be spent on private consumption/production. As we leave a recession, this seems to me to be the opposite of what we really want to do, which is transfer resources to the private sector (since we know that, in general, the market is better at allocating resources than the government). If we do increase tax revenue, as I pointed out, it ought to be from an increase in productivity (i.e. an increase in real income); this would be far less damaging. This also suggests that the priority should be to reduce spending, not increase revenue. How you balance the budget matters -- it's not all the same (increased taxes vs. decreased public expenditure).

    By the way, I make the same point about universal healthcare in my post -- Keynesians see it as a means of reducing public spending on healthcare. Libertarians and right-wingers can disagree that this is true, but as far as Keynesian consistency goes, this is a means of reducing long-term debt. I also raise the point about social security; but, I mention that other increases in spending are either temporary or not associated with Keynesians, but with the right wing (i.e. military!). That's what the two last graphs are about. So, rather than a Keynesian inconsistency, it's a political inconsistency -- the two should not be mixed up.

    Finally, I don't think that was Edwards' argument (i.e. about time inconsistency). His argument is actually that Keynesian prescriptions are inconsistent with their alleged support of reducing deficits during periods of normal activity, because as soon as deficits begin to be reduced there is a recession and Keynesians scramble for stimulus. My point is that: (a) few recessions have been met with grandiose fiscal stimulus (vs. monetary stimulus) and (b) the lack of reduction in long-term debt is a result of political inconsistency, not an inconsistency in Keynesian theory.

    I hope my argument is clearer now.

    1. Aha! OK, that makes more sense.

      I'm not sure if that's contradictory in the context of the deficit unless you think we're on the other side of the Laffer curve. I don't think anyone thinks that, and I don't see a reason to think that - so I'm not clear it's contradictory.

      As you say - it may not be the best thing to do during a recession. That's exactly why I actually supported temporarily extending the tax cuts even for the rich. We can argue about what is more of a priority - the long-term debt or the recession. What you can't argue is that Keynesians who want to repeal the Bush tax cuts now, citing long-term debt concerns, don't care about the long-term debt or are unwilling to commit to fixing it (as Edwards argued). They may be wise or unwise, but they are certainly credible on the long-term debt.

    2. If your "not by an increase in the tax burden" is a matter of opinion, then I suppose we just disagree on what it will take. If it's a statement of fact (ie - increasing taxes is not part and parcel of being a deficit hawk), then I think you're wrong about that objectively.

    3. I largely agree with you, especially with long-term commitment to debt reduction. I didn't make it explicit that I was making a tangential argument (or, at least one unrelated to Edwards'). Although, I don't -- if, for the sake of argument, I agree with the idea that tax cuts are not as effective as actual spending -- necessarily see a contradiction with tax increases (or, even, the lack of tax cuts) during a recession, if we assume these people would just keep retained (from taxation) income idle. I was talking more about when idle resources are not a problem and it's ideal to distribute resources back to the private sector and allow market allocation (i.e. increases in the tax burden to deal with long-run debt).


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