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Economic science has learnt much since then. Alas, however, President Barack Obama’s excellent team still is being limited and thwarted by Republican congressional opponents. That’s politics — dangerous politics.
Perhaps more surprisingly, a number of conservative macroeconomists have signed up as pessimistic opponents of vigorous government stimulus of the ‘real’ economy now. Why would well-trained economic scientists want to repeat old errors at a critical time?
It is an interesting fact, although not an explanation, that some of them are repeating an old Harvard syndrome. In the early 1930s, Harvard’s stars included such famous names as Joseph Schumpeter and Edward Chamberlin. Both led the charge against Roosevelt’s New Deal Recovery Programme.
Joseph Schumpeter put into the record that depressions are good things, not bad ones, because they provide “catharsis” (whatever that means in this context) of the previous boom’s distortions. A depression is, in fact, just what the doctor ordered!
Schumpeter was not alone. Another famous Austrian, Friedrich Hayek, then resident in the UK, earned perpetual guilt for similar insistence on limiting any expansion of credit during the 1931 deflation. It is reported that, in a London seminar deep in the Depression, J.M. Keynes’ young associate, Richard Kahn, asked Hayek: “Do you mean that if I borrow a pound from you and spend it on consumption, I am making the depression worse?” Hayek replied: “Yes, and it is very complicated to explain why.” But it is easy to explain why Hayek’s reputation as a macroeconomist collapsed.
This was not an Austrian peculiarity. Edward Chamberlin, the celebrated inventor of the theory of monopolistic competition, contributed to the critique of the New Deal the loony view that depressions were “impossible” because demand could never fall short of supply. No wonder then that a Boston newspaper ran a glaring headline: “Harvard’s first team strikes out”.
History is in a way repeating itself. Another pair of well-known Harvard economists, Greg Mankiw and Robert Barro, seem to be led by a Hoover-Mellon-style conservative ideology to want to limit and oppose Obama’s recovery proposal.
Keynes and Kahn argued that in an economy with excess idle capacity and unemployment, a dollar of added government spending on goods would add more than a dollar to demand in total output. Their reasoning was that part of the extra private income earned in producing whatever the government bought in the first place would be spent by those who earned it. Current estimates of this ‘multiplier’ suggest that a dollar of public spending on goods generates, after some lag, about a dollar-and-a-half of total spending and output. Like all such estimates, this one is approximate and uncertain.
Today’s followers of Herbert Hoover assert that the multiplier is much smaller, not 1.5 but perhaps 1.01, or 1.0, or perhaps even less. They are probably wrong about that, and the extreme assertions are absurd. Standard forecasting models, used in government and in the private sector, do best with multipliers near the 1.5 suggested here. A comparative study at the Federal Reserve Bank of Boston found that much smaller multipliers, as once advocated by Milton Friedman, work very badly. But even if public purchases of goods added only those goods to national output, that would be no reason to oppose them at a time when workers are being laid off and factories are closing because private buyers for their products cannot be found.
So how to explain such foolishness at this stage of the development of economic science and at a time when the real economy is in such urgent need of an expansionary impulse?
Two thoughts suggest themselves. One is that a long interval of tranquil economic growth, interrupted only by mild recessions, has lulled young macroeconomics into the belief that modern capitalist economies cannot have major failures of demand. The other thought is that it would seem that conservative ideology is being allowed to override good sense.
Good reputations take time to build. But in the unfair jungle of science, they can be lost overnight. Fortunately, after any bad call in economic modelling, one can take some comfort from the last sentence in Gone With the Wind: “Tomorrow is another day.”
© 2009 Tribune Media services
(Businessworld Issue Dated 10-16 March 2009)