Barro on money multipliers and economist sniping

Robert Barro is interviewed in The Atlantic about his views of the stimulus plan (see also a recent WSJ piece here). All in all, he is not a fan:

The Atlantic: And I take it from the Wall Street Journal piece you wrote last week... well, the piece is just specifically about measuring multipliers, but I take it that you are fairly skeptical in general that fiscal policy will boost aggregate demand.

Robert Barro: Right. There's a big difference between tax rate changes and things that look just like throwing money at people. Tax break changes have actual incentive effects. And we have some experience with those actually working.

TA: What would you say is the best empirical evidence there?

RB: Well, you know, it worked to expand GDP for example in '63 and '64 with the Kennedy/Johnson cuts. And then Reagan twice in '81 and '83 and then in '86. And then the Bush 2003 tax-cutting program. Those all worked in the sense of promoting economic growth in a short time frame.

TA: Why does this set of evidence depart from what seems like the standard Keynesian theory that a dollar of spending would have a larger multiplier than a dollar of tax cutting?

RB: I don't think it is really confusing at all, because when you cut taxes there are two different effects. One is that you cut tax rates, and therefore give people incentives to do things like work and produce more and pay more -- maybe, depending on what kind of taxes. And then you also maybe give people more income. This income effect is the one that's related to this Keynesian multiplier argument, where it's usually argued that government spending should have a bigger effect. So that's the income effect. But the tax-rate effect, inducing people to do things like work and produce more and invest more, is a whole separate effect, and that could easily be much bigger than the multiplier thing, than the income thing.

TA: This might just be my confusion, but the inducement to work, is separate from the idea of boosting aggregate demand and consumption in the short run.

RB: Oh it's exceptionally different. But the experiment is that the government is doing something by changing the tax system to lower its collections -- by, for example, a tax cut. The response of the economy to that is not going just to isolate this business of giving people money. It's also going to have these incentive effects, more than tax rebates, on economic activity. It's going to be a combination of those two things -- income effects and incentive effects. One piece looks like this sort of multiplier stuff, which is analogous to government spending -- probably because the government spending has a first-round effect where it comes in and directly affects the aggregate demand -- and then in the second round it sort of looks like a tax cut. That's why the government spending thing is bigger in textbooks: because it has this first round in addition to all these subsequent ones.

But all that is just income responses -- people having more or less income, or the government keeping the money and then that shows up as people's income. None of that is about responses in terms of incentives -- incentives changing in response to lower or higher tax rates. And the evidence that Romer and Romer look at is combining the tax rate stuff with the income stuff. I didn't know it was possible to do that but, hey, you get different viewpoints form different people. But the study I am doing now is intended to include all these things together in one framework.

The upshot is that, much more important than any fiscal stimulus package is the design of new regulations on the housing and financial sectors. He's pretty optimistic that the advisors brought on by the administration will do a good job of that.

Also interesting are a couple of potshots he takes at fellow economists. Paul Krugman gets a bit of a dressing down, in particular...

Hat Tip: Deepa


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And Krugman says negative things about Barro. In fact, lots of economists say extremely negative things about Barro's views here. The idea that the Great Depression was really one long boycott, with 25% unemployment because workers were suddenly not incentivized enough, is beyond ridiculous.

Tax cuts do not get you out of a liquidity trap. People will continue to hold onto their money.

Barro, in fact, has to mislead in order to make his empirical point. So misleading, in fact, that he's essentially lying. 83 and 86 involved tax cuts and tax increases. 84, which Barro doesn't mention at all, was the closing of all the loopholes that were inadvertently created in 81. It wasn't called a tax increase, but that was exactly what it was.

And Bush 03 stimulated the economy? Who does Barro think he's kidding? That growth was simply the housing bubble, created by Greenspan, not tax cuts, and reckless lack of subprime regulation. (Bush didn't even let states try on their own to restrict predatory lending, claiming federal pre-emption.)

And also unmentioned by Barro is the 90% tax rates from WWII until Kennedy. Somehow the US economy grew at record rates, not seen again until after the Bush/Clinton tax increases.

The tax cut mantra is anti-empirical pseudoscientific crackpot nonsense.

By william e emba (not verified) on 06 Feb 2009 #permalink

Lets see... Paul Krugman correctly predicted the bursting of the housing bubble a couple of years ago; Krugman predicted last spring that we were headed for a very deep recession if not a depression last spring. Barro predicted ... what did he predict correctly?

temporary nationalise and bring about current account (deposit accounts in us?) interest controls.


By zombie_bot (not verified) on 06 Feb 2009 #permalink

nationalisation > bailouts

By zombie_bot (not verified) on 06 Feb 2009 #permalink

When was the last time WSJ let a noncrackpot have editorial space?

Prof. Barro probably gets very well paid to say such things as: "....we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant." (from the WSJ article cited in post.)
But the current problem is not lack of investment capital, but lack of demand for goods and services. People, who have money, at the moment chose not to invest it, as there is no demand for the products of any investment.
So anybody giving the above advice does really not want us to address the problem, and does not have the interest of most people at heart.