Friday, October 21, 2011

A Few More Thoughts About Keynes's Victory

-- Posted by Neil H. Buchanan

In my post yesterday, I discussed the views of the winners of this year's faux-Nobel in Economics, Christopher Sims and Thomas Sargent. In particular, I pointed out that the claims of some on the right that Sargent's selection is a slap at Keynesians are simply wrong. Both Sims and Sargent are aggressively apolitical, but even so, at least Sims has said directly that Keynesians are doing the most important work in economics these days. He also approved of further efforts to stimulate the economy through fiscal policy.

The econ nerd in me then made a further argument, which is that Sargent's description of a theory called "rational expectations" was a (perhaps unintentional) endorsement of Keynesianism. Sargent described that theory as merely the assertion that people's expectations (about prices in particular) matter in determining economic outcomes. In other words, the theory of rational expectations is now merely a theory of expectations.

This would not be a problem for the anti-Keynesians if Keynesians had actually built their models on the assumption that people's expectations have no impact on economic outcomes. The fact is, however, that Keynesians have long taken expectations seriously. The only way to get a model that includes expectations in it not to have Keynesian results (most importantly, the prediction that active government policy can improve the economy) is if one assumes that expectations are formed fully rationally, in the very specific and peculiar sense in which rational expectations theorists define that term. (To describe it from a different perspective, the assumption that expectations are formed rationally means that markets are either never out of equilibrium, based on the information that is available at any given moment.)

One interesting aspect of this observation is its analog in American politics. In economics, anti-Keynesian models are built on the idea that expectations are formed 100% rationally (by their definition), and then they say that Keynesians build their models on the idea that expectations are formed 0% rationally (i.e., that expectations do not matter). The reality is that Keynesians say that expectations do matter, that people might be partly "rational" in the stylized sense, but that anything less than 100% rationality still leads to Keynesian results.

In American politics, the right (especially the currently ascendant version of the right) takes the attitude that government is always, completely, dangerously, 100% bad and wrong. They then accuse people in the center and on the left of believing that government is 0% wrong. The reality, again, is that the center and the left are fully aware that government is not perfect, and they are looking for ways to improve social outcomes. If a government program can help, and if we can set it up with proper safeguards, then it should be implemented. If a public/private partnership is better, then that is what we should adopt. If tax incentives will do the trick, great. If there is no problem in the first place, then there is no reason even to ask whether there is a role for government.

This is another reason that claims of equivalence between left and right strike me as so absurd. When someone says that, say, Paul Krugman simply has a bias for bigger government that he builds into his analysis, while right-wing economists do the equivalent to support their bias for smaller government, that is simply wrong. Neither Krugman nor anyone I know who counts as non-right has a baseline preference regarding the size of government. The right does. Only pure sophistry can turn "I don't think government is always wrong" into the equivalent of an absolutist statement.

A second issue relating to yesterday's post was raised by the commenter Doug, who pointed out that I had adopted a definition of "helping" the economy that was inappropriately narrow. That is, even if the rational expectations theorists were right that government policy cannot make the economy grow faster, or push the unemployment rate below its "natural" level (as if such a thing exists), there are still plenty of things that government policy can do to make life better, that is, to "help." I completely agree. This is yet another example of the danger of arguing on the other side's terms. I did not mean to concede anything, but only to describe the anti-Keynesian case in its own narrow terms.

Similarly, I noted yesterday the anti-Keynesian claim that austerity can be expansionary. The interesting thing is that this argument, too, is not supported merely by claiming that stimulus is not expansionary. That is, even if stimulus were proven to be non-stimulative, that would not prove that austerity is stimulative. Under the rational expectations theory (or any other theory, for that matter), one needs additional assumptions to turn austerity policies into expansionary policies. Those assumptions, in turn, must withstand empirical scrutiny, and they do not.

Finally, I should not that one can easily believe that the government can do some goods things for the economy in the long run, even if one thinks that it cannot change short-term macro outcomes. To their credit, some prominent anti-Keynesians have argued over the years that the key to long-term prosperity is increased support of education. That is, if the government wants more prosperity, it can raise people's productivity so that everyone's standard of living can rise. This need not be a Keynesian nor an anti-Keynesian point.

Unfortunately, the new move among economists and politicians on the right has been to denigrate government's role across the board. So, the same people who once might have said that the government should not try to "fine-tune" the economy in the short run, but should instead focus on affirmative strategies for long-term growth, like education, are now arguing that teachers are overpaid and underworked, that education (including college) is not worth it (individually or collectively), and that we should simply give up on trying to change the long-term outcome (and, instead, shut down the EPA). That is a coherent argument, in some sense -- the empirical assertion that government always makes things worse -- but it is both defeatist and unsupported by the evidence.

Again, however, I am not saying that government always makes things better. We do not live in a world of absolutes.

6 comments:

tjchiang said...

Saying "that government is always, completely, dangerously, 100% bad and wrong" is anarchism, not conservatism. It is no more fair than saying that liberals are all communists. Almost no one really takes the absolutes (almost nobody is for literally zero government); the difference is nearly always a matter of emphasis. In fighting conservatives unfairly labeling liberals, I think you have done essentially the same thing on the other side.

Doug said...

"If a government program can help, and if we can set it up with proper safeguards, then it should be implemented."

So if a government program can 'help' in the broad sense, it should be implemented. I would say this is a baseline preference for big government.

"Neither Krugman nor anyone I know who counts as non-right has a baseline preference regarding the size of government."

I think the two quotes above can be seen as contradictory. What I think you mean in the first quote is that some sort of cost-benefit test along with just help.

I'm afraid I also have to agree with tjchiang - some on the right take the attitude that gov is always wrong but most support gov (to an almost unlimited degree) for military spending (to take just one example). Your point about education is well-founded (that overcrowded schools with crumbling facilities exist in the U.S. while Wall Street types don't understand the outrage over bailouts of the rich is beyond me).

Neil H. Buchanan said...

In response to Doug:

Yes, you are absolutely right that by "help" I mean in a cost-benefit sense. That is, after implementing the program, would we be able to say, "That helped," compared to what would have happened if we had not implemented the program. So, again, cost-benefit.

That means that there is no baseline preference for big government, only for government activities that are a net positive (if such activities exist, as an empirical reality). Those and no others. There is a baseline preference for a government (to implement the rule of law, etc.), but not of any particular size.

Note, however, that even if the definition of "help" were "does SOME good," i.e., not by comparison to nongovernment alternatives, but simply "is there a positive effect of this program," then there would still be no baseline preference for big government. That definition would lead, as an empirical matter, to a bigger government than my preferred definition would, but it would not necessarily lead to a Leviathan.

Plenty of potential government activities don't "help" even in the less rigorous sense of the word. I don't know of any liberals who would enact such programs, merely to increase the size of the government.

In fact, Doug's further point about conservatives supporting big government in some contexts is quite apt, because the best examples of government programs that do not "help" in either sense are many current military expenditures (outdated weapons systems, Iraq war, etc.). I readily concede that the words and deeds of American conservative politicians do support big government in some very specific areas. That does not cut against the point of my post, but Doug's point is surely an important one.

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Show you said...

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