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Krugman and Ricardian equivalence

October 15, 2011

Ricardian equivalence, often referred to as the Barro-Ricardo equivalency theorem, is an extreme right wing ideological construct built to support the standard conservative view that government spending can never succeed.  In its essentials it argues that government deficit spending will never work because the private sector will simply reduce its own consumption or investment to the exact same extent in anticipation of the future taxes it assumes will be needed to pay for it.  The theorem was developed in its current form by Robert Barro, a far right economist considered by many, including me, to be a hack.  Acceptance in any manner of this theorem negates the possibility of a significant ongoing government fiscal role in the economy and brands its proponent as a neo-classical true believer in limited government.

Paul Krugman today sadly but not surprisingly mounts a defense of Barro-Ricardo while meekly pointing out that it may occasionally permit a limited role for government.  It’s yet another demonstration of Krugman’s orthodox neo-classical view of the world and why he’s so utterly unqualified to play an intellectual role in any protest movement of the left.

Here’s what we agree on: if consumers have perfect foresight, live forever, have perfect access to capital markets, etc., then they will take into account the expected future burden of taxes to pay for government spending. If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.

The problem here is that Krugman accepts the essential right wing framework that’s focused entirely on orthodox finance rather than the real world.  Here’s how Barro should be attacked from a true progressive position, channeling Abba Lerner’s Functional Finance:  If the economy is operating with unemployment and unused capacity to the tune of $100 billion per year forever and the government therefore spent $100 billion forever, it would not likely be inflationary since it simply brought into play unused resources.  If the government claimed its fundamental mandate was to maintain full employment and capacity utilization forever, then consumers with perfect foresight would have absolutely no logical grounds to think taxes would go up since any tax increase would reduce spending and therefore hurt employment and capacity utilization.  It would be illogical, therefore, to expect them to cut back on spending.

But Krugman doesn’t remotely take this route; instead he seeks only to point out that the Ricardian framework sometimes allows an occasional temporary possibility of some government spending.

But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.

This is a weak argument in the first place as Barro could easily counter that consumers with perfect foresight may very reasonably believe government spending will be required for a very long period and would, given the assumptions of the whole right wing fabrication, cut back spending enough to negate the efforts of the government.  But even more important, Krugman, the very “conscience of a liberal”, endorses the legitimacy of this extreme right wing view and cedes everything other than a possible occasional and very temporary government stimulus.

It’s a sad joke to think the puny limp sterile views of Krugman could form any basis for a protest movement of the left.  I cringe whenever I see his name linked to Occupy Wall Street.

From → Dynamics, Suppression

  1. In general I agree with your Krugman critic. But in this particular case I disagree. You make it look like as Krugman buys into Ricardian Equivalence. I think he doesn’t. He’s explicitly writing:

    “But the fact is that even if you believe in Ricardian equivalence, it doesn’t tell you that fiscal policy won’t work.” and “It’s one thing to have an argument about whether consumers are perfectly rational and have perfect access to the capital markets; it’s another to have the big advocates of all that perfection not understand the implications of their own model.”

    Now for me that sounds like: I, Paul Krugman, think this Ricardian Equivalence thing is only ridiculous because of fantasy assumptions. But the proponents of this RE nonsense are even too stupid to understand the implications of their own science fiction story.

  2. Stephan,

    But what about his statement beginning with “Here’s what we agree on…”? Seems clear to me that he accepts the basic paradigm of Barro. His only quibble being that perhaps some government spending is permitted sometimes if temporary. Krugman’s position is not only anti-MMT, it’s anti-Keynesian (in the original sense).

    While he does qualify his support with: “if consumers have perfect foresight, live forever, have perfect access to capital markets, etc”, that doesn’t negate his acceptance of the basic approach, it just says that there’s some inefficiencies in the marketplace. Barro comes back with something like consumers have good foresight if not perfect, they sort of live forever via their children, have increasingly good access to capital markets, etc. The argument then descends to exactly where the right wants it. It’s a disaster for the left to accept the fundamental truth of Ricardo in my opinion.

  3. Jim,

    Not so clear to me 😉 I would do the same in this particular instance. If I want to ridicule Barro and the other anti-government ideologues with their own theory I would present my argument in the same manner:

    OK. Let’s assume for the moment that all these fantasy assumptions are true and hold in reality. Then “here’s what we can agree on …” but what happens if we relax one strong assumption? Then even within their own paradigm the proponents are clearly wrong with their prediction.

    But this is only a small quibble. You are certainly correct. The proper way to argue is to show why Ricardian Equivalence is nonsense. For me this Krugman post is just another exercise in academic scholastic argumentation. Nothing wrong with that except it’s a waste of time.

  4. But I think there’s something very wrong with it if the person arguing the point is also claiming to be a champion of progressive thought.

    Krugman explicitly says that he agrees with the RE paradigm given the assumptions of perfect foresight, etc. Do you not agree that this is a very major concession to orthodoxy? If everyone is perfectly informed, in other words, then government spending can only work if it’s temporary. That in effect is what Krugman is saying, no? And in fact Krugman has made this same basic point in past writings, saying that fiscal policy is only appropriate when at the zero bound, etc.

    Also, Krugman has long used Ricardian equivalency in his own models and his main argument is always down the lines of showing temporary spending is ok. The fact is that Krugman and his fellow New Keynesians are Ricardians and their argument with the “fresh water types” is very narrow – whether or not temporary government spending can work. Here’s a post which I think gives a good background on his overall approach.

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