Round and Round We Go

Krugman praises DeLong for once more trashing the Chicago School's view of the (in)effectiveness of stimulus. One bit from Krugman:

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.

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 non sequitur. To my knowledge, nobody is arguing that taxpayers should view temporary spending as permanent; they are saying that taxpayers will view present deficit spending as having future costs. The bill will come due, and whether it's a one-time $100bn expenditure or a perpetual $100bn expenditure is irrelevant.

Although in the present case, taxpayers don't know how much taxes will be increased, because the Obama budget projections are ludicrous. Taxpayers have every reason to be skeptical when faced with an uncertain future, so it's certainly possible that they might overestimate the future costs of present-day deficit spending. If that happens, then taxpayers might save even more than if there was no stimulus spending at all, and the multiplier will not just be less than 1, it could actually be negative.

The point of stimulus spending is to, er, stimulate. That depends on the multiplier being greater than 1. That depends on two things: taxpayers thinking that they will be better off by spending money than saving it, and having a functional banking system that can move the money from savers to borrowers. So even if Krugman and DeLong are right on the first point, and I don't think they've proven their case, the banking system is still in chaos. Given that, our expectations for the multiplier should be downgraded.