Objections to government spending such as Mankiw's fall down empirically in the face of the history of wars and military spending generally. WW II did generate a huge debt, but it was partly paid down with the aid of high marginal tax rates and partly erased by high growth. Military spending is still at least as large as the proposed stimulus.

What if the stimulus is over budgeted and mismanaged? Say 1 trillion a year yet pissed away into private foreign bank accounts. Not too out of line an assumption concidering the last 8 years. Then the only increased debt can be passed on.

The multiplier affect occurs when we do something useful in the eyes of the consumer.

What useful thing can government do other than exercise the cash system?

I can think of useful things to do, but IMHO most of the useful things are hard for government to do right.

But EMPLOYMENT IS NOT "ROUGHLY PROPORTIONAL TO OUTPUT". Not even roughly.

The only part I have trouble understanding is the part about the amount of our debt foreigners own is dismissed. Doesn't standard international macro theory say that government borrowing increases the interest rate, which raises the value of the dollar, which worsens the trade deficit? Is the argument here that this effect is much smaller than is generally supposed or that this theory is invalid altogether? Or perhaps that there will be a coordinated stimulus plan so that the dollar doesn't appreciate much more than other currencies?

Or maybe, being a tyro in economics, have I completely confused the issue altogether?

Ryan,

you're absolutely right on this point. I have abstracted away the impact that any stimulus package may have on raising the value of the dollar because the dollar is clearly being driven much more by psychological factors (a flight to safety) than fundamentals. In the current environment, if a stimulus package helps to stabilize the world economy, it is entirely possible that it will actually lead to a lower value of the dollar.

This is of course just speculation, but I doubt that many economists would argue that a boost to government spending at this point would be likely to raise the value of the dollar.

Cool. Given all the bubbles and irrationality apparent in the national and global economy, it makes sense that these standard models based on purely rational actors are of very limited value. Thanks for the explanation, Dean.

Given that Mankiw never had any problem with the Government's debt when it came for tax cuts for the rich or vast spending on foreign wars when he worked for the current President Bush, and that his current hobby horse to solve all the problems of bursting housing bubble is to eliminate the corporate income tax and the capital gains tax, which would create afar larger structural deficit then a short term stimulus, I think we can conclude that his current objections to Govenrment spending are purely driven by the tactics of the moment, and also a concern that economic gains might go to ordinary people and not the "creative class" who have done so much to enrich (or is wreck) or society the last few years. That would be an ethical horror to a true Randian.

Objectivists always take for granted the roads they drive on, or the fact that most people are literate(they can read at the 6th grade level), or that police, courts, prisons, and the military exist and have nothing to do with Government. But of course these public goods and many others (and the safe food we generally eat and a cleaner environment now then we had 30 years ago despite have a 100,000,00 million more people) or all the result of Government, despite the fact that with the National Government, it has been managed by people with contempt for it and who were primarily interested in helping their cronies.

Well said, Rick Kane! To which I would add that the folks who make a religion out of "the-government-can't-do-anything-right", have apparently had little contact with insurance companies, company "customer services" reps, fraudulent salespeople, etc., etc. As but one example, I worked on health coverage issues for many years, and the responsiveness of Medicare and Medicaid workers (i.e., GOVERNMENT), while of course not without problems, was VASTLY superior to that of private health insurance company staff. I guess the "free market" types never met an Enron, or Countrywide, etc. they didn't love.

good post.

I was intrigued by Mankiw's closing paragraph:

"In 1936, Keynes wrote, 'Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slave of some defunct economist.' In 2008, no defunct economist is more prominent than Keynes himself."

What about other defunct economists, whether living or dead? Is Mankiw a slave to, say, Milt Friedman?

It is significant that Gregory Mankiw, an economist with links to Bush and Romney, should in his excellent article encourage us to approach the current economic crisis through the eyes of John Maynard Keynes.

However, his answer to the question “what would Keynes have done?” ignores an element that would clearly have been uppermost in Keynes’s mind - how to get international action to solve the crisis. Keynes would clearly have wanted international coordination of economic policies (monetary and fiscal) between the major economies, and would have wanted international economic institutions (the World Bank and the IMF, both of which he helped to found) to act in ways to free individual countries to take action (e.g. fiscal stiumulus) to overcome the crisis.

Anyone wanting background to this integral part of Keynes’ thinking should read Donald Markwell’s path-breaking study of “John Maynard Keynes and International Relations, Economic Paths to War and Peace”, published in 2006 by Oxford University Press.

Mankiw’s argument that it is hard to see how to get effective stimulus to consumption, investment, net exports and even government purchases makes it even more important that the United States provide leadership and encouragement to international action to overcome the crisis - and all the more surprising that in this otherwise compelling article he neglects to say anything about US leadership to get international stimulatory action.

I wonder why Dean Baker doesn't put any emphasis on international economic cooperation either, when he must surely know how essential it is?

Dean Baker's post is a thorough and capable analysis of the ability of the stimulus to remedy cyclical weakness in demand. But the current mess has more structural causes. In an ideal world, we'd have a structural package on regulation, finance, employer provided health care, etc. to create prosperity - and a counter-cyclical stimulus would be less important.

From his other work, it's obvious the someone like Dean Baker could also do a thorough and capable analysis of the structural policy changes needed. But a cyclical stimulus package seems to be the only thing on the table right now.

I don't see how the Democrats who are taking power in January can address the structural issues. They'll do well on the cyclical, but that is not enough.

The right answer to Mankiw is not to try to argue with his economic analysis but to expose his inconsistency, as Rick Kane has done. Bush has managed to double the national debt within 8 short years by squandering trillions on handouts to the rich and on disastrous and unprovoked wars. Anybody who didn't denounce Bush's runaway spending has simply no standing to complain about spending by the future Democratic government. End of discussion.

CARNIVAL 101 sez, first one needs a guy with CASH in hand, second a SALESMAN, third some EQUIPMENT and nick nacks to gussy up the sale with and the circus is ON= some kind of deal=trade=economy.
First the guy with CASH IN HAND. What 6 trillion ONE DOLLAR BILLS will do if fed directly into the COSUMMER market through STRICTLY BUYING LABOR. 10 dollar, 20 dollar, 50 dollar, and 100 dollar bills WILL get bundled up and fly overseas, ONE DOLLAR BILLS will not. NO MATTER HOW MUCH pay each worker at the end of each day, IN CASH in ONE DOLLAR BILLS. (some sort of ATM process)
Then find a decent SALESMAN. (Obama fits the bill)

Stimulus without restructuring the economy will just get us back on the track to more debt and a rapidly declining economy once again.

Yes we do need a massive injection of capital, to restructure a broken economy.

I am little puzzled by my colleague Mankiw's comment on the last paragraph about the defunct economists contented by John Maynard Kynes in 1930s. I can't agree with Dean Baker more in stating that Pof. Mankiw should know better how important is the stimulus package at this time of economic crisis, regardless you have believe in Keynesian economics or in Milton Friedman's neo-classical doctrine. There is no economist in this world who would be able to unambiguously predict about the long-run impact of this budget deficit driven stimulus package on our children. Prof. Mankiw's vague prediction in the long-run is simply absurd and puzzling to me. The long run prediction by Keynes without doing anything in the short-run is still valid by both intellectual and historical standard- in the absence fiscal stimulus in the SR we would be all dead in the long-run.

Can anyone tell me why Mankiw isn't simply dismissed as hopelessly captive to an outdated and empirically exploded economic ideology? I have read many economists welcoming his input, usually right before they explain why he is dead wrong and even dangerous in his opinions (as in this case).
Why should anyone ever take him seriously? Is it because there are young people out there who don't know how awful he is and might actually believe in what he says?

mmckinl: EXACTLY!

Jack wrote, I have read many economists welcoming his input, usually right before they explain why he is dead wrong and even dangerous in his opinions (as in this case).

For the same reason cops don't rat on other cops, and doctors don't testify against fellow doctors in malpractice suits.

(Not that I think any of that is just.)

Liberal economists can also be captive to ideologies, so it is necessary to address substantive criticisms no matter who advances them.

US Economic policy over the last 25 years has often been dominated by those who have even less understanding than Mankiw.

hi,

thanks for the explanation. i have maybe a more naive, but far simpler explanation. greg mankiw is a supply sider. he thinks of government spending as an avoidable expense. if that is indeed the case, that it is expnse, then we are passing a burden to our kids. however the other alternative view is, that this is not an expense but an investment. if it is an investment, then clearly the returns will be higher.

from an accounting standpoint, its an outflow, it's how the government uses that will make the difference. if its misdirected, we increase the tax burden. if it is invested well, it will be fruitful.

thx

mmckinl: EXACTLY!
Good point.

Hi Dean. Quick question, and perhaps something very obvious that I'm missing, but what are the components of the 0.45% "permanent growth dividend"? I get the .2% as a result of 1% of the stimulus in each of 2 years going to infrastructure etc., with a 10% rate of return. And I get the same concept as to an additional 1% of private investment. But what makes up the other .15%, i.e., .2 + .1 + .15 = .45, but I'm not readily seeing the final .45.

Thanks for an excellent post, & pardon my detail fixation.

-Gary

Dean,

I wish I hadn't come late to this thread. Hope it's not too late to have this question seen and answered.

I assume there is some theoretical point at which the size of a stimulus would be so large that you would consider it a net negative for GDP in the long-term (for "our children", so to speak -- and assuming that a very large portion of our debt continues to be held by foreign investors so it's not just a transfer from some of our children to others among our children).

1) Can you give some idea as to what that point would be? $1 trillion, $1.5 trillion, $2 trillion?

2) What causes that difference from net positive to net negative -- which of your assumed ratios, coefficients, etc. change enough that the long-term net effect becomes negative, and which, if any in particular, are the primary factors in that change?

3) And if the answer to #2 is largely a matter of diminishing marginal returns on investments (e.g., infrastructure, education), on what basis is the ROI for $600 billion in stimulus determined vs. the ROI for, say, $1.2 trillion or $1.8 trillion? Put differently, how do we really know with an adequate degree of precision for these purposes what the appropriate coefficients, ratios, etc. are for calculating the short, medium and long-term effects on GDP of different levels of (deficit-financed) stimulus?

thanks in advance

Thanks for an excellent post, & pardon my detail fixation.

=========

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Dean,

Could you add to your analysis the immediate cost to the economy of taking out the loan for the stimulus, that is, credit used by the government is no longer available to private businesses and consumers whose spending would have the same beneficial effect as the government's. Or, if the stimulus is instead funded by freshly printed money, account the cost of the reduced purchasing power of existing dollars held by private businesses and consumers. Whatever the funding source, I think when you actually account for the cost, you find that the stimulus only adds inefficiency to the economy.

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I can't agree with Dean Baker more in stating that Pof. Mankiw should know better how important is the stimulus package at this time of economic crisis, regardless you have believe in Keynesian economics or in Milton Friedman's neo-classical doctrine. There is no economist in this world who would be able to unambiguously predict about the long-run impact of this budget deficit driven stimulus package on our children.

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I think we can conclude that his current objections to Govenrment spending are purely driven by the tactics of the moment

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I can't agree with Dean Baker more in stating that Pof. Mankiw should know better how important is the stimulus package at this time of economic crisis, regardless you have believe in Keynesian economics or in Milton Friedman's neo-classical doctrine. There is no economist in this world who would be able to unambiguously predict about the long-run impact of this budget deficit driven stimulus package on our children.

The right answer to Mankiw is not to try to argue with his economic analysis but to expose his inconsistency, as Rick Kane has done. Bush has managed to double the national debt within 8 short years by squandering trillions on handouts to the rich and on disastrous and unprovoked wars. Anybody who didn't denounce Bush's runaway spending has simply no standing to complain about spending by the future Democratic government. End of discussion.

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What useful thing can government do other than exercise the cash system?

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