Tuesday, August 23, 2011

Harvard Prof on Attack Against Keynesianism

Robert Barro, an economics professor at Harvard and a senior fellow at Stanford's Hoover Institution, smashes Keynesian economics, in a new WSJ piece.

Here's the takeaway:

Keynesian economics—the go-to theory for those who like government at the controls of the economy—is in the forefront of the ongoing debate on fiscal-stimulus packages. For example, in true Keynesian spirit, Agriculture Secretary Tom Vilsack said recently that food stamps were an "economic stimulus" and that "every dollar of benefits generates $1.84 in the economy in terms of economic activity." Many observers may see how this idea—that one can magically get back more than one puts in—conflicts with what I will call "regular economics." What few know is that there is no meaningful theoretical or empirical support for the Keynesian position...

Keynesian economics argues that incentives and other forces in regular economics are overwhelmed, at least in recessions, by effects involving "aggregate demand." Recipients of food stamps use their transfers to consume more. Compared to this urge, the negative effects on consumption and investment by taxpayers are viewed as weaker in magnitude, particularly when the transfers are deficit-financed.

Thus, the aggregate demand for goods rises, and businesses respond by selling more goods and then by raising production and employment. The additional wage and profit income leads to further expansions of demand and, hence, to more production and employment. As per Mr. Vilsack, the administration believes that the cumulative effect is a multiplier around two.

If valid, this result would be truly miraculous...

How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people? Keynes, in his "General Theory" (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful... there is zero evidence that deficit-financed transfers raise GDP and employment—not to mention evidence for a multiplier of two.

...the administration created one informative data point by dramatically raising unemployment insurance eligibility to 99 weeks in 2009—a much bigger expansion than in previous recessions. Interestingly, the fraction of the unemployed who are long term (more than 26 weeks) has jumped since 2009—to over 44% today, whereas the previous peak had been only 26% during the 1982-83 recession. This pattern suggests that the dramatically longer unemployment-insurance eligibility period adversely affected the labor market..

The administration found the evidence it wanted—multipliers around two—by consulting some large-scale macro-econometric models, which substitute assumptions for identification. These models were undoubtedly the source of Mr. Vilsack's claim that a dollar more of food stamps led to an extra $1.84 of GDP. This multiplier is nonsense, but one has to admire the precision in the number.
This is a fascinating attack on Keynesianisn and mumbo-jumbo econometrics. Barro has an undergraduate degree in physics from the California Institute of Technology (1965), where he studied under Richard Feynman. It's really the true mathematical types---outside of mainstream economics--- that are among the first to spot the voodoo in econometrics.

There's a lot that Barro has written that I would disagree with, but this WSJ article is pretty much an inside the palace prince taking a shot at the King. Awesome.


  1. Here is what British wisdom has to say about that...

    Hey! think the time is right for a palace revolution
    But where I live the game to play is compromise solution

    Sadly I fear the compromise solution will be an even worse, even more remote, IMF based SDR “currency” that will last another 20 yrs (because that is all we have left before the world’s total capital is consumed into an ash heap at the current rate). There will be price and wage controls, “peacekeeping” around the world (read: armed jack-booted thugs and power-tripping bureaucrats of the power elite tyrannizing any independent economic activity or non-conformed thought), fully controlled travel and many more ills thrust upon us “for our own good”. And then will the other bit of British wisdom come into play…

    Meet the new boss
    Same as the old boss

  2. "It's really the true mathematical types---outside of mainstream economics--- that are among the first to spot the voodoo in econometrics."

    Yep. I'm a senior majoring in physics and math, and I see this all the time. We laugh at the social sciences trying to imitate the hard sciences. Econometrics makes for a lot of good jokes among those in the physics department. I especially like when they borrow terms directly from physics, e.g. velocity of money. Gimme a break.

  3. @ gcdugas

    Is this why the inhabitants of the UK and the USA are the most surveilled and media saturated of all?

  4. Roger Garrison explains the Keynesian fallacy best, I think. He can almost convince you of it, before he rips into and shows you why it's a fallacy.

  5. I would have thought a better argument for food stamp is to prevent people from starving.

  6. I would have thought a better argument for food stamps is to prevent Cargill and Monsanto from starving.

  7. @Captain Anarchy:

    "We laugh at the social sciences trying to imitate the hard sciences. Econometrics makes for a lot of good jokes among those in the physics department."

    I certainly agree that econometrics can't generally be relied upon, usually settles nothing, adds nothing and is a waste of time. Economists are foolish to attempt it. But at least economists have an excuse - it's impossible. What's the excuse of scientists in the so-called "hard sciences" for the open politicization of science in the global warming fiasco?

    " It's really the true mathematical types---outside of mainstream economics--- that are among the first to spot the voodoo in econometrics."

    I understand what you're saying Bob but the problem of course is that it was the original importation of these guys, combined with big government political motivations, that created the problem to begin with. The current trend towards encouraging students interested in graduate economics studies to first get a math degree compounds the problem given that, to the extent that students are exposed to (generally correct) basic subjectivist economic intuition, it is at the undergraduate level. The math and science guys may well be able to spot the logical failings in the models and "systems" but the general response is to try to "improve" the empirical techniques given that that's their expertise, rather than to emphasize a priori theory. Not to mention that they may or may not have any professional incentive to cristicize the status quo.

  8. For every crackpot theory that benifits big government there will be an "expert" that supports it, and privides "proof" that the theory works.

    Example: Warren Buffet re. tax hikes.

  9. I am a mathematician by education - and I cannot help but see the entire field of econometrics as one big error stemming from the underlying assumption that one can sum demonstrably non-additive values and get a meaningful result with the aid of some fudging and voodoo.

    The problem with modern math teaching in schools is that they teach a bunch of concepts, techniques, and recipes - but do not teach to look for hidden assumptions and to break down arguments to see if there's a fallacy in the middle. Math teachers never seem to encourage students to find for themselves if some formula doesn't work under some conditions; and I never heard of a math teacher routinely offering his students fallacious "proofs" of something and asking them to pinpoint the places where it went wrong.

  10. I got my BA in economics and ultimately decided I couldn't go on to get a higher degree because I didn't buy any of the mathematical stuff. Imagine how glad I was when I found out Mises and Rothbard didn't buy it either!