New evidence that economists had the entire stimulus vs. no stimulus debate 80 years ago. Damning evidence against economics as a science. What is the definition of progress/consensus if 80 years of theories and data do not produce insights into such fundamental events as great depressions/recessions. This tête-à-tête between Keynes et al. and Hayek et al. can actually be judged with the beautiful hindsight of history. On one side in the ring areJohn Cochrane and Luigi Zingales. On the other side are Paul Krugman and Brad DeLong. Here is Chochrane:
Nobody is Keynesian now, really... Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity... We now understand the links between money and inflation, and the natural rate of unemployment below which inflation will rise... We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment...
Most of all, modern economics gives very little reason to believe that fiscal stimulus will do much to raise output or lower unemployment. How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend. The basic Keynesian analysis of this question is simply wrong. Professional economists abandoned it 30 years ago...There is little empirical evidence to suggest that stimulus will work either. Empirical work without a plausible mechanism is always suspect, and work here suffers desperately from the correlation problem... We do know three things. First, countries that borrow a lot and spend a lot do not grow quickly. Second, we have had credit crunches periodically for centuries, and most have passed quickly without stimulus. Whether the long duration of the great depression was caused or helped by stimulus is still hotly debated. Third, many crises have been precipitated by too much government borrowing.
Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets. Policy needs first of all to focus on the credit crunch. Rebuilding credit markets does not lend itself to quick fixes that sound sexy in a short op-ed or a speech, but that is the problem, so that is what we should focus on fixing.
The government can also help by not causing more harm. The credit markets are partly paralysed by the fear of what great plan will come next. Why buy bank stock knowing that the next rescue plan will surely wipe you out, and all the legal rights that defend the value of your investment could easily be trampled on? And the government needs to keep its fiscal powder dry. When the crisis passes, our governments will have to try to soak up vast quantities of debt without causing inflation. The more debt there is, the harder that will be.
And in the other side of the ring is Paul Krugman, who can hardly contain himself after reading the Keynes/Hayek debate from 1932:
First, Hayek was as bad on the Depression as I thought. The claim that “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities” — in 1932! — is bizarre. The claim that barriers to trade and capital movement were what was preventing recovery is as crazy as … as .. claiming that we’re in a slump because workers decided to take a break in the face of prospective Obama tax hikes.
Second, Keynes pretty much had the policy implications of the General Theory down long before he actually worked out the detailed analysis. I’m especially struck by the way he grasped, right from the start, the point that if higher private spending expands employment in a slump, so does higher public spending.
Third, it’s deeply tragic that we’re having to have this debate all over again, as the world economy slides into deflation and stagnation.