Krugman and Ricardian equivalence
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.