One thing that struck me is that Krugman and Delong are really asking and answering a different question than many of the opposing voices they cite:
1. Can increasing government spending, especially during a downturn, increase output?
2. Does increasing government spending, especially during a downturn, make us better off?
They're answering "Yes" to the first question, based upon either assertion or simple empirics, and taking it as given that this makes us better off. The opposing voices they're citing are typically answering the second question. To answer this question you need a model, typically a quantitative model, to evaluate the welfare counterfactual. These models generally have the feature that government spending can raise output by making people poorer, but in order to a get a positive welfare impact of this spending (assuming that spending was set efficiently without the downturn and hence the marginal production of government spending is at least at its cost), requires more action from the model than the simple negative wealth effect can deliver.
This confusion about what question is being asked and answered is still a bit surprising given that the conventional RBC model, like the one in your [Williamson] textbook delivers an increase in output as a result of an increase in government spending (assuming lump-sum taxes). With marginal taxation this becomes a bit more problematic, and the extent to which government spending substitutes for private more of an issue as we move away from military spending. However, the conventional wisdom - which I take to be Barro's - holds that the multiplier is about 0.8 for military spending and perhaps a bit less than that for nonmilitary.
A lot of this confusion started with Cochrane's original comments on this issue. Cochrane wanted to rule out any model that got an increase in output from a negative wealth effect since that meant that welfare was necessarily being lowered. In the restricted class that he was considering as a result of this, government spending didn't raise output. But that's essentially by assumption.
There are a variety of the saltwater and freshwater types who are trying to re-examine the role of government spending under the circumstances that we now face. In doing so, they are using essentially identical methodologies, but somewhat different assumptions with respect to the stickiness of prices, etc. Mankiw argues recently that their may be a role if we're on the zero bound and cannot commit to future monetary stimulation in a recent piece for Brookings. Christiano et al constructs a standard neo-Keynesian model and shows that the impact can be large when we hit the zero bound. Jesus Villaverde has a paper with financial frictions and also finds that government spending can have a multiplier close to one in its initial impact. Both of the later papers don't (I think) do the welfare analysis, but that is largely because one has to take a stand on the value of the government spending, which is problematic. Mankiw's main point seems to be that there are more efficient ways to undo relative price distortions than government spending.
Tuesday, March 22, 2011
Hal Cole's Take on the Krugman/DeLong Debate
Here's what Hal Cole (U Penn) has to offer on the Krugman and DeLong affair.