Monday, January 19, 2009

Voodoo Krugman?

In my post earlier today, "Krugman v. Obama", I referred to his column in the Time today, "Wall Street Voodoo". My point was his not very veiled criticism of almost-President Obama, who has consistently supported tax cuts, including in his economic stimulus/recovery proposal.

As we know, many on the political left have argued for more Gov spending and less tax cutting (if any), on economic grounds. In my post, I did not argue the point and in fact believe that others better qualified than I am should duke that one out. Well, look who is duking: none other than Mr. Obama's incoming head of the Council of Economic Advisers, Christina Romer. The blog is by Simeon Djankov and was published today at a World Bank site, "Crisis Talk: Emerging markets and the financial crisis".

"How Useful is Fiscal Spending Really?
If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the GDP rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off."

"This is an example from a fun Gregory Mankiw article in the New York Times. Mankiw's main argument is that expanded government spending is less useful in crises than usually thought. The multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States' historical record, Professor Ramey estimates that each dollar of government spending increases GDP by only 1.4 dollars. So, by doing the math, we find that when the GDP expands, less than a third of the increase takes the form of private consumption and investment."

"In contrast, a recent study by Christina D. Romer (the Obama appointee to head the Council of Economic Advisors) and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the GDP by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases."

"This is why tax stimulus is starting to be discussed more and more as a good crisis response. To see a recent calculation of how it can work, see my paper Tax Incentives as Crisis Response with Georgi Angelov."

DoctoRx here. Here is what Dr. Krugman wrote in "Wall Street Voodoo".

"Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans."

If Dr. Romer believes in a 3:1 multiplier from tax cuts, that sure sounds perilously close to being a classic supply-sider. Perhaps it is those such as Dr. Krugman who are advocating for massive government spending not on its own merits but to save us from the Great Recession (or worse) who are practicing a version of voodoo economics?

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