Tuesday, August 16, 2016

The new "voodoo"

From Scott Sumner.

"Here is Arnold Kling:
John Cochrane writes,
Economics is a work in progress. But it is certainly brand-new, made-up-on-the spot economics, designed to buttress policies decided on for other reasons.
He is describing the economic analysis that claims that policies to distort labor markets to try to increase wages will increase aggregate demand, so that instead of reducing employment these policies will raise employment.
I am reminded of the made-up-on-the spot economics of the Laffer Curve, which claimed that cutting taxes would reduce budget deficits. That became known as "voodoo economics."

I'd say this is the just the tip of the iceberg. Old hydraulic Keynesianism from the 1960s was already a pretty implausible model. But what's happened since 2009 involves not just one, but at least five new types of voodoo:
 1. The claim that artificial attempts to force wages higher will boost employment, by boosting AD.

2. The claim that extended unemployment benefits---paying people not to work---will lead to more employment, by boosting AD.

3. The claim that more government spending can actually reduce the budget deficit, by boosting AD and growth. Note that in the simple Keynesian model, even with no crowding out, monetary offset, etc., this is impossible.

4. More aggregate demand will lead to higher productivity. In the old Keynesian model, more AD boosted growth by increasing employment, not productivity.

5. Fiscal stimulus can boost AD when not at the zero bound, because . . . ?

In all five cases there is almost no theoretical or empirical support for the new voodoo claims, and lots of evidence against. There were 5 attempts to push wages higher in the 1930s, and all 5 failed to spur recovery. Job creation sped up when the extended UI benefits ended at the beginning of 2014, contrary to the prediction of Keynesians. The austerity of 2013 failed to slow growth, contrary to the predictions of Keynesians. Britain had perhaps the biggest budget deficits of any major economy during the Great Recession, job growth has been robust, and yet productivity is now actually lower than in the 4th quarter of 2007.

Arnold is right about the similarity between this and the old supply-side voodoo (especially item #3), but I'd say this is even worse. Supply-side economics was taken to extremes by some of its more fanatical proponents, but was ultimately based on sound economic principles---incentives matter. The new demand-side voodoo represents (in part) a denial of many of the most basic tenets of economics. As recently as 10 years ago, New Keynesians would have scoffed at the list above. Their current willingness to adopt these heterodox views represents a triumph of wishful thinking over hardheaded reasoning."

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