Thanks, Robert, especially for that last clarification. I have to admit that I haven't been giving much thought to the scenario in which a deficit-financed stimulus has no effect (under Ricardian equivalence) on aggregate demand and yet still has a big multiplier. I will have to think about that one...I have always thought about Barro's Ricardian equivalence as treating any government deficit as if it were financed by taxes. That is, when people see the government borrow money, they anticipate a future taxes, and they adjust their spending exactly as if the taxes were being levied today.
So, we describe fiscal policy by saying "____ is financed by a tax increase." So, if the government tries a tax cut, we say, "a tax cut financed by a tax increase." I see that as obviously self-canceling, with a multiplier of zero. Because Barro now implies otherwise, Clive Crook is confused, and so am I.
On the other hand an increase in government spending that is financed by borrowing should, in a Barro world, be treated as an increase in government spending financed by an increase in taxes. Thus, the multiplier should equal the so-called "balanced budget multiplier," which can be greater than zero.
Barro himself writes (as quoted by Crook):
The multiplier has to do with how a change in aggregate demand affects output.I think of the multiplier as the product of two factors--how much the policy affects aggregate demand and how much the change in aggregate demand affects output. I imagine that Crook is thinking the same thing, in which case a tax cut in a Barro world should have a mulitiplier of zero.
"I have always thought about Barro's Ricardian equivalence as treating any government deficit as if it were financed by taxes. That is, when people see the government borrow money, they anticipate a future taxes, and they adjust their spending exactly as if the taxes were being levied today."
By the end of his career, Ricardo himself did not believe in Ricardian equivalence. Do most economists currently believe in Ricardian Equivalence? Isn't it conventional wisdom that you can stimulate the economy by reducing marginal tax rates? Reducing the marginal tax rates causes people to spend and invest more (i.e. not all the extra income because of the reduced taxes is saved).
People tend to spend more when they anticipate a strong economy and tend to save more when they fear a bad economy but are definitely not completely rational/well informed in their decisions.
It seems that the results of government paying for a huge stimulus package out of current taxes would have quite different results (resulting in different taxpayer behavior) than borrowing the money to finance the stimulus package.
Given that you borrow the money to stimulate economy, what is the best way to invest it to get the maximum ROI and produce jobs? If the ROI is better than the cost of borrowing the money, then it makes sense to borrow the money to stimulate the economy.
If you do want to do a public works project to generate jobs, it seems that it would be better to loan the money to the individual states because they will have a better idea about how to spend it locally. Some states might even decide to simply retire debt or pass the savings on to the taxpayer (if that is what works best in their state). Some states might even decide they don't want the loan because they don't want additional debt.
Given that nothing generates jobs like small businesses, it might be good to loan the money to small businesses. This micro lending can very effective.
You point out an importnt part of their exchange to try to understand. How about this?
1. What Ricardian equivalence says is that when the government issues bonds because of deficit finance, it does not increase perceived wealth. Thus, there is no increase in consumer spending on account of consumers feeling wealthier.
2. A different channel for the effect of fiscal policy is that the government will spend money buying things, whereas people will save it. Thus, if the government raises taxes and spends the revenue on building pyramids, employment in pyramid building will rise, even though private income has not changed (because the pyramid-builders get more income, even tho other taxpayers get less). And there might be a multiplier effect of the pyramid spending.
Does that sound right? Email me at erasmuse@indiana.edu.