Posted by: Dirk | December 16, 2013

Are neo-classical economists worth talking to (Caballero edition)?

The answer that is in my mind at this point in history is: no. Kuhn in his book on the structure of scientific revolutions said that the old view will just ‘die out’. And I think that this view is correct. Here is the lower half of the abstract of Ricardo Caballero’s new paper:

All these policies depend on fiscal capacity. Once the latter runs out, short term cyclical policy becomes ine ffective. In contrast, credible long run fiscal consolidation relaxes the fiscal capacity constraint and enhances the e ffectiveness of short term policy. An economy that is near its fi scal limits is susceptible to runs on its public debt and to destabilizing feedback loops.

On this blog, I used to discuss his ideas (like here or here) but I’ve grown tired of it. If you are still arguing in 2013 that there is a limit to fiscal spending  – called fiscal capacity constraint – then you are just show that you have no understanding of how the monetary system actually works. Taking the US – the issuer of the world’s reserve currency – as a case of fiscal capacity constraint is a sad choice. This kind of insulated thinking in the economics discipline is not without historical precedent. Here is Carl Föhl, a German economist who published a book on economics in 1937 just after Keynes did and very similar in content, stating the following (p. 6 in the 2n edition):

Man kann der Fachwelt, die in den Jahren vor 1933 in der Sorge um die Verhütung einer zweiten Inflation die immer gegenständlicher werdenden Arbeitsbeschaffungsprogramme der NSDAP mit so großem Eifer bekämpft hat, nicht den Vorwurf ersparen, daß sie sich durch eine dogmatische Verallgemeinerung von Lehrsätzen, denen nur beschränkte Gültigkeit zukommt, dazu verleiten ließ, die Richtigkeit von Schlußfolgerungen zu bestreiten, die für den gesunden Menschenverstand eine Selbstverständlichkeit sein mußte.

This is a large sentence to translate, but let me try: professional circles [of economists], which in the years before 1933 [when Hitler came to power] were concerned about the prevention of a second inflation fought with great fury the ever more concrete job creation programs of the NSDAP [the Nazi party], cannot be spared the accusation of having been misled by a dogmatic generalization of theorems which are only of limited validity to deny the accuracy of conclusions which, using common sense, have been clearly correct. What Föhl says in the paragraph I took the quote from is that credit creation leads to more incomes and more employment, and government can do it if it wants to. (The second edition is from 1955, so he writes with hindsight.)

I can only hope that MIT students will find out the flawed ideas of (one of) their teachers and instead try to look for answers elsewhere.

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