Sunday, October 14, 2012

Ruder comment on Portes

Comment on Portes banished here for excessive rudeness

Your definition of "the multiplier" is misleading.  

Originally "the multiplier" referred to the effect of an increase in autonomous (that is note really modeled) demand on output, but my point is not quite that pedantic.  It isn't just that you mean "the fiscal multiplier" when you type "the multiplier."  There are three fiscal multipliers in the IS-LM model, new Keynesian models and in reality. The effects on output of a government spending cut and of a lump sum tax increase are not the same in any existing theory or in the data. The difference is the balanced budget multiplier which is not zero in any existing model in which the deficit spending multiplier is not zero. 

By your definition, the balanced budget multiplier is meaningless as it is something divided by zero. However there is strong evidence that it is a positive number (well not super strong the direct evidence is the apparent effect of the tax financed war effort in Korea on US output, but different estimates of spending and tax cut multipliers are indirect evidence).  If your definition were the definition of the multiplier then Robert Lucas would have been right when he claimed that if infrastructure investment is financed by taxes then there is nothing for the multiplier to multiply. In fact he managed one of the few errors so extreme that it could cause me to fail a student in my introductory macro course (I am a notorious softy). This post contains that error.

The ratio of output increase to reduced taxes minus transfers is a second multiplier. Finally there is the ratio of output increase to deficit financed government consumption and investment which is the sum of the other two multipliers.

The claim that *the* multiplier multiplies the change in the budget deficit is a gross error in elementary macroeconomics. 

Of course you are not ignorant enough to believe that there is one and only one fiscal multiplier, but you are careless enough to help the ignorant remain ignorant. I think you should have left well enough alone -- it is better to provide no definition for your terms than to provide a grossly incorrect and utterly misleading definition which helps maintain widespread ignorance.

update:  I have a second objection


I have another objection.  You claim without making the case that Spain needs "structural reform, especially labour market reform."

My impression is that Spain enacted quite radical labour market reform starting decades ago.  In particular the extremely rigid Franco era firing restrictions were relaxed for newly hired workers by the Suarez government and then still more by the Gonzales government.  This reform in Spain was enacted long long before the Shroeder reforms in Germany.

The timing is very important, since all the reforms preserved employment protection for those employed at the time of the reform (IIRC).  Spain, unlike Germany, had a huge number of workers without strong employment security -- workers who had been hired since the reforms and not shifted to the protected employment relationship.

This made the extremely rapid increase in Spanish unemployment possible. 

One might also argue that what Spain needs is deregulation of banking so that foreign banks can open offices in Spain and so the international flow of capital is not hindered by the highly regulated protected Spanish banking system.  I don't think that you are one who would make that argument (it is a parody -- I've been in Spain and seen branches of UK based banks all over).  However, I honestly don't see why the argument for labour market deregulation is so much stronger than the argument that Spain wouldn't be in such trouble if only they had been able to attract foreign financial investment (again this is a parody-- I am not suggesting that you (or indeed any sentient being) would make that argument).

Why do you think that Spain needs further labour market reforms ?  It is an important question, yet you seem to consider the answer completely obvious ?

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