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Wednesday, February 06, 2008

In Which I debate Brad DeLong and Larry Summers.

Brad is convinced by Summers.

I hate to disagree with my PhD supervisor for whose extraordinary patience and flexibility concerning the composition of my committee, I am eternally grateful, but 2008 is not the very last year in human history.

If people save most of their rebate checks, there will be a small effect on consumption in 2008 when it may be desirable. However, that is not the end of the story. They may incorrectly believe that they are richer in 2009 etc when high demand at roughly full employment will crowd out investment. I would guess that a poorly designed stimulus package will cause a small long lasting increase in consumption which will end when the chickens come home, that is when the treasury stops rolling over the debt or wehen the value of t-bonds is inflated away whichever comes first.

Summers is assuming people are rational and, therefore, to the extent people aren't liquidity constrained Ricardian equivalence holds. Money to the liquidity constrained is good as they will spend it all soon. Money to the non liquidity constrained will have no effects at all (as they know it is not really wealth) so it will do no harm.

If people are not liquidity constrained but are dumb, they will spend out of their pseudo wealth for decades. This is not good.

Note his argument implies that the deficit is no problem ever. Something which neither he nor you believe.

However, it is a bit shocking (not really) that DeLong and Summers slip into assuming that people are rational except when they are writing noise traders papers.

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