Monday, February 27, 2012

Crowding Out His Detractors

There is an annoying pattern in Robert Frank's work that seems to follow a general pattern. His arguments, while sometimes fair and valid, seem to be incomplete in scope. They usually consist of: first, pretending that his detractors (a.k.a. "right-wing extremists) have few, if any, reasoned arguments; second, picking a relatively obscure argument that some opponent may use to object to his theories and claiming that it is the only leg that they have to stand on; and, third, dismissing the argument he chose, and in doing so, the entire basis of the opposition. It's step two that I find the most offensive, as should any reasonable person who wants a fair debate on fiscal policy.

In chapter four, Frank mounted his counter-argument against those opposed to expansionary fiscal policy by quoting Lee Ohanian's comments on the issue. Ohanian summarized the Barro-Ricardian Equivalence Theorem, which essentially states that taxpayers will decrease current spending to accomodate an expected future tax increase, caused by the accumulation of government debt. In it's most extreme form, government cannot increase aggregate demand by deficit spending because consumers will decrease their current spending proportionally. The theory is controversial, even amoung economists on the right. Whatever it's accuracy, about which I cannot attest, it is not the main counterargument to those supporting expansionary fiscal policy.

The mainstream argument on the right would have been better (and harder) for Frank to rebut. It states that government borrowing raises the demand for credit, thus increasing real interest rates. The natural response of the business sector would be to reduce or postpone some investments. Consumers, reliant on credit and thus also sensitive to interest rate changes, would also curtail spending to accomodate the decreased availability of credit. Instead of simply increasing aggregate demand proportionally to the amount of borrowing the government does, some benefit is lost as public sector spending "crowds out" private sector spending. This is a mainstream argument against deficit spending that even some economists on the left accept as plausible to a degree. That's why I was surprised that Frank (apparently) has never heard it. He can't be blamed for his ignorance. Learning his opponent's actual arguments may have required him to come dangerously close to "right-wing extremists."

1 comment:

  1. Currently, real interest rates are historically low and we are not experiencing a boom in lending.Government borrowing seems to have done the opposite of the hypothesis above. Our situation seems to contradict the view that government borrowing will "crowd out" private spending. How can this be explained? Great post.