At Least One Cheer for Rational Expectations
Robert Frank takes on the argument from rational expectations against a stimulus bill:
[Lee Ohanian's] argument, and that of stimulus opponents generally, thus boils down to this striking contention: As the government spends borrowed funds, consumers will start to realize that the resulting debt spells higher taxes in the future, which will lead them to curtail their current spending. Those cuts will offset increased government spending, leaving no net stimulus.
Although there may be people who would actually spend less now to hedge against uncertain future tax bills, it’s unlikely that you know any of them. As behavioral economists have been saying for decades, that’s just not the way most people act. Hardly any consumers even know how big the national debt is, much less how it will affect future taxes.
This is all true, but it’s worth noting that the conclusion doesn’t follow even if we stick to strong rational expectations. As Brad DeLong says “Increased nominal government spending financed by future taxes is crowded out by a reduction in nominal private consumption spending if and ony if what the government spends money on is a perfect substitute for what private consumers spend money on.” And of course that’s not true.
37 Responses to “At Least One Cheer for Rational Expectations”
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August 23rd, 2009 at 5:30 pm
I’m spending more because the sales are great. Guess it’s just another symptom of my economic ignorance that I don’t hold back in anticipation of higher taxes. I’ll remember that next time I go to the grocery store. I should be saving to pay future taxes.
August 23rd, 2009 at 5:41 pm
Of course — that is why Gold is at $950 an oz , up almost 300 percent in past few years, while the values of the US stock exchanges are about where they were 15? 20? years ago , in real terms.
So yeah –the people with money to spend are all morons and don’t know what is going on. That is why the yield curve inverted steeply in Dec 2006.
August 23rd, 2009 at 5:47 pm
That’s why $550 BILLION slide out the door within a few hours on Sept 15, 2008. Because people got a hankering to got out and splurge.
http://laeastside.com/2009/02/550-billion-disappeared-on-september-15-2008-%E2%80%9Celectronic-run-on-us-banks%E2%80%9D/
What’s in YOUR wallet?
August 23rd, 2009 at 5:56 pm
A lot of insiders? Most of the people who really cleaned up on derivatives had to know it was musical chairs. They grabbed a chair and ran before the music stopped. Steal a hundred dollars it’s theft. Steal millions it’s a crisis.
August 23rd, 2009 at 5:56 pm
I am not even an economist, much less a behavioral economist, but the question immediately comes to my mind: how does Robert Frank know that as soon as government spends some money to stimulate the economy, the amount that the consumers will immediately cease to spend will exactly match the money in the stimulus.
Is there no basic qualification for being an economic pundit?
Mr. Frank must be a very unhappy camper, because he must have concluded that foreplay is futile: as soon as you try to arouse your wife, her immediate pouting will match exactly the amount of stimulation to cancel all the affects of your heroic efforts.
August 23rd, 2009 at 6:11 pm
how does Robert Frank know that as soon as government spends some money to stimulate the economy, the amount that the consumers will immediately cease to spend will exactly match the money in the stimulus.
That is what the model predicts. But of course all micro-economic “models” that simple are worthless for policy decisions, so I don’t know why Matt is taking them seriously enough to write a post about this.
Incidentally, when Matt concludes “And of course that’s not true.”, well it’s true in a basic model because there’s only one good.
August 23rd, 2009 at 6:15 pm
I’m not an economist either, but doesn’t more jobs mean more revenue for the government on every level? It’s not as if a dollar can only be redeemed once, or like the government only spends money on government services and products made with government materials, leaving the private sector completely out of the loop.
Sometimes it seems to me that this characterization of government as a Leviathan of a separate species is leading me to feel more pro-government than is necessary.
August 23rd, 2009 at 6:49 pm
Folks, we have nothing (NOTHING I TELL YA!) to worry about.
FROM http://www.reuters.com/article/politicsNews/idUSTRE57M0WV20090823
“Looking forward, an administration official told Reuters the 10-year budget deficit projection will jump by about $2 trillion to roughly $9 trillion from an original forecast of $7.1 trillion”
August 23rd, 2009 at 7:43 pm
On the other hand, the rational expectations theory is alive and well for businesses that are waiting for their stimulus funds to arrive. Why spend money now when you can wait six months and have the government subsidize the cost?
August 23rd, 2009 at 7:53 pm
Economists are second only to theologians in divorcing their theories from empirical evidence. I couldn’t divine why this is the case, but my early suspicion is that there’s always a booming market for what rich people want to hear.
August 23rd, 2009 at 8:17 pm
It’s been pointed out before, but what makes Riccardian Equivalence any less likely than Deflationary Spirals?
Riccardian equivalence is more of a tautological statement. People will at some point have to reduce spending to pay off taxes. They may not do all of it today, but there will certainly be some increase in the short term.
If we assume that the debt will grow at the prevailing market rates of interest then we must assume that is the general time preference of money. Investments now will grow at the rate of debt growth and limit exposure to it in the future.
More often than not the government gets loans at below the prevailing interest rate. The difference in expanded savings and government spending is actually taxed out right now in inflation.
August 23rd, 2009 at 8:24 pm
The question is can the Treasury continue and always borrow the money at a low nominal rate. Except in the Volker period, in modern history the Treasury has been able to borrow at the lowest rate in the world.(Well Japan is probably an exception) It’s the benchmark rate. Treasuries are the benchmark financial instrument.
In 1980 Reagan ran on the 50 year old fear of excessive government debt. At the time the total was around $900 billion. Now the total is over 10 trillion. (Well you can subtract the Social Security part of that, around 3 billion. The Treasury isn’t going to pay that back.) This fiscal year the Treasury borrowed 2 trillion and there was often stupendous demand for it and next week we will see another 94 billion sold pretty easily.
All this hand wringing about taxes to pay it is ideological masturbation as long as the market is willing to lend it. Now as everyone knows the Fed intends to keep the rate the Treasury has to borrow at low, forever. It that’s good enough for the market then fine, we can borrow our way out of negative growth forever.
When the Treasury can’t borrow at low rates then everything changes. Every single assumption rational or not goes right out the window.
I predict that day will come but don’t know when. 2 months or 20 years?
August 23rd, 2009 at 8:34 pm
Doesn’t the rational expectations theory also fail because it assumes as a universally recognised fact that the government expenditures today could not themselves generate additional future income. I mean businesses regularly borrow money to make purchases today. Generally what happens is that the money is spent on things which generate income sufficient to pay of the debt. If government is spending money on things like education, improved security, transportation and research, why would a rational person assume that it would require future tax increases any more than I would assume that if the owner of the business I work for borrows money he will require me to do more work to make up for the cost of the debt?
August 23rd, 2009 at 8:44 pm
Don’t talk to us in Philly about “rational expectations” — our guys kick the Mets in the nuts with game-ending UNASSISTED triple plays. heh heh heh
http://sports.yahoo.com/mlb/recap?gid=290823121&prov=ap
August 23rd, 2009 at 8:46 pm
“When the Treasury can’t borrow at low rates then everything changes.”
Currently the Treasury borrows 10 years bonds at 3.625%. The current overall growth rate of the economy, all of that growth being composed of government expansion, is a nominal about 3%. (The private sector is growing at 0% currently.) So, for every 3% growth in government output, we pay 3.625%. That seems like a bad deal, a loss.
The Treasury can borrow short, but that requires short term management of Federal programs to keep books balanced, Congress cannot do that unless the Fed does it for them and buries the loss.
August 23rd, 2009 at 8:48 pm
Wow, gold’s dropped about 10% in the last few months, and gone up less than 50% in the last 30 years. The DJIA has gone up 900% in that time. Fifteen years ago, the DJIA was at 1/7 the current value.
Gold is a rotten long term invesstment. It only pays off when everything goes to hell.
August 23rd, 2009 at 9:12 pm
Re Njorl at 16: “Gold is a rotten long term invesstment. It only pays off when everything goes to hell.”
————
Er…
http://www.kitco.com/charts/livegold.html
$300 per oz in Aug 2002 — now $950 an oz
August 23rd, 2009 at 9:37 pm
Re Njorl at 16: “Fifteen years ago, the DJIA was at 1/7 the current value.”
————-
Well, TWELVE YEARS AGO in August 1997, the Dow was at 8000. ADJUSTED for inflation, it should be at 10,800 around now, even with NO GAIN in real value.
Instead it is only 9500 — and that is with a recent spike. It was at 6500 !!!! back in March.
August 23rd, 2009 at 9:38 pm
Whether or not gold is a wise personal investment, speculation isn’t all that productive an activity.
August 23rd, 2009 at 11:10 pm
Whether or not gold is a wise personal investment, speculation isn’t all that productive an activity.
Every human action is a form of speculation.
August 23rd, 2009 at 11:18 pm
Increased nominal government spending financed by future taxes is crowded out by a reduction in nominal private consumption spending if and ony if what the government spends money on is a perfect substitute for what private consumers spend money on
And here I was all set to spend money on other children’s public school education, and on policing neighborhoods I don’t live in, and on inspectors to watch over the food. Ah, well, guess I’ll just blow it on shoes and cable.
August 23rd, 2009 at 11:18 pm
Gold is natural money. As such, it provides a decent hedge against currency devaluation. The problem is that it provides absolutely no return otherwise, so there tend to be better ways of hedging against currency devaluation such that you are also paid for locking up your money for some extended term.
And then there is always the risk that one day the world will wake up and stop treating gold as natural money, since that is really just a matter of convention. I think of this as gold going the way of seashells, but I guess some people put it as the thought that real survivalists horde bullets, not gold.
August 24th, 2009 at 12:21 am
Re DTM at 22: “but I guess some people put it as the thought that real survivalists horde bullets, not gold.”
———–
Real survivalists know that you will always have government –like herpes and crabgrass. The rich will always have their bully boys to keep the rest of us in line and to protect “property”.
And since they don’t want to pay the bully boys, you will always have something called taxes. Which means you lose that retreat unless you can pay taxes and then you don’t have no place to keep those heavy boxes of bullets. Google “Great Depression” and “Sheriff’s auctions”.
August 24th, 2009 at 12:35 am
I have to give credit where credit is due; the more I study it, the better the stimulus package looks. It was about as well conceived and crafted by it’s many designers as a bill of that size could be in the short time they had to put it together.
That being said, it’s not nearly enough. The stimulus was all about patching up leaks and replacing broken windows and busted tiles. But it mostly ignored the foundation, which is cracking and crumbling away.
This country needs to dig in and start pouring some concrete. We need to think a little more Hoover Dam and a little less Home Depot.
August 24th, 2009 at 1:26 am
I’ve learned so much at TP and Yglesias. The launch codes are a metaphor, and every human act is a form of speculation. Trippy. Dude. Wow.
August 24th, 2009 at 1:28 am
Which means no human act is a form of speculation.
August 24th, 2009 at 1:58 am
#22 What does Goldman have our money invested in currently?
August 24th, 2009 at 6:52 am
Gold is natural money.
This is meaningless. People cling to gold for psychological reasons based on historical usage. Yes, non-corrosive, easy to transport, whatever. It is a commodity, and is such subject to the same bubbles any other commodity is subject to.
August 24th, 2009 at 7:25 am
The real question is what will be the effects of higher taxes in the future on private sector investments. There is probably a much higher correlation between taxes and investments versus taxes and consumer spending. Most Americans do not make long term decisions based upon taxes (look at the number of stupid Americans who brag about their tax return) but business half to consider future taxes when investing.
More business could become like parts of healthcare where the investment horizon has to be 12 months or less because the long term cannot be adequately anticipated.
August 24th, 2009 at 9:32 am
I’m wondering how long gold has been used for money historically. Thousands upon thousands of years? I’m guessing that what this means is that gold has been used for trading over medium- to long-distances(for various values of medium and long) and so that as long as there is trade of some kind that involves distances longer than what lies between, say, Macon and Moberly(Missouri), gold will be of some value as a medium of exchange.
August 24th, 2009 at 10:09 am
Investing in Gold should only be done speculatively. The problem is that people only tout it when it’s too late. If people are advising others to buy gold publicly, you shouldn’t buy gold.
You can see the DJIA as a function of gold here:
http://preview.tinyurl.com/goldvDJIA
August 24th, 2009 at 10:13 am
It is a commodity, and is such subject to the same bubbles any other commodity is subject to.
So Gold and Natural Gas are basically the same thing? Apart from the fact that one is actually consumed, and it’s price is subject to wide variations based on seasonal needs and new extraction operations, while the other is virtually indestructible and 99.9% the gold mined in history is still around.
August 24th, 2009 at 10:39 am
Careful. The Paulites’ heads will explode.
“‘Gold is natural money’.
This is meaningless. People cling to gold for psychological reasons based on historical usage. Yes, non-corrosive, easy to transport, whatever. It is a commodity, and is such subject to the same bubbles any other commodity is subject to.”
August 24th, 2009 at 10:45 am
“So Gold and Natural Gas are basically the same thing?”
In that they’re both commodities, yes. Different commodities have different characteristics, naturally. But gold is similar to a wide range of metals, many of which have also been used as money since ancient times (silver, iron, copper, platinum, etc). Note – gold prices also can vary around new extraction operations. It’s just that recently there have been few new smines discovered.
August 24th, 2009 at 1:28 pm
‘Both government and consumers can spend dollars but on different things. Consumer demand is still high when government spends. The dollars come from somewhere. Economic growth can be ignored.’ Message recieved. Thanks.
August 24th, 2009 at 2:44 pm
The fact that it’s a “commodity” means nothing. Are houses commodities? Is the internet a commodity? Saying things can have bubble because they are commodities is useless. You are entirely ignoring the fact that humans have been mining the shit for most of civilization. Any new mines will not noticeably impact supply. It’s not likely we will find a cheaper way to get it.
Gold is subject to bubbles in the sense that government force people to buy it when they dilute the money supply.
August 24th, 2009 at 4:22 pm
Actually, yes, the word “commodity” actually means something. Houses are (usually) not commodities because each house differs from every other house. Now, two similar houses standing next to each other in the same new development might be somewhat close to a commodity, but as they age they’ll become less similar, and thus less like commodities.
There’s not much intrinsically different between gold and many other metals. Gold’s just shinier.