The Quote of the Day^TM Award goes to

Krugman: Crying Fire! Fire! In Noah's Flood (May 21, 2010)

I was trying to come up with an explanation of the curious insistence that we're facing an imminent interest rate and/or inflation crunch; then I realized that John Maynard Keynes had already done that, in explaining the hold classical economics retained on thought despite its obvious inability to account for the Great Depression:

The completeness of the Ricardian victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.

And all of this has a real, damaging effect on policy. The econ team at Goldman Sachs (not online) makes the interesting point that FOMC inflation forecasts are pulled up by a small group that keeps forecasting much higher inflation than anyone else; this in turn helps limit the Fed's willingness to support the economy. And the deficit hawks have, of course, killed any hope of more stimulus.

Oh, and did he say Ricardian view?

We also have to acknowledge that there is a lot of uncertainty regarding the short run effects of fiscal adjustment. There is an extensive literature examining this issue and different studies have yielded quite different results. But broadly speaking, what we can ascertain from this literature is that the short run costs of fiscal adjustment are likely to depend on a variety of conditions. Notably, these costs are likely to be more limited:

• If the fiscal starting position is precarious and the adjustment is credible;
  
• If financial markets react by lowering long-term interest rates;
  
• If households have correctly understood the need for fiscal adjustment and have factored this into their spending decisions; in other words, if households are - at least partly - "Ricardian";
  

and if monetary conditions are accommodative.
This last condition touches on the very subject of today's conference: monetary and fiscal policy interactions. And in certain respects, it has to be acknowledged that such interactions are particularly challenging for the euro area.

That's the ECB asking households to be Ricardian... [Europe.Is.Doomed^TM Alert]

The world has been fighting the financial crisis by using every possible trick according to John Maynard Keynes` playbook.

Is this really a difficult question to be asking?

The second point is:

The Ricardian equivalence maintains that public sector profligacy can be fully offset by private sector prudence if economic agents correctly anticipate that future tax liabilities will rise as a result of a fiscal expansion. It then follows that the contractionary consequences of a fiscal retrenchment will be offset by an increase in private sector spending as economic agents correctly anticipate a decline in future tax liabilities.

Loaded language much?

And logically it doesn't follow at all. If you Cause A creates Effect B (let's pretend...) it doesn't follow that doing the opposite of A creates the opposite of B - in the same way that pushing a string isn't the same as pulling it.

The `crowding out' thesis maintains that fiscal expansions lead to a rise in real interest rates thus inducing a decline in private sector spending because of its sensitivity to higher costs of borrowing.

Unless of course you're the US, in which case you can spend as much as you want while keeping real interest rates close to zero, until everyone who isn't anyone is unemployed.

The strong version of this thesis suggests that the decline in private sector spending will exceed the increase in aggregate demand induced by the increase in government expenditure. It follows that, under such circumstances, fiscal austerity can boost growth by stimulating private sector spending.

Wait - what? Is that supposed to make sense?

And let's just ignore the obvious point that in most Western countries, the public sector is one of the private sector's biggest customers.

I'll just repeat my point about public stocks and vegetables. Why isn't this kind of "logic" being laughed out of public debate?