Saturday, February 28, 2009

Microeconomics and the Stimulus Package

Christina Romer Christina Romer, the Chair of the White House Council of Economic Advisers, recently spoke at the University of Chicago about the American Recovery and Reinvestment Act, of which she was a principal architect. She laid out in simple terms why she believes the act will work, and what that means.

As part of her discussion she supported the plan's breadth with some basic concepts from microeconomics:

The microeconomic reason is the simple one of diminishing returns or diminishing marginal utility. While all spending provides stimulus, it is obviously important to devote the spending to valuable activities. The short-run aggregate demand effects of government outlays are generally similar across different activities, but the effects on social welfare or on long-run productivity can be quite different. Moreover, these benefits—like the macroeconomic benefits—tend to decline as the government does more of a particular type of spending.

This puts diminishing marginal utility and short-run vs. long-run effects into a context that's more meaningful to me than the textbook examples. Is this a great time to be studying economics or what? :-)


Chris Selland said...

and who exactly determines what is 'valuable'?

She falls under the typical politician's conceit that 'wise' politicians can make more 'valuable' decisions than the market.

History has proved that untrue numerous times. And it's about to do so again.

Charlie said...

OK, but I don't think the choice of what's "valuable" is really the point here. Instead, it's the idea that by spreading spending over a larger number of smaller programs, you get more bang for the buck sooner.


Ryan Romanchuk said...

This is similar to saying smashing windows across the country will 'generate' misallocated factors of unproductive production FASTER then it would smashing the same number of windows on the Mascone Building in downtown San Francisco.

The government cannot create wealth, it can only redistribute capital and labor to areas in which it prefers by force. In doing so they not only destroy wealth but they take the function of the price system down, without the CRITICAL role of prices to align actual entrepreneurs with consumers, misallocated capital/inventories pile on already massive piles of misallocated capital/inventories/labor.

Equilibrium analysis is not real world, but it does give the economist a toolkit for understanding why the market has a tendency to move toward equilibrium. What we call "market failure" is what should really be called "model failure." The now-day models of current organizational structure is not an a priori demand from the universe. The most important questions we must ask, is if at any one point we are above or below an equilibrium do we give bastards (like ourselves, who are 95% employed by the state hehehe) armed with statistics and excel spreadsheets to 'help fix'

It's incredibly naive, yet accepted by almost all, to assume that if the model fails monetary or fiscal can help us nudge our way to perfection.

Thank god the study of Public Choice. If you are going to make models and analysis on the 'free' market, you better make the same analysis in the public market. If the profit-maximizing firms fail reach nirvana, how are the budget-maximizing politicians doing?

It's ironic that the famous catchphrase "We're all dead in the long run" of the central bankers is actually used as an argument FOR government spending. It is a complete farce to believe that the 10 horrible years of the great depression was a quick recovery.

How can we argue that things would be "so much worse" if we DONT do anything when we have never even tried it! I am stretching the truth a bit to get my point across, because there have been a few times where we have done NOTHING....but the problem is... nobody remembers it ;) I wonder why....


Ok, just the usual rant.

Chris Selland said...

I guess I don't have the larger context here, but as Ryan says, she seems to be suggesting that breaking a lot of small windows across the country will 'create' more jobs than breaking one really big one.

So what? It's still a guaranteed net negative for the economy. And there is no net 'creation' - only reallocation and lower GDP.