Tuesday, April 07, 2009

Two Questions about Macroeconomics

I am not a macroeconomist. One of the reasons for this, I suppose, is that I was taught a lot of rational expectations overlapping generations stuff in graduate school and while I found it elegant, I did not believe it. The reason I didn't believe it is because the models are rejected by data: for instance, when households get short term changes in income, they seem to change their consumption behavior somewhat.

Nevertheless, there are two macro issues that puzzle me. The first is how to think about the size of the money supply. For example, while M1 and M2 are increasing, the shadow bank sector (i.e., securities financed debt) has dramatically decreased. It seems to me that this effectively reduces the size of the money supply, although I am not sure by how much.

The second is that Ricardian equivalence types seem to have an underlying assumption that government can't invest in positive NPV opportunities. For instance, Robert Lucas argues that if the government borrows $100 million to build a bridge, household will know they have a future tax liability of $100 million, reduce their spending accordingly, and therefore offset the stimulative impact of the bridge.

But what if the cost to borrow for the bridge is 3 percent and the bridge's IRR is 5%? Then doesn't the bridge stimulate spending for the simple reason that it is a good investment? The federal government has made, it seems to me, some very good investments. Hoover Dam is one. Rural electrification is another. The interstate highway system. The Golden Gate Bridge. The New York City subway system. [update: yes, these last two were largely a local projects. But still...] I could continue...

I do worry about bridges to nowhere. But many macroeconomists seem to believe in the hearts that public goods don't exist, and that there is nothing government can do better than the private sector. I think it is here that macro takes its cues more from religion than science.


Uncle Billy, Mental Widget said...

To the layperson, it looks like the concept of money has become very murky. I haven't checked but the grapevine says that repurchase agreements which made up the bulk of M3 are way down.

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