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Friday, June 27, 2008

Those poor New Classical Economists...

Fiscal stimulus works, and it works more than most economists and analysts give it credit for. Since the field of econ has slowly steered away from studying short-run effects, in favor of focusing on supposedly long-run topics, it seems have ignored the fact that fiscal stimulus works exactly like the neo-Keynesian model says it should. One can still credbly argue whether or not stimulus is worth it, but you can't argue it doesn't work. There are still a few prominent (mainly Chicago school?) new classical economists arguing that even short-run effects of tax cuts are negligible to non-existant; if reality doesn't change their minds, I don't know what will.

It seems like all those bogus and unrealistic assumptions about: perfectly "rational" people with "rational" expectations (people that take into account their entire life-cycle at all times when making decisions and are in the aggregate generally 'correct' about their expectations), costless information gathering, perfect inter-generational altruism, etc, ... are exactly that - bogus.

From Bloomberg (quotes)
Tax cut effect on income/GDP:
"The gain in income was almost five times larger than the median forecast of a 0.4 percent gain. Disposable income, or the money left over after taxes, surged 5.7 percent, the largest increase since May 1975. "

Tax cut effect on spending:
"Adjusted for inflation, spending rose 0.4 percent, the biggest gain since December [Holdiays] 2006. "

Having said that though, there is a 'kernal of truth' to ricardian equivalence and rational expectations. Tax cut effect on savings:
"Because the increase in spending was smaller than the gain in incomes, the savings rate jumped to 5 percent, the highest since March 1995, from 0.4 percent in April. " ... That's a huge jump in savings, but I would suspect that spending will continue to be higher than normal for the next few months because of the tax decrease - which will serve to depress the savings rate during that timeframe.

All in all though, it seems like all those bogus and unrealistic assumptions about: perfectly "rational" people with "rational" expectations (people that take into account their entire life-cycle at all times when making decisions and are in the aggregate generally 'correct' about their expectations), costless information gathering, perfect inter-generational altruism, etc, ... are exactly that - bogus.

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