Boo, Eugene Fama
By Arnold Kling
Readers of this blog know that I am against the Paulson/TARP bailout thingy and against a big stimulus. Some of you may also have read that distinguished (some would say Nobel caliber) financial economist Eugene Fama has a new blog, where he wrote a post against bailouts and stimulus. I did not link to that post, because I did not think that he contributed to our economic understanding of the issue. Today, I want to go further, because it occurs to me that we should not just leave it up to ideological opponents of Fama, such as Mark Thoma or Brad DeLong, to bear the sole burden of pointing out the vapidity of Fama’s analysis.
Basically, Fama says that national savings equals national investment. So, if the government deficit goes up and private saving is unchanged, then investment must go down. Therefore, the argument runs, a government deficit crowds out private investment and does not raise output.
That story holds for an economy that is always at full employment. However, if the economy were always at full employment, then hardly anyone would have heard of a fellow named John Maynard Keynes, and we would not be talking about the issue of an economic stimulus.
In the Keynesian story, if investment declines (due to a drop in “animal spirits”), saving declines to match investment. They re-equate at a low level of total output, at which there is unemployment.
The Keynesian story is not without its problems. As David Henderson has pointed out in a couple of recent posts here, and as I pointed out at greater length in my lectures on macroeconomics, the simple Keynesian model is “priceless” in that it acts as if the usual economic adjustment mechanism, most notably the response to prices, does not work.
If Fama wants to make these sorts of criticisms, or add his own criticisms, that would be fine. But to just pretend that full-employment economics is the only economics and ignore Keynes completely contributes nothing to our understanding.