Ricardo Paging Alan Blinder

I almost hesitate to suggest that anyone actually read Alan Blinder’s defense of Keynesian economics in today’s Wall Street Journal, except that the piece lays out clearly in my mind why Blinder is so wrong.  The only part you really need to read is:

In sum, you may view any particular public-spending program as wasteful, inefficient, leading to “big government” or objectionable on some other grounds. But if it’s not financed with higher taxes, and if it doesn’t drive up interest rates, it’s hard to see how it can destroy jobs.

So in Blinder’s world, deficits are explicitly not future taxes, despite what I believe is a fairly strong consensus among economists that some form of Ricardian equivalence holds (see John Seater’s literature review and conclusion, “despite its nearly certain invalidity as a literal description of the role of public debt in the economy, Ricardian equivalence holds as a close approximation.”).  Perhaps Blinder is blind to the fact that deficits are so much a part of the public debate today because households absolutely see those deficits as future taxes.

I also think Blinder misses that fact that crowding out can occur without raising interest rates.  As Cato scholar Steve Hanke points out, the Fed’s current policies have basically killed the interbank lending market, which has encouraged banks to load up on Treasuries and Agencies, rather than lend to the productive elements of the economy.  While I sadly don’t expect most mainstream macroeconomists to focus on the link between the banking sector and the macroeconomy, Blinder has no excuse; he served on the Fed board.

As I have argued elsewhere, banks are indeed lending, but to the government, not the private sector.  The simplistic notion that crowding out can only occur via higher interest rates, as if price is ever the only margin along which a decision is made, has done serious harm to macroeconomics.  But then if macroeconomists actually understood the mechanics of financial markets, then we might not be in this mess in the first place.