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Are Chicago economists deaf, dumb, and blind? (One of these three especially)

Economists' debates about whether Keynesian stimulus can work are outside my core area of professional expertise, but I do feel that I know something about the issues.

For that reason, courtesy of a recent blog entry by Brad DeLong, I couldn't help commenting how laughable it is that U of Chicago Business School economist John Cochrane apparently believes that the principle of Ricardian equivalence helps prove that Keynesian stimulus necessarily must be ineffective. Cochrane should be called up before a professional review board, and ordered to show cause why his PhD shouldn't be revoked.

Ricardian equivalence holds that government fiscal policy has no intergenerational distributional effects because rational actors in multi-generational households offset it by adjusting bequests and other transfers between the generations. E.g., as David Ricardo noted (though he rejected what came to be known as Ricardian equivalence), in a sense it makes no difference if I leave my kids (a) a bequest of 19 pounds with no government debt and (b) a bequest of 20 pounds, where the extra pound came out of a tax cut for me that the kids will have to repay via a one-pound (plus market interest) legacy tax.

Economist Robert Barro (although unaware of Ricardo's discussion of the issue until economist James Buchanan pointed it out to him) then posited that rational behavior would ensure actual Ricardian equivalence in practice. E.g., if I want to leave my kids exactly a 19-pound net bequest, I'm damn well going to do that whether the government lends me a pound to be repaid by them or not.

The full applicability of Ricardian equivalence has pretty decisively been rebutted by empirical research. I recall a study by Altonji and Kotlikoff in which it appeared to hold only to the extent of about twenty cents on the dollar. Uncertainty, myopia, bounded rationality, etc., all presumably play a role in its not fully holding. But it also fails theoretically on its own terms, as it does not follow from rational behavior unless one artificially and unrealistically constrains the actual preferences that people are assumed to have.

It is not irrational for me to care about the gross bequest I leave my kids, rather than the net bequest given government policy (which, as they will know, I obviously had very little ability to effect). All we need for this to follow is a more natural set of assumptions about family behavior than assuming disinterested altruism and consequent counting of the child's utility from consumption in exactly the same way as one's own. E.g., suppose I care about how grateful they will be to me or how much they will benefit specifically from my actions.

I'm a former Chicago person myself (having taught at the law school for 8 years), am fond of the place, and learned a lot from the Chicago perspective, which continues to be an important input into my own thinking about policy (albeit one that's lost ground due to the last ten years of economic events, going from the Internet bubble through Enron through the current financial crisis). But the place is embarrassing itself these days, with seemingly reputable economists saying things that anyone who has done even minimal thinking and reading about the issues should realize are trivially false.

Since he can't imagine that there are actually intergenerational budget policy issues, Cochrane presumably believes that the AARP doesn't actually exist, or that it is only a service organization without policy interests. Who are you going to believe, him or your lying eyes?

DeLong has been flogging this issue of the Chicago economists' outrageous ignorance for some time now, in effect dusting off his persona from the Order of the Shrill days of years past. But it is difficult not to entirely agree with him.

Full post as published by Start Making Sense on March 21, 2009 (boomark / email).