Fama on Fiscal Stimulus

Eugene Fama is a stimulus skeptic.

In fact, he is even more skeptical than I am. I am willing to concede that many Keynesian effects work in the short run, although I prefer monetary policy to fiscal policy and, within fiscal policy, I prefer the use of tax instruments to government spending as a tool for short-run demand management. By contrast, I read Fama's article as a largely wholesale endorsement of the classical model with complete crowding out.

Update: Brad DeLong takes me to task for not taking Fama to task:

No, Greg. It's not an endorsement of any model. It's just a mistake. Fama mistakes the NIPA savings-investment accounting identity for a behavioral relationship that constrains the behavior of investment: when the government deficit goes up, Fama says, private investment must go down by the same amount.

When the government deficit goes up, private savings could go up by more--and private investment could increase. Private savings could go up by less--and private investment would fall by less than the rise in the government deficit. Private savings could remain unchanged. Or private savings could fall. Determining which of these is most likely to happen would require a model of the economy of some sort--and Fama does not have one: all he has is an accounting identity that he does not understand.

This post reflects a fundamental difference between Brad's approach to the world and mine. When I read others' work, I try to read between the lines and put it in the best possible light. In particular, when I read the work of an economist as distinguished as Eugene Fama, I am reluctant to jump to the conclusion that I am vastly smarter than he is.

In the case at hand, I think Fama's arguments make sense in the context of the classical model, the model presented in Chapter 3 of my intermediate macro textbook, even if Fama in his brief essay does not spell out all the details of that model. Unlike Fama, and like Brad, I would not stop at that model. To understand the present situation, I would go on to the Keynesian model presented in Chapter 9 to 11. But whether one leaves the classical model behind to embrace the Keynesian model is a judgment call. On this particular judgment call, Brad and I agree, but I am not eager to castigate those like Fama who reach differing judgments.