Sunday, August 23, 2009

Basic Economics For The Economics Challenged

Menzie Chinn corrects Richard Posner's faulty math about the effect of the stimulus. Chinn is actually basically right about the math in this. Posner appears to assume that growth is calculated in a European way, not in the American way.

However, while the math is right, the economics isn't. The case that stimulus spending really raised growth that significantly depended on four assumptions

1) Not even a partial Ricardian equivalence (increase in private savings in response to budget deficits).
2) No increase (or decrease in decline) in the trade deficit.
3) Despite 1)&2), interest rates did not increase (or fail to decrease)as a result.
4) Prices did not rise (or decline less).

If you take these factors into consideration, even the short-term effect of the stimulus is at best small.


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