EconoSpeak: Ricardian Equivalence Does Not Imply That Obama’s Fiscal Stimulus Will Be Ineffective

The debate arises in part because some economists focus on rationality in the long run, while others (Keynesians et al) focus on irrationality in the short run.

It seems the argument that “stimulus” cannot work rests on rational expectations — people expect that fiscal/monetary expansion now will require fiscal/monetary retrenchment later. In other words, rational expectations defeat Keynesian prescriptions.

But Kindleberger argued, cogently, that crises are irrational. If we had continuous rationality, we would not observe manias and busts. But we do observe such, so there must be some irrationality out there.

How to reconcile the opposing views? Rationality is useful for the long run where Say’s Law works, and irrationality applies to the Keynesian “short run,” when prices and wages are sticky. We are somewhere in between these two “runs,” so there is room for old-fashioned Keynes and also for some skepticism as to its potency.


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