Ricardian Effects

by Henry on December 16, 2008

The _Financial Times_ published an article based on an interview with Jean-Claude Trichet today (the article itself seems to be borked, along with the rest of the FT’s website, but the interview itself, which is more informative in any event, is available “here”:http://www.ecb.int/press/key/date/2008/html/sp081215.en.html ). In the interview, Trichet suggests that large scale deficit spending is a bad idea because of ‘Ricardian effects.’

Consider the Ricardian effects, the level of confidence or the lack of confidence that you observe in the various constituencies of economic agents, particularly at the level of households: they suggest that there are certain situations where if you do not behave properly you might lose more in terms of confidence than what you are supposed to gain through the additional spending.

and

Every nation has its own Ricardian effects and its own assessment of the situation. I do not want to comment on any particular country, because my duty is to look at the continent of 320 million fellow citizens as a whole. But I fully accept that there are differences in the capacity of households in various cultures to accept a deterioration of their situation, and again, the Ricardian channel tells us that one might lose more by loss of confidence than one might gain by additional spending.

Is this plausible? The broad political economy literature on consumer behaviour that I’m aware of would suggest that this argument rests on some fairly heroic assumptions about individual information (and in particular their awareness of the possible long term consequences of government spending – and this leaves aside the claim that for some reason they will systematically _overestimate_ the consequences tomorrow of deficit spending today). As best as I’ve been able to tell from a quick glance at the WWW, the claim that Trichet is making is a controversial one, which lacks solid empirical support. But then, my understanding of macro theory is based on fast-disappearing memories of my BA coursework. So is there any solid empirical basis for the claim that strong Ricardian effects exist and are a real issue for policy makers? Or is this just a theoretical figleaf to cover over the less abstract political-economic reasons (to do with institutional prerogatives, inter-state relations, worries about defection etc) why the European Central Bank really wants to keep controls on national spending? This is not a rhetorical question – I honestly don’t know the answer, and would appreciate information from those who know this literature better than I do.

{ 36 comments }

1

Kieran 12.16.08 at 4:14 am

But then, my understanding of macro theory is based on fast-disappearing memories of my BA coursework.

If you wait till it disappears altogether you can get a job at a big-time news magazine or somesuch.

2

Henry 12.16.08 at 4:21 am

Perhaps even better never to have had those memories to begin with?

3

notsneaky 12.16.08 at 5:24 am

I guess he’s talking about the possible changes in the risk premium (and hence the real interest rate, and hence investment) resulting from changes in the debt/gdp ratio. Usually though this argument is/has been used in the opposite situation, and yes, there it does have a good bit of empirical support. The argument is that starting from a position where the debt/gdp ratio is growing at an unsustainable, or close to unsustainable rate, a fiscal consolidation (contraction of deficits) may not be recessionary, or at least not as recessionary as you’d expect. This is because the risk premium falls due to improvements in the long term fiscal position of the government, lowering the interest rate and offsetting part of the reduction in demand due to lower government spending. More specifically, it matters what kind of government spending gets cut – gov investment or consumption.
Alesina, Perotti and Tavares (1998) document this happening in several European countries in the 1980’s.
Here however the argument is used symmetrically for an opposite case – starting from the position of sustainable debt/gdp ratio, a fiscal expansion intended to stimulate the economy may not end up getting much bang for the buck because of the rise in the risk premium due to worsening in the long run fiscal situation of the government.
I can’t think of specific research that looks at this case and the relevant multipliers may very well be asymmetric (the argument can work one way but not the other) – because who the hell knows what ends up going in to the risk premium at the end of the day.
But “normal” (as in ‘normal times’, not these ones) estimates of the fiscal multipliers tend to be small. This is more true for tax cuts than gov spending though although the difference is not that big.
But of course these aren’t ‘normal times’ and it’s not like monetary policy by itself is likely to be helpful here. I think the basic thing to take away from this is that any kind of fiscal stimulus should be directed at government investment rather government consumption since the former doesn’t involve as much (if any) “Ricardian effects”.

This is all assuming that this is indeed what he means by “Ricardian effects”. At first I thought he was talking about Ricardian Equivalence – and empirical support for that holding exactly is weak, and which is based on some heroic assumptions (which doesn’t mean that there isn’t some Ricardian Equivalence “effects” which reduce the difference between the effects of bond and tax financed spending) – but the context doesn’t seem to bear that interpretation out.

4

J. Michael Neal 12.16.08 at 5:31 am

Perhaps even better never to have had those memories to begin with?

Best is to develop a capacity to remember things that never happened at all.

5

John Quiggin 12.16.08 at 7:13 am

There are real problems with announcing large expenditures now and saying nothing how they will be financed. But we are already starting to see some governments (UK, for example) saying that they will increase taxes when the immediate crisis is over.

I doubt that, in this context, we are going to see lots of households and businesses taking the view that they should increase saving to deal with their future tax liabilities (the standard Ricardian equivalence line). Most will be grateful if they can stay solvent long enough to face those liabilities, and even more so if they can avoid a severe reduction in consumption along the way.

But to restate and reinforce notsneaky, running big deficits with no apparent thought about the need for subsequent surpluses is likely to increase risk premiums.

6

jrbarch 12.16.08 at 8:50 am

“The argument that deficit-financed tax cuts don’t boost consumption demand is known as Ricardian equivalence or debt neutrality. For it to be true, the aggregate consumption demand of consumers has to behave in the same way as would the consumption of a representative infinite-lived consumer with perfect foresight. This consumer knows, when his taxes are cut, that he will pay higher taxes in the future and that the present value of current and future taxes has not changed. His permanent income or wealth have not changed. He will not feel better off as the result of the tax cut. He will save all of the tax cut to pay the higher future taxes.

The demographics of the Ricardian equivalence model are not convincing….. ”

READ ARTICLE HERE: Confessions of a crass Keynesian

7

Tracy W 12.16.08 at 9:12 am

From memory, Riccardian equivalence has been offered as a potential explanation for why Japan had so little economic response to its public spending in the 1990s. I don’t know what the current verdict of the literature is on that theory.
Though as my macro-lecturer pointed out, our understanding of Japan’s economic history is hampered by a shortage of native Japanese economic historians writing in English.

8

stostosto 12.16.08 at 9:46 am

My understanding is that Ricardian equivalence is overwhelmingly a speculative concept that became popular on the heels of the – very successful – Lucas critique of rational expectations. It says you can’t achieve anything by an expansionary fiscal policy (i. e. deficit financed public expenditures), because everybody will realise that the government will have to raise taxes at a later point in order to service the debt it acquires in the process. Hence, they will increase their savings by exactly the amount that is required to pay for future tax increases which will exactly cancel out the intended short term demand boost from the fiscal expansion.

I believe what notsneaky discusses is the crowding-out argument. That argument, of course, is a lot stronger when the economy operates at full capacity and the private sector investment is vigorous.

I think Trichet displays a lamentable lack of knowledge and thoughtfulness in his comments.

9

Bob B 12.16.08 at 10:40 am

I’ve a nasty suspicion that much of Trichet’s concern with Ricardian effects (= “Ricardian equivalence” in economics jargon) relates to the UK and Conservative criticism there of the government’s supposedly “crass Keynesianism” and its proposed fiscal stimulus to soften the impact of the recession. The claim made is that the fiscal stimulus will add too much to Britain’s national debt.

The following quotes with links help to put that claim into perspective:

First, from a comment by Sam Brittan in the FT:

“Those alarmed by UK official projections showing public sector net debt climbing from 36 per cent of gross domestic product last year to 57 per cent in 2012 should bone up on their history. There are long passages in Macaulay showing how the nation prospered despite increases in the national debt – regarded by sages as catastrophic. In his one and only Budget speech, Harold Macmillan noted how the national debt had risen from £600m in 1914 to £8.4bn in 1939 and £27bn in 1956 – representing 27, 133 and 146 per cent of GDP. As Macmillan [Chancellor of the Exchequer 1955-7] put it: ‘Whatever the temporary difficulties from trying to run too fast, if we stand still, we are lost.'”
[Financial Times on 5 December 2008: Sam Brittan: A framework for economic stability]
http://www.samuelbrittan.co.uk/text324_p.html

For international comparisons of projected outstanding Government debt as a percentage of GDP in 2009, try Table 1 in the Lloyds TSB Economic Weekly report of 26 November:
http://www.fxstreet.com/fundamental/analysis-reports/economics-weekly/2008-11-25.html

From the comparative data in the Lloyds Bank report, the UK’s projected national debt/GDP ratio next year is relatively modest compared with that for the US, Germany and the average for OECD countries.

10

stostosto 12.16.08 at 10:46 am

Okay, having read the full interview (note to self, always do that), I think what Trichet really says in a coded form, is that Germans have a hardwired preference for price stability over almost anything else. Plus, his is a classic “where you sit is where you stand” attitude. The call for fiscal expansion will never, ever, come from a central bank governor.

11

Bob B 12.16.08 at 10:51 am

This piece: Complacency rules as time slips away, by Wolfgang Münchau in Monday’s FT is especially recommended for those who, with Herr Steinbrück, the current German finance minister, passionately believe that a fiscal stimulus for an economy in a recession amounts to “crass Keynesianism”:
http://ft.onet.pl/1,18620,druk.html

12

Ginger Yellow 12.16.08 at 10:55 am

“I can’t think of specific research that looks at this case”

Really? It would seem to be one of the most fundamental applied questions in economics. Should you spend your way out of a recession or not?

13

stostosto 12.16.08 at 11:04 am

Googling around, it seems that Ricardian effects is a bit of a hobby horse to Trichet. Here he explains it himself in an interview from 2006:

“the Keynesian argument: the more you spend, the more you activate the economy. But besides that argument, there is what economists call the “Ricardian effect’’. David Ricardo rightly stated that the greater the deficit becomes, the more investors and consumers alike start to realise that such a deficit is not sustainable in the longer run. Somebody will have to pay for it, either through higher market interest rates or through tax increases. Entrepreneurs become nervous and slow down their investments, consumers start saving more and spending less. So the economy slows down and jobs are lost. The more the budget goes into the red, the stronger this Ricardian effect becomes, and the more it outweighs the Keynesian arguments for deficit spending. That is why the stability pact is also a growth pact. “

14

reason 12.16.08 at 3:30 pm

In this case (debt-deflation) which like non-squeaky I think is an unusual case, I think the government should finance its expenditure (which I think should be a mixture of infrastructure spending and tax credits to improve household balance sheets) by printing money. I don’t see any reason to finance it through selling bonds.

15

reason 12.16.08 at 3:34 pm

And when Ricardo was writing, we didn’t have Fiat currency but a gold standard. I think it is odd that people think the situation is the same. And Ricardian equivalence, doesn’t make sense to me, because there is absolutely no reason for people to believe the people receiving the stimulus and the people paying the eventual tax are one and the same.

16

notsneaky 12.16.08 at 3:46 pm

“I believe what notsneaky discusses is the crowding-out argument.”

No, no, there’s three separate arguments relating to fiscal policy here; crowding out, Ricardian equivalence and what Trichet calls “Ricardian effects”.

Crowding out occurs because of an upward sloping LM curve. As demand rises incomes this increases demand for money balances which puts upward pressures on the interest rates which “crowds out” investment, leading to a less than one for one increase in output/demand. What matters here is not whether the economy’s at full capacity or not but how high (or low) interest rates are already. This is the reason why, for example, Krugman qualifies his analysis in this column:

http://krugman.blogs.nytimes.com/2008/12/14/european-macro-algebra-wonkish/

with: “We start from the proposition that Europe is, or soon will be, in a position where interest rates are up against the zero lower bound. This means … that we can use ordinary multiplier analysis.” (Basically he’s saying you’re on the portion of the LM curve which is flat)

This has nothing to do with the risk premium or whether the fiscal stimulus is financed by taxes or a deficit (borrowing). Which is what Ricardian Equivalence addresses. It says that under some assumption it doesn’t matter whether the spending is financed one way or another (because of anticipation of higher taxes). If you remember your Macro 101 then a tax financed increase in spending has no multiplier. dy=dg=dt. So the effect on demand – or the shift in the IS curve – is only equal to the boost in spending, regardless of what happens through the money market (crowding out). What RE says is that the same thing is true if this spending is financed by borrowing – it doesn’t matter. Support for RE is mixed at best though. But this also has nothing to do with risk premiums.

The whole thing with that came in the 90’s when folks noticed that cuts in spending in Europe in the 80’s, which you’d normally expect top be contractionary, actually seemed to be expansionary. And real interest rates at the time moved inline with what you’d expect from changes in the risk premium. But this occurred in a situation where you were starting from a position of growing debt/gdp ratios which, as Ricardo quoted above says affects the expectations about gov budget sustainability and possibility of default.

Like I said, I’m not aware of any specific studies looking at the symmetrically opposite case (expansionary fiscal policy turning contractionary because of increases in risk premium) but that argument can certainly be made. And yes, it’s better to be upfront about how you gonna pay for this down the line which would reduce uncertainty and hence any movements in the premium. It would also be better if the increases in spending where on investment which will realize a (cash) return (social return is nice too but it’s not going to pay the future debt which is what matters here) however small which would make the long run sustainability situation better (I believe the fiscal rule of the UK takes this into account differentiating between gov investment and consumption unlike the Growth and Stupidity Pact which just says 3%!) (It’s less stupidity than it used to be)

17

notsneaky 12.16.08 at 4:02 pm

Re:15 “And when Ricardo was writing, we didn’t have Fiat currency but a gold standard.”

This is relevant to the extent that under a Gold Standard the interest rate would stay the same, so that the exchange rate (or the parity with Gold) stays the same, and the adjustment takes place through Gold flows (i.e. automatic monetary policy) – so no crowding out would take place. It’s analogous to the case where monetary policy is accomodating (keeps interest rates where they’re at) to fiscal policy or when the LM curve is flat (rising incomes don’t have much effect on desired money balances) – which is why Krugman throws that qualifier in there. Since EU countries have basically a gold standard between themselves and flexible exchange rate with rest of the world, then IF monetary policy is not accomodating or LM curve not flat then this is an additional argument for fiscal policy coordination amongst themselves. Part of the reason for the G&S pact is precisely that though in the past that constraint has been readily ignored when “key” countries didn’t feel like it.
It also has some implications for the risk premium through the link between interest rates and expected exchange rate depreciation (which is zero within EU but non zero with rest of the world) – which may be why the first question of the Trichet interview asks about the viability of the euro in the present crisis. Again this is basically another reason for fiscal coordination.

18

notsneaky 12.16.08 at 4:05 pm

“And Ricardian equivalence, doesn’t make sense to me, because there is absolutely no reason for people to believe the people receiving the stimulus and the people paying the eventual tax are one and the same.”

The argument relies on intergenerational altruism. More or less. The argument makes sense, it’s just far fetched.

19

Alex 12.16.08 at 4:15 pm

If you remember your Macro 101 then a tax financed increase in spending has no multiplier. dy=dg=dt

If you remember your Macro 201, that only holds if the incidence of taxation is such that the payers of the net tax increase have a marginal propensity to save identical to the inverse of that of the recipients of the spending increase. This implies an equal marginal propensity to save across the income distribution, which is a heroic assumption even by economists’ standards.

20

lemuel pitkin 12.16.08 at 4:43 pm

that only holds if the incidence of taxation is such that the payers of the net tax increase have a marginal propensity to save identical to the inverse of that of the recipients of the spending increase.

Doesn’t even hold then. If the tax-financed spending consists of direct purchases of goods and services, then the balanced-budget multiplier is always positive, regardless of propensities to save.

21

notsneaky 12.16.08 at 4:59 pm

Re:19 it may be heroic but it’s standard. Because the point is to show that deficit spending has a bigger effect than tax financed spending (even if you got different MPCs). RE kills that difference. Anyway, once you start talking about different MPCs you’re going to pretty much end up with Permament Income Hypothesis where temporary gov spending increases don’t have a multiplier either.
Re: 20 Of course it’s positive. But in that case it’s not greater than 1.

22

lemuel pitkin 12.16.08 at 5:03 pm

once you start talking about different MPCs you’re going to pretty much end up with Permament Income Hypothesis

Why do you say that?

23

notsneaky 12.16.08 at 5:15 pm

What accounts for difference in MPC’s? Subjective factors (which more or less one should assume are the same across income classes unless one thinks there’s something ‘intrinsic’ about poor people that makes them not save as much), liquidity constraints and MPC as a function of present and permanent income. I.e. poor people consume more out of every dollar of income because they have lower incomes. But in that case what matters is not just individual’s present income but lifetime income (or permanent income). Liquidity constraints would basically determine the relative weights of present and permanent income in such an MPC.

The classical assumption of “workers eat their wages, capitalists save their profits” if taken at face value would imply that somehow the source of one’s income determines what one does with that income. Which seems silly. Rather it was probably intended as a very simple basic model of the permanent income effect.

24

notsneaky 12.16.08 at 5:25 pm

To clarify a bit, under PIH with liquidity constraints (and different MPCs), temporary gov spending will have (some) effect, maybe even a multiplier effect, but, absent Ricardian Equivalence that effect will still be less if it’s tax financed spending rather than deficit financed spending. But with PIH you should have some kind of RE, even if not fully offsetting (due to liquidity constraints) for sake of consistency. I was arguing against Alex – that the proposition about tax vs. deficit spending is more general.

25

lemuel pitkin 12.16.08 at 5:36 pm

Liquidity constraints would basically determine the relative weights of present and permanent income in such an MPC.

In other words, liquidity cnstraints lead to a departure from permanent income. You can only argue that varying propensities to consume reduce to the permanent income hypotheisis if you think liquidity constraints are relatively unimportant.

the source of one’s income determines what one does with that income. Which seems silly.

It only seems silly in a model — as in mainstream macro, where I guess you’re coming from — that doesn’t include firms, only households. In the real world, the division of income between wages and profits is even more important in terms of the MPC than that between households of different income levels.

26

dsquared 12.16.08 at 5:42 pm

Liquidity constraints would basically determine the relative weights of present and permanent income in such an MPC.

I don’t see how you get from here to the no-multiplier conclusion. Surely progressively-financed government spending would increase consumption in such an economy? Just simplistically, a straightforward transfer tax from top to bottom deciles would increase the average marginal propensity to consume out of an increase in aggregate income.

Also, the real heroic and ubiquitous assumption here is that of generic “tax”. Pay for your infrastructure spending with a windfall tax on the banking system (that good old Thatcherite policy) and you can surely have a fiscally neutral spending with a multiplier.

27

a 12.16.08 at 8:13 pm

It would seem to be that the present level of debt of a society is relevant. It’s all well and good for the U.K. to promise higher taxes in the future, but given the indebtedness of British society, it seems doubtful that these taxes will hold. So large deficit spending now is particularly dangerous – maybe the British will manage not to default on their sovereign debt, but they are well on their way.

28

notsneaky 12.16.08 at 10:53 pm

“I don’t see how you get from here to the no-multiplier conclusion.”

Ok, that’s what I was trying to clarify. Things got confusing because there were like two or more arguments criss crossing each other.
So, let me clarify again. If you take ‘basic Keynesian’ framework (like c=a+b(y-t)) and you compare it to a PIH framework you get a smaller multiplier. If you take a ‘basic Keynesian’ framework with different MPCs (reflecting liquidity constraints) you still get a smaller multiplier than from a PIH framework with roughly similar liquidity constraints. But yes, you can still get a multiplier out of PIH with liquidity constraints.
To put it another way, in ‘basic Keynesian’ framework (yes, the bastard, mainstream version) all that matters for consumption is temporary, present, income. In pure PIH with no liquidity constraints all that matters is permanent income. PIH with liquidity constraints is in between the two, where both matter (the fact that consumption depends at all on present income is sometimes even called the “excess sensitivity”).

Of course with a quadratic utility function, it’s all just a random walk, per Hall’s famous “He Must’ve Been on Drugs When He Wrote It” paper.

The confusion arose because Alex said that with different MPCs it’s no longer true that tax financed spending multiplier is 1 and smaller than a deficit spending multiplier. This is false. I didn’t have a piece of paper handy then but a quick run through the algebra confirms that even with different MPCs it’s still the case that if dG=dT then dY=dG, unlike the deficit spending in which case dY>dG. Then I made the off hand comment that if you’re gonna talk about different MPCs then you pretty much got to go with PIH since that’s the framework in which that makes the most sense. (Liquidity constraints in ‘basic Keynesian’ framework being an ad-hoc quick and dirty version of PI effects here).

So I don’t think we disagree here except for some minor quibbles.

“Just simplistically, a straightforward transfer tax from top to bottom deciles would increase the average marginal propensity to consume out of an increase in aggregate income.”

Not necessarily under PIH with no liquidity constraints.

29

notsneaky 12.16.08 at 11:09 pm

“In other words, liquidity cnstraints lead to a departure from permanent income. ”

Sure, that’s what I said.

“You can only argue that varying propensities to consume reduce to the permanent income hypotheisis if you think liquidity constraints are relatively unimportant.

Not quite. But I do think that the PIH is the natural way to talk about different MPCs. Why are some people credit constrained? Because their future (permanent) income is low. What are some other reasons for different MPCs? Because people are at different points along their lifetime income path.

“”the source of one’s income determines what one does with that income. Which seems silly.”

It only seems silly in a model—as in mainstream macro, where I guess you’re coming from—that doesn’t include firms, only households. ”

No, no, we got firms and households. But by their nature firms don’t consume and save, they invest, pay out dividends, and pay out income to factors. Again, what should matter is how much income a person has (both temp and perm) not what the source of that income is. Whether or not there are firms or just households’ is sort of irrelevant here.

“In the real world, the division of income between wages and profits is even more important in terms of the MPC than that between households of different income levels.”

It’s really not, and to the extent it is, it is only because the division of income between wages and profits correlates with the differences between household’s incomes. Hence, the assumption that workers have high mpc and capitalists don’t can sometimes be a useful simplifying assumption. But that’s all it is.

30

lemuel pitkin 12.16.08 at 11:50 pm

Why are some people credit constrained? Because their future (permanent) income is low.

No. Because credit markets are far from perfect, because the future is fundamentally uncertain, and because lenders are concerned about liquidity. Your implicit model, where all future income flows have a known probability distribution, is not relevant to the real world.

31

notsneaky 12.17.08 at 12:36 am

Ok, where their expected future income is low, however those expectations are formed. I don’t need an implicit model where all future income flows have a known probability distribution. And surely when deciding whether or not to extend a loan to somebody potential lenders are likely to consider the future income of the potential borrowers? All the other stuff about imperfect credit markets and fundamentally uncertain future is fine but by itself it doesn’t explain why certain people are credit constrained and others are not. I mean, if all that mattered was that the future was fundamentally uncertain and stuff these credit constraints would be randomly distributed or something. Obviously it’s the low-permanent income people who face mostly face these constraints. You’re trying to make this more unrealistic than it is (and are doing this by ascribing implicit models where they ain’t necessarily).

And come on, arguing that saving behavior follows from some kind of hard wired class consciousness or something is wayyyyyy more unrealistic.

32

lemuel pitkin 12.17.08 at 4:19 am

arguing that saving behavior follows from some kind of hard wired class consciousness or something is wayyyyyy more unrealistic.

Here, we simply disagree. I think the assumption that profits are saved and wages are consumed is much more realistic — and more importantly, more useful as a heuristic — than the assumption that households are maximizers of income, consumption or “utility”.

Have you read much Lance Taylor? Check out Chapter 1 of Reconstructing Macroeconomics — it makes the case much better than I can.

33

notsneaky 12.17.08 at 4:59 am

I haven’t read Taylor. And as I’ve already said, yes, for some purposes the ‘workers eat wages, capitalists save profits’ can be useful simplified assumption (i.e. a heuristic). But for the purposes of figuring out the effects of transitory changes in income on consumption behavior it’s gonna get the multiplier only by accident. And it won’t differentiate between permanent increases in wages and temporary ones. Which do after all have different effects and that can be seen in the data (whereas this heuristic would tell you it’s all the same).

Remember that the whole PIH came out of an effort to reconcile contradictory time series and cross section evidence on consumption and income. And it was roughly successful at this. Since then the analysis got more refined and currently as far as I know a “PIH with liquidity constraints” does very well at explaining empirical data (for example as in Muellbauer’s work). You control for some demographic effects and you’re golden. So you got a consistent theory, which doesn’t rely on ad hoc assumptions, which takes into account the fact that the future matters, which takes into account ‘real world’ institutional constraints and market imperfections and which does very well when tested against actual data. Why throw that out and rely on a hit or miss unrealistic heuristic (I mean seriously, do you really think that wage earners never save? And that investors never spend their dividends?)?

Just because it comes from a school of thought which has a certain ideological pedigree?

34

dsquared 12.17.08 at 8:02 am

But by their nature firms don’t consume and save, they invest, pay out dividends, and pay out income to factors

Note that firms are also often liquidity constrained (and often behave as if they were even when they aren’t; pecking order theories of capital structure and similar models under which propensity to invest out of current profits is greater than out of external finance are quite mainstream). A tax on profitable firms redistributed to loss-making companies would also probably have a multiplier.

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notsneaky 12.17.08 at 4:48 pm

Yeah… I don’t think ‘standard’ Keynesian thinking quite reaches those conclusions. At least I hope it doesn’t. Usually firms which are loss making are loss making not because of under investment but because of lots of stupid investment. Liquidity constrained firms – pretty much small businesses – tend to mostly operate at small scale and small profits (depends on the sector though) – often zero net of owner(s)’ salaries.
I’m sure the sellers of sub prime mortages are quite liquidity constrained and I’m sure there’s some kind of spending multiplier there.

36

Robert 12.17.08 at 5:03 pm

For anybody that cares, my name links to a summary of a model like the one lemuel pitkin describes.

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