The History of Macroeconomics: Fiscal Policy, Fama's Fallacy, and Say's Law Yet Once Again
I am puzzled.
Consider Fama's Fallacy:
There is an identity in macroeconomics... private investment [PI] must equal the sum of private savings [PS], corporate savings (retained earnings) [CS], and government savings [GS].... (1) PI = PS + CS + GS.... Government bailouts and stimulus plans seem attractive when there are idle resources - unemployment. Unfortunately, bailouts and stimulus plans are not a cure. The problem is simple: bailouts and stimulus plans are funded by issuing more government debt.... The added debt absorbs savings that would otherwise go to private investment.... [G]overnment infrastructure investments must be financed -- more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount.... Suppose the stimulus plan takes the form of lower taxes... lower tax receipts must be financed dollar for dollar by more government borrowing. The government gives with one hand but takes them back with the other, with no net effect on current incomes...
I can skip back in time from Eugene Fama at the University of Chicago today to Henry Hazlitt writing on the post-World War II Wall Street Journal editorial page. But I cannot find the Full Fama there. It is true that Hazlitt, in his Economics in One Lesson, writes:
We will take it for granted... that every dollar of government spending must be raised through a dollar of taxation.... [F]or every dollar that is spent on the bridge a dollar is taken away from taxpayers. If the bridge costs $1,000,000, the taxpayers will lose $1,000,000.... [F]or every public job created by the bridge a private job has been destroyed somewhere else... things that we do not see because, alas, they have never been permitted to come into existence...
But when he comes to deficit spending he has a different view--stimulus spending now and debt repayment later can bring demand forward from the future into the present:
The Wisdom of Henry Hazlitt: How would that deficit [spending] be financed?... [I]f the money were borrowed, then the previous spending stimulus would be reversed by a deflation when the borrowing was repaid...
Certainly Jacques Rueff did not believe in the Full Fama:
[I]nvestment expenditures can... reduce temporary unemployment...they entail secondary effects... Financed by taxes and loans... Purchasing power taken away from individuals... the investment program [may] increase employment, but it need not.... An investment programme financed by inflation [will] bring about [a short-term] increase in employment... [1]
Nor did Milton Friedman: to Friedman, the effects of expansionary fiscal policy were definitely there, but he thought they were:
And I have finally figured out that neither Frederic Bastiat nor Jean-Baptiste Say believed in Fama's Fallacy. They did not believe that expansionary fiscal policy could not boost production and employment because money spent by the government must come from someplace and so be necessarily offset by money not spent by somebody else. Frederic Bastiat and Jean-Baptiste Say, instead, not only believed that government-funded public-works programs--timely, targeted, and temporary ones--could affect employment, but also that such stimulative fiscal policies should be used to cushion the impact of depression:
Frederic Bastiat: What Is Seen and What Is Not Seen: There is an article in the Constitution which states: "Society assists and encourages the development of labor.... through the establishment by the state, the departments, and the municipalities, of appropriate public works to employ idle hands." As a temporary measure in a time of crisis, during a severe winter, this intervention on the part of the taxpayer could have good effects... as insurance. It adds nothing to the number of jobs nor to total wages, but it takes labor and wages from ordinary times and doles them out, at a loss it is true, in difficult times...
Jean-Baptiste Say: Treastise of Political Economy: [A] benevolent administrationcan appropriately make provision for the employment of supplanted or inactive labor in the construction of works of public utility at public expense, as in construction of canals, roads, churches, or the like...
So where did it come from? I am puzzled because now when I try to pick up the history of Fama's Fallacy I find myself stymied and roadblocked at every turn.
I can get back to R.G. Hawtrey and his "Treasury View"--even though the Treasury View is not the Full Fama.[2] But Hawtrey is definitely the closest I have found:
R. G. Hawtrey (1925), "Public Expenditure and the Demand for Labour," Economica 13 (March): The policy of the regularisation of the demand for labour by advancement or retardation of public works was, I belive, originally proposed in the Minority Report of the Royal Commission on the Poor Law in 1909.... Professor Pigou first dealt with the question in his Wealth and Welfare in 1913. There he defended the proposal against the objection that:
the quantity of resources devoted to the purchase of labour at any time is rigidly determined...
and that:
any resources which the State or private persons turn to the purchase of extra labour at one point are necessarily taken away from the purchase of labour at some other points....
Perhaps if Professor Pigou had carried the argument so far, he would have become convinced that the distorting veil of money cannot be put aside. As well might he play lawn tennis without the distorting veil of the net. All the skill and all the energy emanate from the players and are transmitted through the rackets to the balls. The net does nothing; it is a mere limiting factor. So is money....
We take a community in which there is unemployment... outlay is sufficient only to employ a part of the productive resources of the country. The Government, with a view to starting new public works, borrows a sum in the investment market....
[I]t must not be supposed to be self-evident that this shrinkage [in private outlays] cancels the effect of the new expenditure of the Government.... The question... [is] a very subtle and elusive one. For, as fast as the Government [by borrowing] takes money away from the existing body of consumers, it pays it out again to a new section of consumers, those employed on the works it udnertakes. Will not these make good the reduction... restore the [private] demand for goods and services... to the previous level? If that happens the new works will be a clear addition to the amount of unemployment....
As soon as the people employed on the new public works begin to receive payment, they will... accumulate cash balances... [that] can only be provided at the expense of the people already receiving incomes. These latter will tehrefore become short of ready cash and will curtail their expenditure with a view toward restoring their balances.... If all simultaneously try to increase their [cash] balances, they try in vain... In the end the normal proportion is restored. It is this limitation... that really prevents the new Government expenditure from creating employment.
But, it may be asked, is not this to take the old narrow rigid view of the quantity theory?... If, when the Government started new works, there were any circumstances which would tend to make people content with smaller [cash] balances, that would affect the problem.[3] To put forward an increase in trade activity itself as having this effect would be to beg the question. If the increase in activity does occur, an increased rapidity of circulation would follow. But, except in cases of marked distrust of the currency, the increased cash requirements of a revival of trade activity are only partly, not wholly, met by increased rapidity of circulation. There must be some increase in the unspent margin, though not in full proportion to the turnover of cash. If a tight hold is kept on the unspent margin, in other words, if no expansion of credit at all is allowed, the conditions which produce increased rapidity of circulation cannot begin to develop.
There is, however, one possibility which would in certain conditions make the Government operations the means of a real increase in rapidity of circulation. In a period of depression the rapidity of circulation is low, because people cannot find profitable outlets for their surplus funds and they accumulate idle balances. If the Government comes forward with an attractive gilt-edged loan, it may raise money, not merely by taking the place of other possible capital issues, but by securing money that would otherwise have remained idle in balances. That could only occur in exceptional circumstances. The idle balances are not in general accumulated for want of attractive enough permanent investments; they are rather composed of unemployed circulating capital, often that of manufacturers who prefer not to be dependent on their bankers. But it is conceivable that the outlook for industry might be so extremely unfavourable that promoters of new enterprises do not come forward in sufficient numbers, along with public borrowers, to use up savings as they accrue. In that case additional public borrowing might not displace any trade issues. There would be a diminution of balances on one side without any diminution in the flow of money to set against the increase of Government expenditure on the other.[1] With our hypothesis, therefore, we have reached this conclusion, that additional public expenditure can only give additional employment if it increases the rapidity of circulation of money, and it is only likely to do so in the exceptional case described....
The original contention that the public works themselves give additional employment is radically fallacious. When employment is improved, this is the result of some reaction on credit, and the true remedy for unemployment is to be found in a direct regulation of credit on sound lines...
I had thought that Fama had gotten his Fallacy from Hawtrey and the British "Treasury View", transmitted via Hazlitt and company to Chicago through some non-Friedman chain. But I cannot find it.
And I had thought that Hawtrey had gotten it, indirectly, from Say's Law of Markets.
But Say did not get it from Say's Law of Markets.
And Bastiat did not get it from Say's Law of Markets. (Never mind that any interpretation of Say's Law of Markets that would make fiscal policy powerless would also make monetary policy powerless, that neither Hawtrey nor Say believed that changes in the quantity of money had no effect[4], and that Hawtrey was not fully committed to Fama's Fallacy in any event.)
So where did it come from?
[1] This is not to say that Jacques Rueff was in favor of fiscal stimulus spending in a depression. It would, he said, lead to a government as bad as Hitler. If the government continued deficit spending:
Hindividuals... cannot be supposed to increase their cash holdings indefinitely... general rationing... revive... an economic regime invented by Hitler.... [I]t is probable that the next period of depression will see a general application in the world of the policy suggested by Lord Keynes. I am confident that this policy will not reduce employment, except to a very limited extent, and that it will have profound consequences... re-establish in the world a regime of general planning... based upon the suppression of all individual liberty.... Whom Jupiter wishes to destroy, he first makes mad.
[2] Note that Hawtrey' "Treasury View" is a more sophisticated and much more defensible doctrine than Fama's Fallacy. Hawtrey does not subscribe to Fama's Fallacy along two dimentions. First, for Hawtrey, fiscal policy is effective in the "exceptional case" of "idle [cash] balances"; second, for Hawtrey, the impotence of fiscal policy is not a consequence of the NIPA identity and the circular flow of economic activity but rather the workings of the quantity theory of money.
[3] Note that John Hicks--and everybody else--would say that when the government borrows it pushes up interest rates, raises the opportunity cost of holding money, and thus provides households and businesses with a powerful incentive to be content with smaller cash balances
[4] Jean-Baptiste Say (1829), Cours Complet d'Economie Politique Pratique:
The Bank [of England], legally obliged to redeem its banknotes in specie, regarded itself as obliged to buy gold back at any price, and to coin money at a loss and at considerable expense. To limit its losses, it forced the return of its banknotes, and ceased to put new notes into circulation. It was then obliged to cease to discount commercial bills. Provincial banks were in consequence obliged to follow the same course, and commerce found itself deprived at a stroke of the advances on which it had counted, be it to create new businesses, or to give a lease of life to the old. As the bills that businessmen had discounted came to maturity, they were obliged to meet them, and finding no more advances from the bankers, each was forced to use up all the resources at his disposal. They sold goods for half what they had cost. Business assets could not be sold at any price. As every type of merchandise had sunk below its costs of production, a multitude of workers were without work. Many bankruptcies were declared among merchants and among bankers, who having placed more bills in circulation than their personal wealth could cover, could no longer find guarantees to cover their issues beyond the undertakings of individuals, many of whom had themselves become bankrupt...
