who headfakes, and attacks Simon Wren-Louis before ultimately agreeing with him.
First, the attack:
TheMoneyIllusion » Nobel Prizes for alchemy?: I’m not sure if Wren-Lewis knows this, but Nobel Prizes are frequently awarded to people who don’t accept the Keynesian model…. Lots of people believe the fiscal multiplier is roughly zero, including Lucas, Friedman and me. That doesn’t mean one is ignorant of basic economics…. Cochrane is dividing debt-financed government spending into two components, a tax-financed spending increase and a deficit-financed tax cut….Then he argues the debt-financed tax cut will do nothing, because of Ricardian equivalence. I don’t entirely agree, but it’s certainly a respectable argument. Then he suggests that the balanced budget multiplier is zero. Obviously the Keynesian model says it’s not, but why assume that model is correct?… [I]t’s not a question of Chicago economists not having studied Keynesian economics. He simply doesn’t agree…
At which point Sumner tiptoes away, without answering the question of why Cochrane doesn't agree.
First, let me call an intellectual foul on Sumner's association of Milton Friedman with the claim that the fiscal multiplier is likely to be very low right now. Friedman believed that the constant-money stock fiscal multiplier was quite small, "certain to be temporary and likely to be minor" unless the interest-elasticity of the demand for money is well-approximated not by -1 or -2 but by -∞.
Well guess what the interest elasticity of the demand for money is right now?
If I had Milton Friedman here beside me right now, he would say that the government needs to expand the money stock and needs to expand the money stock not by buying things that have an elasticity of substitution with money of ∞ but by buying things that don't: bonds that carry substantial default or duration risk or stuff that isn't tradable on financial markets at all--and to what extent that is "unconventional monetary policy" and to what extend that is "fiscal policy" is all one to me: it's effective.
Second, let's answer the question of why Cochrane doesn't agree that the fiscal multiplier right now is likely to be substantial. Cochrane appears to say that he does not agree because he believes that we live in an economy with velocity of money V fixed by a technological cash-in-advance constraint in which MV=PY. But there are things in his paper that definitively reject that model (as well as things that definitively endorse it). And that model is wrong.
The only other model Cochrane presents is one in which S = I + D, savings equals investment plus the government deficit. And in that model the balanced-budget multiplier is definitely non-zero: boosting government debt by running a deficit is a very good thing to do.
Then, after this initial headfake, Sumner starts backpedaling as fast as he can to ultimately wind up in exactly the same position as Simon Wren-Louis:
[T]he point is not that Wren-Lewis and Krugman are necessarily wrong about fiscal stimulus, but rather that the argument they present is incredibly weak…. [Cochrane] needs to explain why fiscal stimulus won’t boost velocity, or why any boost would be offset by a lower money supply. Cochrane doesn’t do that.