Must-Read: On the breakdown of intertemporal Euler equation utility arbitrage in consumption spending: Paul Krugman.
More broadly: There are, supposedly, three channels through which a future full employment equilibrium in which Say's Law holds reaches back in time and shapes the equilibrium of the economy in the present:
In the labor market, expectations of future real demand and more importantly prices shape wage bargains today.
With respect to real consumption demand, the Euler equation marginal condition reaches back from the future to shape consumption spending today.
In asset markets, financial market arbitrage means that equilibrium asset prices in the future come close to nailing the levels of asset prices and expected asset returns today.
But are any of these operating right now? The first has not been seen in the Global North since 1984. The second was never there. And the third... where is the third? (Cf. Paul Krugman (2015): Rethinking Japan
Paul Krugman (2015): Multipliers and Reality: "An exchange between Simon Wren-Lewis and Robert Waldmann... raises some interesting issues...
...Wren-Lewis argues for a multiplier of around one, based... on a priori reasoning. Suppose the government builds a school....
Because the increase in government spending is temporary, any impact on pre-tax income or taxes will be relatively small relative to a consumer’s lifetime income. As a result, aggregate consumption is likely to change either way by an amount that is a lot less than the cost of the school.
Waldmann counters that there is essentially no reason to believe that consumers engage in the kind of calculation that’s involved here, that real consumption decisions reflect rules of thumb that can easily lead to a multiplier much more than one. I’m... mainly with Waldmann on this one, although Wren-Lewis’s analysis is nonetheless very useful.... The point he makes about the implications even of perfectly well-informed and rational consumers was and as far as I know still is totally misunderstood by freshwater economists.... Lucas’s attack on Romer rested in part on the claim that government spending on a new bridge would lead consumers, anticipating future taxes, to offset it one for one with cuts in their own spending; this is completely wrong if the spending is temporary.
But aside from exposing the intellectual decline and fall of the Chicago School, is this the way we should go about modeling such things? Well, yes, sometimes, because rigorous intertemporal thinking, even if empirically ungrounded, can be useful to focus one’s thoughts. But as a way to think about the reality of spending decisions, no. Ordinary households--and that’s who makes consumption decisions--have no idea what the government is spending, whether it is temporary or permanent, whatever.... Imagining that they do anything like the calculations assumed in DSGE models is ludicrous. Surely they rely on rules of thumb that don’t make use of the kind of information that plays such a large role in our models...
