Wednesday, November 02, 2005

Barro on...

Via Cafe Hayek comes this interesting interview with Harvard macroeconomist Bob Barro. Here's Barro's slightly more subtle than popularized view of Ricardian equivalence:
Let me say first that I think the Ricardian equivalence idea is basically right as a first-order proposition. However, people get confused as to exactly what it says. [...] To illustrate the potential pitfalls in what Ricardian equivalence says and does not say, one can consider the famous quote attributed to Vice President Cheney to the effect that President Reagan proved that budget deficits don't matter. The Cheney quote is often interpreted to mean that the level of government expenditure does not matter, and that surely is not what Ricardian equivalence says. The Ricardian proposition is about the consequences of paying for a given amount
of public expenditure in different ways. Specifically, does it matter—or does it matter a lot—whether the government pays for its spending with current taxes or with current borrowing, which entails higher future taxes?
Yet he doesn't address the very valid concern that most people don't act in a way consistent with Ricardian equivalence. On Bush:
I should say, in general, that the Bush administration has been a real failure with respect to fiscal discipline, especially during its early years. I mean this with respect to the level of federal expenditure, not about fiscal deficits per se. [...] Unfortunately, the spending discipline coming from fiscal deficits did not seem to work during Bush's first term. Maybe that is because they figured out Ricardian equivalence—that is, that fiscal deficits do not matter (much). In some ways, it's better if Washington pretends that fiscal deficits and public debt are awful even if they really are not. [...] President Bush really should try vetoing a spending bill sometime.
On the equity premium puzzle:
The equity premium is mostly about the very low risk-free real interest rate. The rare-disasters framework says that this low risk-free rate reflects the large demand for risk-free assets because of the potential for big disasters. In addition, the framework explains how the expected real interest rate on, say, government bills moves around when perceived disaster probabilities change. You do not need very big changes in probabilities to get fairly substantial responses. A small increase in this kind of risk—as an example, due to the September 11th events—leads to a noticeable response of real interest rates. When this probability goes up, the risk—free rate goes down because people put more of a premium on holding a relatively safe asset. [...] I'm trying to get more objective measures of disaster probabilities by using options prices on the stock market.
Or more subjective measures, depending on how you think about it. On Bono:
We had a wonderful lunch back in 1999—Sachs, Bono and I. It was clear that they invited me not to get information or advice. Instead, Bono wanted to learn the conservative, free-market objections to his approach so that he could come up with better counterarguments. Then he could be more persuasive, as he turned out to be, even with Republican officials in Washington. I'm sure I had no impact on the policies that Bono ended up proposing. It's amazing what kind of influence he's had. He really did manage to convince many people in Washington to carry out substantial debt relief. It's a shame that we could not harness his talents for persuasion in more productive directions.


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