Tweet [1]
Mario Rizzo, over at ThinkMarkets, explains well [2] the difference between economists who understand that the modeling tractability made possible by thinking in terms of aggregates (such as "aggregate demand") is not worth the price of losing focus on the necessity of countless resources being arranged and re-arranged in very specific ways – not worth the price, that is, if the goal is sustained and widespread prosperity. The micro-foundations are all-important.
Mario's post is among the best that I've ever read on this topic. Read it. Re-read it. Re-re-read it. (And read the comments, too.) Here's the heart of Mario's post:
that government spending is as good as private in restoring employment,
he is speaking against the whole thrust of the principle of efficient
resource allocation. The essence of our recessionary problem
is not the fall in aggregate demand and the lack of business confidence
that accompanies it. First, it is the misallocation of resources
produced by excessive risk-taking and by excessive expansion of
interest-sensitive sectors. (These were generated by excessively low
interest rates over the past several years.) Second, it is the
uncertainty that is natural to the discovery of more appropriate
combinations of resources. Third, it is the endogenous uncertainty
created by the fits and starts of stimulus, bailout and unclear
monetary policies.
When government adds to investment as
a result of fiscal stimulus or directed monetary expansion (like buying
mortgage-backed securities, student loans, etc) it does not act as a
super-entrepreneur who is trying to determine the efficient and
sustainable direction of resources, including the allocation of capital
goods. It spends according to economically irrelevant criteria of job
creation, propping up over-expanded sectors, and preventing politically
painful adjustments.
Such spending is counterproductive in
the medium to long term. It is also unsustainable (once the stimulus
stops) since it is not consistent with the preferences of
consumers-savers-investors.