January 30th, 2009

Let’s see if I get this right.

The Keynesian, “saltwater” majority of American economists – for example, Krugman, deLong, Stiglitz, and Feldstein – think a big stimulus is essential to raise output and employment. (Feldstein is politically conservative and doesn’t like the balance of the House bill, but has no quarrel with the principle.)

A minority of macroeconomists (“freshwater”, because based in Chicago) – Barro, Cochrane, Fama – think the stimulus will be ineffective and leave output and employment where they are. The reasoning escapes me, but has something to do with the idea that the same Americans who fell for the housing bubble, Bernie Madoff, and George W. Bush are Vulcans who instantaneously adjust their life-cycle spending plans to the rational expectation of higher future tax burdens to service the national debt.

Pascal’s Bet is therefore: try the stimulus.

To be exact, Pascal would recommend the stimulus as long as the expected benefit of the Keynesians being right (chance of being right x benefits of being right) is greater than any expected disutility from the assured shift from private to public consumption. Suppose Krugman has (for the sake of argument) only a 5% chance of being right, but if he is, then the stimulus will create 5 million job-years over the baseline of doing nothing. So Pascal’s agnostic policymaker has to weigh 250,000 job-years against the evil of replacing private consumption of $1200 waste-paper baskets by shamefully repainted schools.

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