The Recurring Theme

Paul Krugman takes on John Cochrane taking on Paul Krugman in the always-sexy debate over Ricardian equivalence. Krugman notes that Cochrane doesn't even seem to know the definition of the proposition that he's defending as he defines Ricardian equivalence as

the theorem that stimulus does not work in a well-functioning economy

It's worth noting that the textbook definition of Ricardian equivalence (literally, from my Macroeconomics textbook) is

the proposition that changes in the government budget deficit caused entirely by changes in (lump-sum) tax collection have no effect on the economy.

But the biggest problem with Cochrane's analysis isn't his definition, it's his lack of understanding of Keynesian economics (the recurring theme). Krugman touches on this, but I think it's worth expanding upon. In Cochrane's analysis, the $100,000 that is lent to the family could have just as easily been lent to someone else. In normal times, this is true. But Keynes didn't write about normal times, Keynes wrote about times of economic crises and in times of economic crises that $100,000 isn't being lent to anyone. It's just sitting in a bank vault waiting until the economy improves.

Which is the point of the Keynesian stimulus: to take resources that would otherwise be idle and put them to work.