Now the Cato piece seems to equate a fiscal stimulus strictly with the “broken window fallacy“. I do not completely agree with this. As Thoma points out government investment should be counter-cyclical, as by investing this way they get to build public goods (which will not be provided in sufficient quantities by the market) cheaply!
However, some fiscal stimulus does fit into the broken window frame – however it does so in two different ways. First we have the case where the windows are broken and then we are wondering what to do with policy. Then we have the case where the government could break windows. Lets discuss.
Mark Thoma discusses the first type of broken window (the already broken one) himself. In this case the broken window is a sunk cost – the fact it has been broken should not enter our decision, or prevent us from reinvesting. If the window maker was previously an unemployed resource, the shop owner is credit constrained, and as the new window adds value the government paying someone to fix the window makes sense.
As a result, the first point is that government using unemployed resources to create value that the market can’t (given that the price mechanism is out of wack or the credit market is in trouble or confidence/animal spirits are a mess).
The question then is – is there a case where the government should go round destroying windows to create work?
On the face of it no – doing this pushes people to work without adding any value. As work is costly to the employee, this can’t be welfare maximising.
However, if other resources are unemployed, you know the worker will stimulate demand for these resources, and the government cannot target them directly – there could be a case for going around and “breaking windows” to make the window maker busy.
The burden of proof that we are in such a dire situation depends on those making recommendations to break windows! As is obvious from above, the conditions required for smashing up the neighbourhood to be a welfare maximising government policy move are very restrictive – and if they do not hold, the government would be hurting society.
Sometimes I get the feeling that those pushing for a large stimulus (some of which, by adding no value and increasing the future tax burden is like smashing windows) are doing so only because they believe doing something, anything, is better than nothing. This appears to be, by itself, an unjustifiable cognitive bias.
Then again – people that are completely against any type of fiscal stimulus better be able to explain why they think the government can’t make any productive (insofar as the value made exceeds the cost) use of a growing pool of unemployed resources.
Note: This is not inconsistent with my belief that potential is being overestimated and that a large scale stimulus could be a bad turn – this critique was mainly against the idea of a “paradox of thrift” situation stemming from very low confidence and incredibly sticky prices. Personally, I think that any intervention needs to be focused on areas of market failure – broadbased policy just doesn’t seem appropriate in the face of all the recent structural shocks to the economy.