Wednesday, June 1, 2011

The Lucas Explanation of the Persistence of the Great Recession: The Barro Objection

Robert Lucas offers the following as one of his reasons for the persistence of the Great Recession:

Likelihood of much higher taxes, focused on the “rich”

Gavyn Davies and Paul Krugman argue that the Lucas attempt to explain the persistence of the Great Recession on purely classical principles lacks credibility with Davies noting:

As yet, there has been no increase in taxation, on the rich or anyone else. Nor have the Obama administration’s medical and financial sector reforms really taken effect. It would take a remarkably far sighted private sector to have already reacted adversely to this set of long term reforms, even if they might do so eventually.

One could argue, however, that the Barro reformulation of Ricardian Equivalence would argue that it is not current taxation that matters but the expectation of future taxes when government spending outstrips taxes. But if one is basing one’s argument thusly, I don’t see what has fundamentally changed in the past few years. We knew back in the 1980’s that Reagan’s fiscal policy has spending outstripping taxes until we got the return to fiscal sanity during the Clinton years. Of course, that changed when a new Administration took office but that new Administration took office in 2001 – not 2009. Professor Lucas does not explain to us why he believes that the Obama Administration signals an even further long-term commitment to more government spending. In fact, the medical reforms he mentions were designed to reduce long-term spending. So if the rich were forward looking ala Ricardian Equivalence, the likelihood of much higher taxes would have been realized well before the Great Recession.


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