Suppose I throw a rock through a store owner’s window. You admonish me for this act of vandalism. But I reply that I have actually done a good deed. The store owner will now have to employ someone to haul the broken glass away and someone else, perhaps, to clean up afterward. Then, the order of a new glass pane will create work and wages for the glassmaker. Plus, someone will have to install it. In short, my act of vandalism created jobs and income for others.
The French economist, Frédéric Bastiat called this type of reasoning the “fallacy of the broken window.” All the resources employed to remove the broken glass and install a new pane, he said, could have been employed to produce something else. Now they will not be. So society is not better off from my act of vandalism. It is worse off — by one pane of glass.
But there is a new type of Keynesian (to be distinguished from Keynes himself) that rejects the economist’s answer. Wasteful spending can actually be good, they argue. If so, they will love what happens in health care.
By some estimates one of every three dollars spent on health care is unnecessary and therefore wasteful. ObamaCare’s “wellness exams” for Medicare enrollees — so touted during the last election — is an example. Millions of taxpayer dollars will be spent on this service, yet there is no known medical benefit. Similarly, ObamaCare is encouraging all manner of preventive care — by requiring no deductibles or copayments — which is not cost effective.
Yet all this wasteful spending could actually help the economic recovery according to the resurrection of an old Keynesian idea called the “liquidity trap.” Here is New York Times columnist, Paul Krugman:
As some of us keep trying to point out, the United States is in a liquidity trap: […] This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken window fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment.
John Cochrane provides further explanation:
“Fiscal stimulus” is the prediction that even completely wasted government spending is good for the economy. Paul Krugman recommended, with refreshing clarity, that the U.S. government fake an alien invasion so we could spend trillions of dollars building useless defenses. (I’m not exactly sure why he does not call for real defense spending. After all, if building aircraft carriers saved the economy in 1941, and defenses against imaginary aliens would save the economy in 2013, it’s not clear why real aircraft carriers have the opposite effect. But I’m still working on the nuances of new-Keynesianism, so I’ll let him explain the difference. I’m not a big fan of huge defense spending anyway.)
According to new Keynesianism, we are in a liquidity trap when nominal interest rates hit zero. At that point, according to the theory, hurricanes and earthquakes are good for the economy. So are sudden increases in the price of oil.
A new paper by Johnnes Wieland, tests some of these predictions. As summarized by Cochrane:
Johannes looks at the earthquake in Japan, and oil price shocks. Surprise, surprise, earthquakes are bad for output…[and] he finds that oil shocks have worse negative effects on employment at the zero bound than in normal times!
Cochrane’s post is good throughout. Also see my piece in Forbes, “Can We Spend Our Way From Recession to Prosperity?”