Recalculation and State and Local Relief By Arnold Kling

Tyler Cowen finds and responds to some criticisms of the Recalculation story.

Avent and Yglesias suggest that Kling is making up his own macro but the innovation is simply to call the adjustment process “recalculation,” to give it a more Austrian gloss.

He mentions plenty of predecessors to the sectoral shift story. I would add James Tobin’s AEA Presidential Address on inflation and unemployment. For that matter, the old Lucas-Phelps “island” model is an adjustment story. I am pushing the Recalculation story hard because I think that it is a mistake to try to do macro with a one-sector model where all off us work at GDP factories. I want the profession to emerge from what Krugman calls the Dark Age of one-sector, representative-agent, rational-expectations models.

The point of the Recalculation story is not to argue against stimulus. In fact, I am in favor of stimulus. The Recalculation story may help support the kind of stimulus that I favor, which is an immediate cut in the employer contribution to the payroll tax. I do not see how any story can support the kind of stimulus that was passed, where much of the spending will not take place until 2011 and after.

The Recalculation story does not tell you whether relief for state and local governments is a good stimulus idea. But it does lead you to ask whether it is right to think of state and local governments as 50 Herbert Hoovers or 50 Wesley Mouches.

For those of you who do not know, Wesley Mouch is a fictional character in Atlas Shrugged who increases government control over the economy. Herbert Hoover is also a fictional character, whose policies are laissez faire and balanced budgets. (There was a real President Herbert Hoover, but he was interventionist and ran deficits.)

State and local governments obtained a lot of revenue during the boom–higher home prices do tend to raise property tax revenues. So payrolls and pension plans expanded, average government salaries rose relative to average private sector salaries, state universities competed for top-drawer professors, and school systems held onto incompetent teachers. If you think that ought to continue, then you should favor aid to state and local governments to get them through this period of low tax revenues. If you think that has to change at some point, then stimulus funds will better help recalculation if they are distributed to other sectors.