I love reading the K-man's blog. (A morning chuckle is always a good way to start the day.) Great title here: I'm Going to Haul Out the Next Guy Who Calls me "Crude" and Punch Him in the Kisser. In it you will find Krugman lamenting:
All through this debate, a recurring theme among anti-Keynesians has been that Keynesians like me or Brad are ignorant primitives who don’t know anything about modern macro. It’s really hard to see where that comes from, since I’ve done plenty of intertemporal optimizing in my time.
(Can't help but notice that he does not include his wing-man in that last sentence.)
This quote is rather revealing. What it reveals is the K-man has little idea what constitutes "modern" macro. There is, of course, no sin in this. Not everyone can devote most of everyday trying to advance the frontier of economic theory. Most people have real jobs. And, of course, just because one is not up-to-date on the entire body of macroeconomic research produced over the last 10-20 years (or so) does not mean that one might not contribute usefully to contemporary debate on theory and policy.
The K-man's sin (venial, rather than mortal) is an ego that does not permit him to admit that he's a little out of date on the theory front. What he labels "modern" macro is theory as it largely existed in 1980. A representative agent, a cash-in-advance constraint, no financial frictions (apart from CIA), and a sticky nominal price. Oh yes, and let's not forget intertemporal optimizing (as if this alone is what distinguishes the modern from the primitive).
We now have models that explicitly incorporate heterogeneity, financial frictions (the product of underlying commitment and private information problems), and search and matching frictions. Moreover, we have models of liquidity shortages-models in which government money and/or debt plays a socially useful role. More importantly, greater attention is being paid to matching a model's microstructure to microdata (ultimately, the only way to discriminate against competing theories with similar macroeconomic properties).
One lesson that emerges from this literature is how little we in fact know. The message is one of caution when faced with the real-world problem of formulating policy. Admittedly, this is not an attractive product for those who demand religion (a great many people, judging by the evidence). But then, we are supposed to be disinterested scientists--not the self-appointed "conscience" of any liberal or conservative.
Alright, enough of that. Now here is another good laugh -- the K-man accusing Bob Lucas of not understanding the implications of his own theory; see One More Time.
Here’s what we agree on: if consumers have perfect foresight, live forever, have perfect access to capital markets, etc., then they will take into account the expected future burden of taxes to pay for government spending. If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.
But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.
Is that explanation clear enough to get through? Is there anybody out there?
Hey Paulo, here is a model for you. Let preferences be U(c+g)-v(n), so that the private sector views government spending as a perfect substitute for private spending. Assume lump-sum taxation and a fixed real wage w, so that the private sector budget constraint is c = wn - g. The effect of an increase in g on GDP here is zero. Embed this into a fully dynamic model and the result is the same (whether or not the change in g is temporary or not).
Conclusion: no, this is not enough of an explanation for me. You have to be more specific. The answer depends on an annoying set of details. Is this clear enough to get through? Probably not.