But big government can be about fiscal policy.  Let’s see why:

In 2001 President Bush said we needed to cut taxes to give the economy a boost.  Paul Krugman opposed the tax cut.  At the time I supported it for supply-side reasons, although in retrospect it was probably a mistake.  What can we infer from all this?

1.  Fiscal stimulus need not involve any increase in the size of government.  Indeed it can lead to smaller government.  In the long run if the government collects less revenue it will have to spend less (yes, “starve the beast” is true as a long run proposition.)  From my perspective, what I now think made Bush’s tax cut a mistake was that it was a missed opportunity to do tax reform, and also he boosted spending sharply, running up substantial deficits during the boom years (when the government should run surpluses.)

2.  But what about fiscal stimulus done in the form of more government spending, surely that means big government?  Not at all.  Suppose the government spends 4% more as a share of GDP during recessions than booms.  Thus instead of spending 22% of GDP all the time, it spends 20% in booms and 24% in recessions, where the average is still 22%.  A conservative Keynesian could easily argue for both small government, and also recommend that government projects like dams and highways should be built in recession periods, not boom periods.  You’d move spending around, without changing the average.

3.  Some might argue that there is an asymmetry, as monetary policy is enough when you need to restrain AD, but fiscal policy is needed when you need to boost AD.  Doesn’t that bias you toward big government?  No, for the reason I just mentioned.  If government spending is countercyclical then it will be above average during recessions and below average during booms.  Why?  Because that’s what the word ‘average’ implies.  It’s logically impossible to have a fiscal regime where spending is above average during recessions and average during booms.  In any case, you can always cut taxes during recessions.

4.  Despite all of the above, it’s certain possible that fiscal stimulus can be associated with big government.  But that would not be fiscal policy causing big government, it would be the desire for big government leading to a particular type of fiscal policy.  For instance, Larry Summers recently argued that the problem today is not the business cycle, but rather secular stagnation.  He suggests that even if monetary policy could fix this problem, it would lead to such low real interest rates that the Fed would end up blowing up serial bubbles.  And the resulting investment would be wasteful.  So he wants more government investment, which he believes will be more efficient.  He doesn’t want tax cuts, which would lead to (wasteful) in his view) private spending.

Summers can certainly make this argument, and perhaps it’s even true (although I doubt it.)  But this is very far away from the textbook Keynesian fiscal stimulus with the various multipliers, nudging the economy toward the natural rate of output when actual output is too high or too low.  That traditional sort of fiscal policy has no relationship to big government.

When people really want to do something, they can always find a justification.  You’ve probably seen those famous phrases like “never let a crisis go to waste” and “now more than ever we need to invest more in . . .”  For me it’s “now more than ever we need to legalize drugs and establish a NGDPLT regime and a progressive consumption tax.”  And it doesn’t matter what happened, I’ll find some way to connect it up to my pet causes.  For instance, the cover of this week’s Economist magazine complains that there are 2.3 million Americans in jail or prison.  That makes me bring up drug legalization, even though “only” 400,000 are in there for drugs.  Or if structural unemployment is discussed I’ll bring up occupational licensure, minimum wages, vouchers for education, or any other pet cause that is even tangentially related to structural unemployment.

To summarize, you can obviously find ways to do fiscal stimulus in a way that leads to bigger government.  But I guarantee that if there was a Republican in the White House right now, and they were doing tax cuts to boost the economy, nobody would be equating fiscal policy and big government.

Some people wrongly think I believe fiscal policy is ineffective for ideological reasons.  Sorry, but that doesn’t even pass the laugh test.  Consider:

1. I recently provided some of Mark Sadowski’s graphs that show fiscal stimulus can work when countries lack their own central bank, as in the eurozone.

2.  I’ve argued that fiscal stimulus can work if a central bank is not targeting inflation or NGDP.

3.  I’ve argued that even under inflation targeting, VAT and employer-side payroll tax cuts work, by reducing prices and forcing the central bank to stimulate to hit their inflation target.

4.  I’ve argued that massive government spending programs can work even under inflation targeting, by lowering private consumption and making people work harder (as in the early 1940s).

5.  I’ve argued that cuts in MTRs can work for supply-side reasons.

6.  I’ve argued that fiscal stimulus can work even under inflation targeting if the central bank in incompetent in a certain way (say frightened of a large balance sheet and also reluctant to do forward guidance.)

Six exceptions—does that sound like an ideologue that thinks fiscal stimulus can never work?  I just think the world would be better off if we thought of monetary policy as the normal way to control AD, and I’m pushing to achieve that sort of world.  Ironically we pretty much had that sort of world from 1984 to 2007.  And double ironically Paul Krugman is also pushing to create that sort of world when he advocates a 4% inflation target.

People who think there’s some vast ideological different between me and Krugman on fiscal policy simply don’t know what they are talking about.  We simply differ on whether the Fed could and/or would offset fiscal stimulus right now.  That’s a small technical issue.

PS.  I have a post responding to Krugman over at Econlog.

Update:  Nothing in this post should imply I disagree with Russ Roberts’ claim that ideological bias can affect how some people feel about issues like fiscal stimulus.  I think he’s right.  I am just trying to point out that there are many aspects of the fiscal policy question that are highly technical, and that go far beyond ideology. There is no necessary logical connection, but many people certainly perceive a connection, as Russ indicates.   For instance, I favor carbon taxes, but some other libertarians disagree with me on this issue. Ideology is not the only factor that goes into policy views.

I know, you are gagging on the title of the post.  I hate commissions too.  But there’s already a lot of discussion about a commission to re-evaluate the Fed’s goals and tactics.  And the current proposals are both too much and too little.  Too much because there are some tactical questions that the Fed itself can resolve better than any commission.  But there are also some questions that the Fed currently cannot answer, and where a commission could be very useful to the Fed. I believe the biggest issue now is what to do about stabilization policy in a world that frequently hits the zero bound during recessions. That’s not the world of the past 50 years, but I believe it’s quite likely to be the world of the next 50 years.

Although I don’t recall doing so, it’s quite possible that at some point in the past 6 years I insinuated that Paul Krugman favors fiscal policy because he likes big government.  Perhaps there’s even a grain of truth in that statement.  But there’s also one really big problem with that claim.  Consider:

1.  Paul Krugman strongly supports raising the inflation target to 4%

2.  There is only one justification for raising the inflation target to 4%; it makes it possible for the Fed to handle 100% of the responsibility for stabilization policy.

And it’s not just Krugman; lots of other liberal economists have also favored raising the inflation target to 4%.  Why do I bring this up now?  Because I can just hear commenters saying how naive I am; “liberals will never agree to a plan that eliminates the need for fiscal policy.”  Then why do so many favor 4% inflation target?  And why does Paul Krugman say fiscal policy is pointless when nominal interest rates are positive?

Now I don’t happen to favor a 4% inflation target, and I doubt that this would be the outcome of the commission.  But I do believe the commission’s output would be very useful, even if I don’t “get my way” on fiscal policy.

Both liberal and conservative economists agree on these basic facts:

1.  When trend NGDP growth rates are lower, the economy will hit the zero bound more often.  One option is to raise the inflation target.  The Paul Krugman solution.

2.  Another option is to do something like NGDPLT.  My preferred solution.

3.  Another option is to keep the Fed’s current policy framework, 2% PCE inflation, growth rate targeting, and unemployment near the natural rate.

Economists also agree that option three may require some hard choices.  These include:

a.  Pursuing QE to the limit in a liquidity trap.  Allowing the Fed to buy whatever it takes, even if they have to move beyond Treasury debt.  Telling the Fed not to worry about capital risk, the Treasury has them covered.  My second preference.

b.  Constraining the Fed to buy securities of no more than a specific amount, say 50% of GDP, to avoid excessive risk.  Other options are also possible here, such as more aggressive cuts in IOR, perhaps to negative levels.  Then just live with a slow recovery.  Similar to current policy.

c.  Same as option b, but have an implicit agreement that once the Fed hits its QE limit, fiscal stimulus will take over.  The Larry Summers solution, Krugman’s second preference.

Policy is currently hindered by the fact that the Fed doesn’t know exactly how aggressive it should be, partly because Congress is not even aware of these “hard choices.”  So we don’t have any sort of clear policy regime, rather we drift in a sort of limbo, where the Fed doesn’t really know how much others want it to do.  Or whether it would be scolded for large capital losses on its balance sheet if rates rose sharply.  Or whether Congress would support the Fed if it shifted its target higher in order to keep interest rates above zero.  The Fed knows that politicians are concerned that rates are low for savers, but doesn’t know if that concern implies they’d favor higher interest rates that are caused by higher inflation.

I don’t think this commission is politically feasible until January 2017, but at that time it just might work. I’m assuming the Dems will again win the presidency and the GOP will retain the House.  Gridlock will make fiscal policy impossible unless an agreement can be reached.  If you put sensible conservatives like Taylor, Mankiw and Hubbard on the committee, with sensible Keynesians, they are all going to understand the trade-offs I discussed above.  The GOP economists can explain to GOP politicians “look, it’s inflation or socialism, take your choice.  If we don’t have a bit more inflation then interest rates will fall to zero, and the Fed will keep expanding its balance sheet, bigger and bigger.”  Or we’d get fiscal stimulus, another option the GOP doesn’t like.  The liberal members of the commission can explain to Democrats “look, it’s better if the Fed handles stabilization policy, and fiscal resources are utilized for pressing social needs, not economic stabilization. And in any case, the GOP will never let us do the amount of fiscal stimulus we need, or they’ll insist on tax cuts that ‘starve the beast’.”

Krugman and I may not get our way.  Maybe the commission will compromise on a monetary/fiscal mix, where the Fed takes the lead, but the fiscal authorities act if the Fed ‘s balance sheet hits X% of GDP.  If I lose the battle I’ll stop objecting to fiscal stimulus.  I’ll stop claiming the multiplier is zero.  I’ll stop claiming there is monetary offset.  If that’s clearly the regime, and it’s all spelled out, then so be it. At that point I’ll argue that payroll tax changes are the best form of stimulus.

But right now there is great uncertainty about who is in charge, and what is expected of the Fed.  This stuff really needs to be clarified for the zero bound environment.  Or at least discussed.  I’ll bet the Fed would be thrilled if Congress told them exactly what their responsibilities were in terms of capital losses, instead of leaving it quite vague.

What would Congress decide in the end?  One possibility is keeping the 2% inflation target, and a continual role for fiscal policy.  That’s very possible.  Or Congress might ask the Fed to study options for preventing the zero rate bound from hamstringing monetary policy, and they might buy into a technical fix like level targeting and/or NGDP targeting. I don’t know.  But politics goes in cycles.  After so many years of gridlock, 2017 might be a good time for a compromise.  To make this happen we all have to starting talking up the idea right now—assuming anyone agrees with me.

I don’t believe so, although the term ‘socialism’ (like capitalism) is so vague that I find it almost meaningless.

But public opinion polls suggest that Democrats are becoming more socialist.

And, by the way, Sanders’s self-identification as a “socialist” no longer marks him as extreme, at least to Democrats. Forty-three percent of Democrats say they approve of socialism, the same percentage who like capitalism. The public, to say the least, does not agree: By a margin of two to one, they preferred capitalism to socialism in a May YouGov poll.

So why don’t I think the Dems are becoming a bunch of socialists?  Because I don’t believe public opinion polls measure public opinion.  Indeed I don’t think public opinion exists in the sense that most people think it exists.  I doubt that as much as 43% of the American public even knows what terms like “socialism”, “inflation”, “NGDP growth”, “unemployment”, “quantitative easing”, and “the Fed” mean.  If the GOP insists that Obamacare is socialism, is it any surprise that Dems increasingly call themselves socialist?

Now of course many people disagree with me.  But here’s something for progressives to think about.  Suppose you hear Rush Limbaugh complaining that the Democrats are increasingly dominated by socialists.  Your first reaction might be to accuse him of McCarthyism, or red-baiting.  But would that be fair, at least is it fair if you actually believe in public opinion polls?  Would it be fair to argue that Limbaugh is a red-baiter and at the same time argue that, “polls show the public supports a higher minimum wage.”  I guarantee I could design a poll question that shows the public prefers a higher EITC to a higher minimum wage rate.  It’s all in the framing effects.

You need to take the sweet with the sour.  Either polls are believable or they aren’t. If you insist on giving credence to polls of public opinion, then you need to start calling the Dems a bunch of socialists.

PS.  Just to be clear, I believe polls on voting intentions are much more accurate, as the question of which way you will vote in an election is relatively well defined.

I thought the following observation was sort of related to my recent posts on CommodityAmerica and InfoAmerica. (This from the FT):

In the past, Chicago acted as the locomotive of its hinterlands “” in Mr Longworth’s words “” buying the Midwest’s farm produce and other raw commodities and then converting them into products. The city was linked umbilically to its surrounding geography and vice versa. Today, it mostly hovers above its hinterlands. But in some ways it is also parasitic on them. Much like the giant sucking sound of London hoovering up the UK’s talent, Chicago takes the best and the brightest from the small towns of America and plugs them into the global economy. Chicago’s success is no longer symbiotic with its rural neighbours. In some ways it comes at their expense.

Hovers and hoovers.  I’m seeing a sci-fi movie with vast circular cities that float 1000 feet up in the air, populated by the elite and with long tubes sucking the resources from below, produced by the lower classes.  Or did H.G. Wells already write that story?

Off topic:  I’m looking for links to Fed officials saying that they were easing policy in late 2012 because of worries about the fiscal cliff.  I recall reading that sort of thing, but can’t find a link.

I recently ran across a very revealing article from April 24, 2012:

NEW YORK, April 24 (Reuters) – Federal Reserve policymakers are sounding the alarm over a “fiscal cliff” at the end of this year, when scheduled U.S. tax hikes and spending cuts could pose a big threat to the fragile economic recovery.

Along with its official mandate of watching unemployment and inflation, the U.S. central bank is keeping a close eye on a potentially debilitating political fight over how to fix the budget deficit.

If lawmakers in Washington do not get rid of the tax hikes and spending cuts due to take effect in early 2013, the country could easily careen into another recession. Any moves by Congress, however, aren’t expected until after the Nov. 6 presidential election.

The Fed is worried that individuals and companies could hunker down and curb spending, making markets antsy as the country awaits the outcome of an election that could pave the way for new tax and spending policies.

Though few expect Washington to do nothing while fiscal policies push the economy into another downturn, partisan politics could undermine the Fed’s unprecedented actions to revive the economy.

“I have been disappointed that the president and Congress are not taking action until after the election,” St. Louis Fed President James Bullard told reporters in Utah last week.

“I’m also worried that markets will react badly to the fiscal cliff at the end of this year. Markets might start to speculate about what might or might not happen … after the election,” he said.

Asked what the Fed can do, however, Bullard seemed to dismiss the possibility of resorting to new bond buying to counter the effects of political gridlock over the budget deficit and economic policy.

“It’s up to the Congress,” he said.

By the end of 2012, it was pretty clear that fiscal policy would sharply tighten in 2013. The Fed responded with QE3 and some additional forward guidance.  Bullard was so confident that these steps would offset the fiscal guidance that he forecast an acceleration of RGDP growth in 2013, to around 3% to 3.5%.  Actual RGDP growth (Q4 to Q4) turned out to be about 3.1%. So we have a nice example of monetary offset, with a happy ending.

But notice something strange at the end of the long quote; Bullard seems to be warning Congress not to expect the Fed to bail them out if the send the economy into a recession with reckless fiscal austerity.

When I was young I got a nice job offer from the New York Fed, at a salary 75% higher than my Bentley salary.  My department chair took the offer to the Dean, who responded, “Tell him I hope he likes New York.”  In the end I stayed at Bentley. (Feel free to insert dog retreating, tail between legs metaphor here.)  I learned a lesson, and indeed not once have I ever told my daughter “If I catch you smoking pot you can forget about me paying for your college education.”  My threats aren’t credible, due to the time inconsistency problem.

Matt Yglesias once wrote a post pointing out that the Fed denies that it engages in monetary offset:

A curious issue that in my opinion he and other proponents of the full monetary offset thesis haven’t fully grappled with is that Federal Reserve officials keep saying it’s not true. I heard John Williams of the San Francisco Fed say it’s not true at the Brookings event this morning. I heard Ben Bernanke say it’s not true at the American Economics Association meeting in Philadelphia earlier this month. I separately heard William Dudley of the New York Fed say it’s not true in Philadelphia. Janet Yellen has repeatedly said it’s not true. And since full monetary offset isn’t just an abstract economic thesis, it’s specifically a thesis about the actual behavior of the Federal Reserve, the fact that nobody in a position of authority at the Fed believes in it seems like a big problem worthy of a more substantive response.

You find lots of counterarguments in this post, written in response to Matt’s post. That post is my best counterargument. But I’d add this post as a footnote, as it shows how statements by Fed officials regarding their intentions may not accurately describe the Fed’s actual future policy response, but rather may reflect a desire to get Congress to do more of the heavy lifting.

That’s not to say that Matt’s completely wrong, indeed his views are actually about halfway between my view and the views of more traditional Keynesians.  Here’s the very next paragraph of the Yglesias post:

What I think clearly is true is that partial monetary offset is very real. The people who thought the tight fiscal policy of 2013 would crush the economy were wrong, and they were proven wrong precisely because of monetary offset.

That’s a reasonable argument, and if my version of monetary offset were proved wrong at some later date, Yglesias’s view would be the alternative that I’d find most plausible.  But thus far the data seem to support something close to full offset—both the 2013 case of austerity in the US, and the cross sectional study by Mark Sadowski.  Of course “further research is needed.”

PS.  Here’s a perceptive observation from the April 2012 article:

“We’re naive if we think that [fiscal cliff] doesn’t play into the Fed’s thinking about monetary policy,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.

“But the way that the Fed would want to present it is a minor consideration at best, because they don’t want to be supplementing fiscal policy,” Porcelli said.

Porcelli clearly gets it, although the term ‘supplementing’ doesn’t really capture the idea he’s trying to express.  He should have said, “offsetting.”

PPS.  I have a new post on the euro over at Econlog.