Why not the best?

Nobody knows exactly what the Fed is up to, and that includes the Fed itself.  Of course inanimate institutions don’t know anything.  What I really mean is that Ben Bernanke doesn’t know precisely what the Fed will do in the future.  But there’s one thing that no one can deny—the Fed has set an explicit 2% inflation goal, and in recent years has frequently moved aggressively when inflation expectations seemed to be diverging sharply from that goal.  Indeed it seems to me that the 2% inflation target is gradually becoming more credible, and hence I would not expect the 5 year TIPS spreads to diverge too far from 2%.

What does all this mean?  Ryan Avent has a good post that discusses one implication:

The bottom line is quite simple, says CBO. If all of the fiscal blow is deflected, the economy should grow at an annual pace of 5.3% in the first half of the 2013 fiscal year. If Congress is unable to find a way to defer some of the impact, the economy will instead shrink by 1.3%.

.   .   .

Except, of course, that the economy will almost certainly not grow at a 5.3% rate no matter what Congress does. Arguments to the contrary are subject to what econ bloggers have come to call the Sumner Critique, after economist and blogger Scott Sumner. It is reasonable to assume, by this critique, that the Federal Reserve has a general path for unemployment and inflation in mind and it will react to correct any meaningful deviation from that path. A 5.3% growth rate is well outside the range of current Fed projections. Growth that rapid would almost certainly bring down unemployment quite quickly, triggering Fed nervousness over future inflation and prompting steps to tighten monetary policy. Growth might run slightly above Fed forecasts for a bit, but the overall fiscal effect will be dampened considerably.

I think this is right.  But Ryan is less confident that the Fed would cushion the blow if we had a fiscal tightening in early 2013:

There can be quite a large lag between the onset of falling real output and a drop in inflation, especially (thanks to downward nominal rigidities) at low levels of inflation. If the Fed becomes less responsive than normal, the fiscal multiplier rises. Imagine a world in which the Fed waits to see how Congress behaves and then waits until the economic impact of Congress’ behaviour translates into falling inflation before stepping into action. Inflation may not depart from trend by all that much, but real output would likely dip substantially as a result of the fiscal cliff.

Ryan points out that it doesn’t have to be that way:

The Fed could therefore proclaim to the world that will maintain aggregate demand growth (in the form of, say, nominal income growth) at all costs, and that it would by no means allow the fiscal cliff to knock the economy off its preferred path. It could explain in great detail what specific steps it would be willing to take to achieve this goal, so as to boost its credibility. And if demand expectations as reflected in equity or bond prices showed signs of weakening ahead of the cliff, the Fed could preemptively swing into the action to establish the credibility of its purpose.

I think these are plausible arguments.  But then he makes a very peculiar claim:

The Fed will almost certainly not do this.

Why? Because the Fed is thinking about moral hazard, specifically, that if it promises to protect the economy against reckless fiscal policy Congress will have no incentive to avoid reckless fiscal policy. The Fed would very much prefer that Congress behave—lay out a plan for medium-term fiscal consolidation but keep short-term cuts small and manageable. It is therefore in the Fed’s interest to imply that the fiscal cliff is a real economic danger, even if it could potentially prevent it from being one.

This is a very peculiar definition of “reckless” fiscal policy.  The standard theory says the Fed should take a tough line on fiscal irresponsibility, and not help Congress out when they run up massive deficits.  They should tell Congress they have no intention of monetizing the debt.  The standard model says the most effective policy is to run small deficits, or even surpluses, and have the Fed do the demand stimulus required to keep aggregate demand on track.  Ryan’s making precisely the opposite claim.  He’s saying that if Congress does the right thing, and gets its fiscal house in order, then it’s in the Fed’s interest to punish Congress with tight money, so they don’t ever again do something so “reckless.”

Now I’m pretty sure that Ryan would claim I’ve mischaracterized his views.  It seems his point isn’t that smaller deficits are a bad thing, but rather that Congress shouldn’t move so precipitously.  And why not?  Presumably because the Fed cannot or will not cushion the blow.  I think they can, and my hunch is that Ryan agrees.  So then it becomes “will not.”  But here’s where things get really strange.  In that case the Fed would be punishing Congress for not realizing just how irresponsible Fed policy really is.  “If you do the policy that would be optimal conditional on us doing the right thing, we’ll punish you for having the audacity to assume we’ll do the right thing, by doing the wrong thing.”  Or something like that.  This is not to say that Ryan is wrong; just that it’s a strange argument, the more you think about it.

UpdateRyan Avent has a new post clarifying his argument.

Game theory isn’t my forte, so let’s talk about the supply-side, where things are a bit easier to pin down.  In my view the fiscal cliff would slightly reduce aggregate supply.  It might also reduce AD, but I think the Fed would mostly offset that effect.  But aggregate supply is a different story.  Even though the reduction in AS is likely to be small, under inflation targeting it would lead the Fed to reduce AD as well.  So I think growth would slow modestly if there is a fiscal cliff.  Say 1% to 2% RGDP growth in 2013, instead of 2% to 3% with no fiscal cliff.  Inflation would be roughly 2% either way.  That’s just a guess on my part, but then who’s got a model that’s included all the game theory I’ve been discussing?  Have any of our elite macroeconomists figured out how to model the monetary/fiscal interaction?   .    .   .  Bueller?

PS.  Some might argue that the British case undercuts my argument.  But they have a less robust supply-side than the US, with inflation running consistently above target, even in the recession.  It seems unlikely that the US could have both a demand-side recession and inflation running persistently above 2%.  Note that I said “demand side recession,” I’m not disputing that a big oil shock could do the trick.

PPS.  In a previous post I tried to cause trouble between Krugman and Yglesias.  In a new post Matt gracefully avoids being snared in my trap:

When I wrote about this previously, I think I was too clever by half and just acted as if the Fed would in fact offset this all. Very possibly they won’t.

My point is that if they don’t offset it, they’ve failed to do their jobs.

Even though he’s more pro-fiscal stimulus than I am, I love the way Ygleisas writes about this problem.  So many people make excuses for the Fed (on both the left and the right.)  They say it’s not easy for them to do their jobs.  There is public criticism.  True, but then again it’s not really all that hard, when you consider other jobs like fighting in Afghanistan.  I expect our monetary policymakers to step up to the plate and do something dramatic for the millions of unemployed.  Deep down in their guts they know we need more demand.  We should insist on nothing less than the best from them.

PPPS.  During football games when the other team has the ball 4th and 1 on our 40, I’ve always been quietly pleased when the other coach sent in the punter.  This is odd, as the opposing coach should make a decision that makes me upset.  Later I learned from the football equivalent of Bill James that most coaches blow this call, and you actually should go for it.  (Or they used to blow it, perhaps it’s changing now.)  I think the same is true of Bernanke.  I’m pretty sure that over the past three years he’s quietly rooted for the NGDP numbers to come in above the Fed’s forecast.  And that’s just not right.

HT:  Bruce Bartlett


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48 Responses to “Why not the best?”

  1. Gravatar of dwb dwb
    23. May 2012 at 19:22

    good post.


    Some might argue that the British case undercuts my argument. But they have a less robust supply-side than the US, with inflation running consistently above target, even in the recession. It seems unlikely that the US could have both a demand-side recession and inflation running persistently above 2%. Note that I said “demand side recession,” I’m not disputing that a big oil shock could do the trick.

    1. the GDP deflator has been running under 2% for the last 2 quarters but TIPS is based on the CPI, while the fed targets PCE. i’m so confused! seriously: as long as import prices (oil) are high, deflation will become more deeply rooted. I think that the “Wal Mart” tax of an appreciating CNY will weigh against PCE (make it higher) unless the Fed sucks it up and admits they don’t control Chinese monetary policy.

    whats the Bernanke Gertler theory on how high oil prices cause recession??! Fed response to import prices! kinda ironically sad.

    2. i am starting to rethink this whole “high inflation” supply-side business re: the BoE. I am starting to wonder if its really supply side issues, or a credibility expectations issue: i see an awful lot about how the BoE is not terribly serious about the 2% target. I dug this up from the WSJ (4/12/2012):

    http://online.wsj.com/article/BT-CO-20120426-711227.html


    The median for inflation expectations in the year ahead increased to 3.0%, the highest reading since December and up from 2.7% in March, Citi said. Expectations for inflation over the next five to 10 years also rose to 3.7% from 3.4% in March, the highest level since September last year.

    just a thought.

    3. is Bartlett still “thinking” about ngdp targeting. we know he’s “sympathetic.” how can we close that deal?

  2. Gravatar of Neal Neal
    23. May 2012 at 19:28

    Philosophical point: “Of course inanimate institutions don’t know anything.” Don’t make the error of the Chinese Room; the institution itself certainly knows quite a lot. But you’re right, it probably isn’t sure what it’s going to do next.

  3. Gravatar of Morgan Warstler Morgan Warstler
    23. May 2012 at 20:03

    Ryan says this CORRECTLY:

    “Why? Because the Fed is thinking about moral hazard, specifically, that if it promises to protect the economy against reckless fiscal policy Congress will have no incentive to avoid reckless fiscal policy. The Fed would very much prefer that Congress behave—lay out a plan for medium-term fiscal consolidation but keep short-term cuts small and manageable. It is therefore in the Fed’s interest to imply that the fiscal cliff is a real economic danger, even if it could potentially prevent it from being one.”

    What Ryan means is that the Fed sees RAISING TAXES as reckless fiscal policy.

    And it is.

    Spending cuts, firing public employees, thats Fiscal policy to be rewarded.

    What am I missing Scott?

  4. Gravatar of Major_Freedom Major_Freedom
    23. May 2012 at 20:47

    I expect our monetary policymakers to step up to the plate and do something dramatic for the millions of unemployed.

    Hayek said that would be very harmful.

    If you want to help the unemployed, let them compete on price by abolishing the minimum wage. A huge chunk of unemployment exists at and below that price range. Get rid of 99 week unemployment benefits which is just financing the “production” of unemployment.

    Asking the Fed to print more money and increase AD via the bank’s credit expansion system will just foist workers onto the wrong projects AGAIN.

  5. Gravatar of Bonnie Bonnie
    23. May 2012 at 21:10

    “In that case the Fed would be punishing Congress for not realizing just how irresponsible Fed policy really is.”

    The entire debate over spending and debt is the wrong one to be having when there is really no way out of this mess except to get rid of Bernanke’s ugly inflation-targeting baby. The things we would have to do on the fiscal/supply side to make it work well enough are not politically doable, and shoving this disinflationary/deflationary policy that doesn’t fit our needs on the congress and ultimately the people is the tail wagging the dog. It is the responsibility of the Fed to give warnings about the implications of what is being contemplated by the congress and allowing congress to be responsible and held accountable for the choices it makes. Forcing it into a corner is not its job, but rather following the law and being focused on production is.

    The only reason Obama and Democrats spent as much as they did is because of this monster recession that happened because the Fed didn’t handle the crisis as it could have, and they were egged on by Bernanke himself. He told them to do bailouts and to spend and then left them holding the bag. I could understand lack of complicity on the part of the Fed if Bernanke had been saying not to spend, explaining the impact to public policy by his policy intentions. That would have made far more sense, but it just did not happen that way.

    The debate we should be having is what we are going to do about the over reach and power grab by the Fed and possibly Bernanke himself.

  6. Gravatar of Liberal Roman Liberal Roman
    23. May 2012 at 21:54

    And now there is this from Kocherlakota http://www.minneapolisfed.org/news_events/pres/speech_display.cfm?id=4870&ref=none

    He is ready for QE3 if the “fiscal cliff” happens.

  7. Gravatar of Saturos Saturos
    23. May 2012 at 23:12

    “There can be quite a large lag between the onset of falling real output and a drop in inflation, especially (thanks to downward nominal rigidities) at low levels of inflation.”

    It sounds like he is talking about the drop associated with a rightward shift of the AS curve, as opposed to the drop associated with a leftward shift of AD. But then he says:

    “the Fed … waits until the economic impact of Congress’ behaviour translates into falling inflation before stepping into action.”

    But once AS has shifted, there is no need to use monetary policy to boost AD.

  8. Gravatar of Max Max
    24. May 2012 at 00:18

    “They should tell Congress they have no intention of monetizing the debt.”

    I doubt the Fed could persuade the markets that government bonds are riskier than money, even if they wanted to.

    It’s the same in other countries. So people scream about Japan’s debt/GDP ratio, but there’s no risk premium in the bonds.

  9. Gravatar of Max Max
    24. May 2012 at 00:38

    “Asking the Fed to print more money and increase AD via the bank’s credit expansion system will just foist workers onto the wrong projects AGAIN.”

    The “right projects” being panhandling, selling apples, etc? You know, the things people did to survive depressions in the good old days.

  10. Gravatar of ssumner ssumner
    24. May 2012 at 04:37

    dwb, 1. Good point about import prices.

    2. Maybe, but isn’t the real problem that inflation has not fallen? Perhaps I should look a the GDP deflator in Britain, that might tell a different story.

    3. Don’t know about Bartlett.

    Neal, I suppose you could look a it that way. But let’s put it this way—no one knows what the institution knows, whereas people can infer what markets know.

    Morgan, No, that’s not what Ryan meant.

    Bonnie, Good point about IT.

    Liberal Roman, Of all the hawks, Kocherlakota seems the most open-minded.

    Saturos, I thought he was referring to a shift in the AD curve, at the fiscal cliff.

    Max, I agree that it would be hard to convince markets on that point.

  11. Gravatar of ssumner ssumner
    24. May 2012 at 04:44

    Liberal Roman, Did he actually say that, or is that your inference?

  12. Gravatar of Bill Woolsey Bill Woolsey
    24. May 2012 at 04:52

    The only sense I can make of this is that the goal of the Fed is to go back to making periodic changes in the Federal funds rate based upon their estimates of the output gap and inflation. If Congress sharply cuts spending and raises taxes, and so reduces the budget deficit, it will interfere with the Fed’s desire to get back to normal operating procedures. To the degree this is true, then we need to get rid of Bernanke and friends. They are damaging the economy for their convenience.

    This is completely different from the opposite scenario, where Congress refuses to cut spending or raise taxes, and depends on the Fed to fund the budget deficit by money creation.

  13. Gravatar of Bill Woolsey Bill Woolsey
    24. May 2012 at 05:08

    Let me try again.

    Market monetarists favor a regime of targeting the growth of nominal GDP.

    This should have nothing to do with taxes and spending by the government.

    If government sharply reduces the budget deficit, nominal GDP should stay on target. If the government gradually reduces its budget deficit, nominal GDP should stay on target. If government greatly raises its budget deficit, nominal GDP should stay on target.

  14. Gravatar of J.V. Dubois J.V. Dubois
    24. May 2012 at 05:09

    I would just add another observation that indirectly comes from Alesina – Ardagna paper about fiscal austerity being more effective for fighting recessions than fiscal cuts. They thought that their conclusions were counterarguments against Keynesianism – but since we know that it is CB that ultimately controls Aggregate Demand their finding can be considered as a proof of political bias of people responsible for monetary policy. It would be an indirect proof that they tend to support spending cuts more than they support tax hikes.

  15. Gravatar of Morgan Warstler Morgan Warstler
    24. May 2012 at 05:19

    Liberal Roman, did you read something else?

    My read is this: Kocherlakota and Sen. Tom Coburn are speaking on message: The US must make like Sweden of late, and reduce the social safety net and decrease regulations.

    If they do that, the natural full employment rate will fall.

    ——

    Scott, So I went and REREAD it again, and I think you ought to too.

    I’m not saying that Ryan thinks that way.

    I’m saying Ryan has read Fisher indicating there is a problem with moral hazard, and that Fisher VERY MUCH MEANS exactly what I am saying.

    You might be right that Ryan misunderstands Fisher…

    But I’m right about the Fiscal Cliff.

    We have been over this, you don’t like that the Fed is biased to tax cuts and spending cuts…. but it is a fact!

    See Liberal Roman’s Kocherlakota:

    “For example, suppose that Congress and the president choose to reduce the payroll tax paid by employers. Such a move would provide an additional incentive to employers to hire more workers (albeit at the cost of increasing the deficit), and increase employment and reduce unemployment.”

    Eh hmm.

    And then…

    ” So, what has been happening with inflation? Inflation was distinctly higher in 2011 than in 2010 and continues to run above the FOMC’s target of 2 percent. Even core measures of inflation, which strip out energy goods and services, and food, went up notably. I see these changes as a signal that our country’s current labor market performance is much closer to “maximum employment,” given the tools available to the FOMC, than the post-World War II U.S. data alone would suggest. As I’ve argued in the past, appropriate monetary policy should be responsive to such signals.
    It is worth reiterating a point that I made earlier. “Maximum employment” for monetary policy is not the same as “maximum employment” for all policymakers. Congress and the president can choose to provide direct subsidies to employers for hiring. Such subsidies will increase the federal deficit, but they do have the power to increase “maximum employment” for the FOMC.”

    —–

    Scott the message is perfectly clear:

    1. We’re over the 2% inflation rate (view it as we’re having make up), and that means we are at maximum employment.

    2. The congress needs to provide “wage subsidies” – employment tax cuts and deregulation (and My Guaranteed Income plan), in order to reduce what “maximum employment” means – even if it increases federal Debt.

    ————

    It is a Mexican stand-off, and Scott it would HONEST for you to admit, that EVEN IF you prefer the Fed to act now…

    They are more likely to act the way you want if the Administration changes.

    WHY don’t you talk more about this Scott?

    Since you and MM want a more accommodation Fed and the Fed wants a more Romney like administration…

    Why aren’t you simply giving the Fed what they want?

  16. Gravatar of Morgan Warstler Morgan Warstler
    24. May 2012 at 05:25

    Woolsey,

    do you disagree with me that NGDPLT makes it more likely that public employees get cut, the regulations get reduced?

    Once you are using up that cap of 3% NGDPLT for this year., the only way to keep inflation down and / rates down is to make the public sector more productive.

  17. Gravatar of J.V. Dubois J.V. Dubois
    24. May 2012 at 05:44

    Sorry, it should be “fiscal austerity being more effective for fighting recessions than fiscal stimulus”. The point is that if CB did their job right neither should have any impact on how well or quick an economy gets from a demand induced recession.

    Particular fiscal policy should matter only for aggregate supply reasons, possibly affecting the level of medium to long-term RGDP growth.

    So one has to wonder if Central Bankers changed their mandate from “manage aggregate demand” to the one “engineer recession so that government make supply side adjustments”

  18. Gravatar of Saturos Saturos
    24. May 2012 at 05:51

    Yeah, it’s a dumb argument.

  19. Gravatar of Saturos Saturos
    24. May 2012 at 05:55

    So as we can see, the only thing “reckless” about the fiscal cliff is its supply-side effects, ie. raising taxes. Ryan says the Fed is ready to punish Congress for such recklessness. So apparently the Fed has turned into Grover Norquist.

  20. Gravatar of Saturos Saturos
    24. May 2012 at 06:00

    This argument is also suspect:

    “The funny thing about this approach is
    that it neuters one of the Fed’s more powerful policy tools … the Fed will ultimately do what it can to prevent a big drop in inflation and it would certainly prefer that unemployment not rise sharply. But it will have spent months implying that its power to minimise the impact of fiscal cuts is limited (because if it isn’t, why would the Fed be warning Congress about them?). Having done so, it will have a tough time convincing economic actors otherwise. Its interventions will be less effective as a result, and the fiscal multiplier will be quite large.”

    This contradicts everything Scott has been teaching us about how the market knows what the Fed wants and is likely to do than it does, and hence knows perfectly well what it is capable of doing. These are profit-maximizing speculators we’re talking about – they aren’t confused by political statements when it comes to predicting what their optimal strategy is.

  21. Gravatar of Saturos Saturos
    24. May 2012 at 06:04

    “fiscal policy does actually matter over the long run. At one extreme, we can imagine a situation in which America’s government has entirely lost market confidence and is unable to sell its debt. In that case, the central bank, as lender of last resort, would be unable to avoid stepping in to buy that debt, in the process transferring control over inflation to the fiscal authorities.

    To turn to something a bit closer to the realm of the plausible: imagine what happens when the economy begins running hot and the Fed starts raising interest rates. If the ratio of debt to GDP is above 100%, rising interest rates could have quite a damaging impact on the government’s fiscal position. And that, in turn, could generate some interesting conversations in Congress. Perhaps the legislature would get its fiscal act together. Or perhaps it would threaten the central bank’s independence.”

    Once again, Ryan does a great job of undercutting his own argument. He seems unable to get straight in his head the twin hypotheses of “Fiscal policy matters (demand-side)” and “Fiscal policy matters (supply-side)”. One of these clashes with the role of the Fed. The other does not. It’s a shame, he’s usually a lot more perceptive.

  22. Gravatar of Bill Woolsey Bill Woolsey
    24. May 2012 at 06:23

    Morgan:

    No.

    I don’t think that a 3% growth path for nominal GDP requires public employees to get more efficient in order for inflation to come down.

    I would expect that if they continued with their current level of inefficiency, inflation would be zero.

  23. Gravatar of Steve Steve
    24. May 2012 at 06:27

    I think the Fed is afraid of overshooting, i.e., offsetting the fiscal cliff drag only to have a grand tax bargain reached a month later (or an analogous event in Europe). The Fed doesn’t want to produce 3% inflation by accident, nor does it want to be so obvious as to explicitly tighten in response to a tax bargain.

    It’s the 2% inflation ceiling at play again. The Fed is hell bent on capping inflation, but is very uncomfortable with the political implications of its policy preference; namely that it should explicitly and immediately tighten in response to a tax cut extension deal.

  24. Gravatar of dwb dwb
    24. May 2012 at 06:48

    Maybe, but isn’t the real problem that inflation has not fallen?

    well, the GDP deflator to me looks like its running 2-3%. UK does issue inflation linked gilts, here’s the BoE “UK instantaneous implied inflation forward curve.”

    http://www.bankofengland.co.uk/statistics/Pages/yieldcurve/default.aspx

    Looks to me like people expect inflation to rise. How would i differentiate between a)discretionary policy that allows inflation expectations to become unachored; b) supply side issues (that are not expected to be fixed). I am starting to lean towards the former to be honest.

  25. Gravatar of Britmouse Britmouse
    24. May 2012 at 07:00

    The UK GDP deflator has been running sub-2% most quarters, with some spikes (blame VAT in 11Q1 at least) some data here along with the unbelievably bad NGDP number for 2012 Q1:

    http://uneconomical.wordpress.com/2012/05/24/uk-gdp-2012-q1-were-doomed-edition/

  26. Gravatar of Morgan Warstler Morgan Warstler
    24. May 2012 at 07:03

    “I would expect that if they continued with their current level of inefficiency, inflation would be zero.”

    ho, ho Bill.

    I don’t question the inflation will be zero, after all rates of borrowing will be higher, right?

    I think the issue is that I come at this as a political junkie, I think in terms of what can Fox News sell.

    And I think that running at 3% NGDPLT where the Fed is determined to keep inflation at nil, then neccessailry:

    more productive govt. = lower rates of borrowing

    Every month repeat.

    And that gives Fox News et al a powerful bludgeon to remake the political discussion.

    Am I missing something?

  27. Gravatar of dwb dwb
    24. May 2012 at 07:19

    @britmouse,
    thanks -
    i was looking at the UK GDP deflator in FRED (which is OECD, slightly different, i am not sure why offhand). My grasp of the UK inflation-linked gilt market is limited, but i think they are linked to retail or CPI prices (which i would expect to be higher if imports were higher).

    1.5% GDP deflator does not smell like domestic inflation to me? Why are forward inflation expectations rising?

  28. Gravatar of Josiah Josiah
    24. May 2012 at 08:17

    Here is my best Sumner Critique critique:

    Suppose that Congress passed a huge fiscal stimulus. What effect will that have?

    If the Fed is targeting NGDP, then the answer is: approximately none. The Fed will simply adjust monetary policy to meet its target.

    Suppose, though, that the Fed is targeting not NGDP but inflation. In that case it will offset the fiscal stimulus to the extent that it raises inflation, but not to the extent it raises output. And in a depressed economy with lots of idle workers and resources around, we should expect/hope for a lot of the fiscal stimulus to raise NGDP by raising output rather than by increasing inflation.

  29. Gravatar of What the Fed fears | News – All Net 24 IT Service What the Fed fears | News – All Net 24 IT Service
    24. May 2012 at 08:25

    [...] SCOTT SUMNER and TIM DUY offer responses to yesterday’s post on monetary policy and the fiscal cliff that are worth a read. To summarise very briefly, Mr Sumner asks why the Fed wouldn’t be happy to fully accommodate a plunge over the fiscal cliff given the resulting improvement in the government’s budget position, and Mr Duy argues that members of the Federal Open Market Committee are already signalling that a dive off the fiscal cliff would be one of the events that might cause the Fed to take additional expansionary action. They both make reasonable points, so let me see if I can’t rephrase and clarify my argument. [...]

  30. Gravatar of Saturos Saturos
    24. May 2012 at 09:04

    Just thought I’d mention – Mike Moffatt on Worthwhile Canadian Initiative just put up a bunch of great Milton Friedman quotes (on monetary policy): http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/05/milton-friedman-on-monetary-policy-circa-2000.html#more

  31. Gravatar of Saturos Saturos
    24. May 2012 at 09:09

    Josiah – but doesn’t the SRAS always have a positive slope, as there are always some flexible prices? So if fiscal stimulus shifts AD to the right, then for every rise in output there will always be some rise in inflation as well? So if the Fed prevents any increase in inflation it also prevents any increase in output. Of course the Fed could allow inflation to get a bit above target – but then if it wants more inflation and jobs then it’s perfectly capable of getting that anyway. So we’re back to “political/game theory” explanations…

  32. Gravatar of TylerG TylerG
    24. May 2012 at 09:26

    I love the football analogy at the end. I used the same analogy when I commented on one of your previous posts last year speculating on Ben Bernanke’s motivations. David Romer’s explanation was that head coaches often irrationally decide to punt on 4th-1 so that they are not held exclusively responsible for losing the game if they fail on 4th down attempt. If you punt and end up losing the game it, it was really a team loss whereas failed 4th down attempts during critical times are exclusively the coaches fault. I suggested that, similarly, Bernanke could ‘go for it on 4th down’ after many other failed attempts (stimulis, etc) and engage in additional QE monetary stimulus. But that means he’ll be held exclusively repsonsible for the economy afterwards despite making an optimal ex-ante decision with all other things equal.

    Here’s another one I’ve used trying to explain to one of my football-enthusiast friends how there is nothing intrinsically ‘unfair’ about China’s currency pegging: You wouldn’t complain that another team is being unfair if they ran a wildcat formation where the quarterback is substituted for another blocker or runningback. They’ve simply traded-off the propensity of a conventional pass-play for greater likelihood of a trick running play. Analogously, by fixing their exhange rate and insisting on capital controls the Chinese central bank is substiting that in lieu of being able to conduct independent monetary policy like our Fed does.

    Can you just make monetary policy to sports analogies one of your new memes?

  33. Gravatar of TylerG TylerG
    24. May 2012 at 09:36

    ^Whoops nevermind, analogy fail. Because China insists on capital controls they are able to fix their currency without sacrificing the independent autonomy of the central bank :(

  34. Gravatar of Matt Waters Matt Waters
    24. May 2012 at 09:59

    I think Ryan is making a claim that moving suddenly from fiscal stimulus to monetary stimulus could have some real costs. For example, the sequestered cuts for defense workers will probably reduce employment in defense a lot faster than those people could find work elsewhere.

    If there is serious skills mismatch of defense employees, then the Fed propping up AD would partially go to just inflating wages of current workers instead of finding defense employees jobs.

    On the other hand, the other cuts in the fiscal cliff are very broad. A payroll tax increase would decrease AD in and of itself, but the increased employment/wages would offset that decrease.

    Also the cuts in particular sectors have to be done eventually anyway. We made such drastic cuts in the 90′s with pretty mild to non-existant real costs.

  35. Gravatar of ssumner ssumner
    24. May 2012 at 11:50

    Bill, I agree.

    JV, It could be that, or if might reflect the negative supply-side effects of (some types of) fiscal stimulus.

    Morgan, So cutting our safety net will make us more like Sweden?

    Saturos, Let’s see what his reply says.

    Steve, Yes, but there’s no danger of overshooting if they do no QE, but rather set a higher NGDP target path.

    dwb, Good point.

    Britmouse, That makes it pretty clear Britain has a demand side problem, at least recently. Any thoughts on those two quarters with very high inflation? Could they reflect the rising price of North Sea oil?

    Josiah, You said;

    “Suppose, though, that the Fed is targeting not NGDP but inflation. In that case it will offset the fiscal stimulus to the extent that it raises inflation, but not to the extent it raises output. And in a depressed economy with lots of idle workers and resources around, we should expect/hope for a lot of the fiscal stimulus to raise NGDP by raising output rather than by increasing inflation.”

    But that’s likely to be most of the effect, as they only raise output by raising AD, which is the same factor that raises inflation. So if you don’t want more inflation, then you must stop AD from rising. But in that case you get no extra growth. (Ignoring supply side effects.)

    TylerG, Keep sending me ideas and I’ll try. I like your comment about coaches (and the Fed) not wanting to be held accountable.

    Matt, That might be what he had in mind.

  36. Gravatar of Mark A. Sadowski Mark A. Sadowski
    24. May 2012 at 12:10

    A couple of quick comments:

    1) We already fell off a fiscal cliff in late 2009:

    http://static1.firedoglake.com/37/files/2012/05/cliff2.png

    Fiscal Analysis Shows Risks of Austerity Program
    By: David Dayen

    “The chart above is from a Goldman Sachs analysis, and it shows the effect of fiscal policy on growth from 2009 to the present, as well as projections for growth in a variety of scenarios surrounding the fiscal cliff, the combination of expiring tax cuts and imminent spending cuts all set for the end of the year.

    I think there are a number of things notable about this. First, you have the fact, contrary to popular belief, that America never really experienced a fiscal stimulus. The stimulus had an impact on growth in the first two quarters it was operative, in Q2 and Q3 of 2009. After that, state budget cuts basically canceled out whatever the stimulus provided. Every quarter since Q4 of 2009 has shown a negative contribution to growth from federal, state and local fiscal policy. And since Q3 of 2010 – when Democrats still controlled Congress – federal fiscal policy has either been flat or negative for growth. If we pull forward to this year, we see that state and local spending has stopped hindering growth. Only federal policies drag on growth at this point, with the stimulus expired and cutbacks in fiscal accommodation from the government.

    Now, I know if I were the President, I would not be bragging about this. But it goes a long way to explaining the slow or non-existent recovery we have had since the Great Recession. Keynesian theory suggests that you fight recessions with fiscal spending instead of austerity. This chart shows that we effectively did not do that. And the results in terms of economic performance fit with that.”

    http://news.firedoglake.com/2012/05/18/fiscal-analysis-shows-risks-of-austerity-program/

    The impending “fiscal cliff” only increases the level of fiscal drag the economy has been experiencing since 2009Q4. And Goldman Sach’s analysis has been somewhat more conservative than the CBO with respect to fiscal multipliers, so their estimates may even understate it.

    So when people say the Fed is out of ammunition they have to ask themselves, why then is the economy even growing at all?!?

    On the other hand it would appear that the Fed shifted away from Greenspan’s Constrained Discretion to Bernanke’s Inflation Targeting in January 2006. So in my opinion the Fed will only do something if inflation expectations fall significantly. They won’t care if NGDP sags.

    2) Given that the literature on tax structure and growth suggests that the implications of tax structure changes are mainly long run in nature I would caution against drawing any conclusions concerning taxmaggedon’s immediate effect on AS. Also, even if we go back to a pre-2001 tax structure, thanks to the depressed nature of the economy the personal and payroll tax burden as a percent of GDP will still be below what it was in the gogo 1990s. I think this will only become an important concern should we ever start to approach something resembling full employment.

  37. Gravatar of Britmouse Britmouse
    24. May 2012 at 17:23

    Scott, turns out that’s an interesting question. The Q1 spike is VAT but the Q4 spike comes from a sharp rise in government spending without a corresponding rise in output. I did a post with the numbers:

    http://uneconomical.wordpress.com/2012/05/25/inflationary-fiscal-expansion/

  38. Gravatar of Morgan Warstler Morgan Warstler
    24. May 2012 at 21:05

    “So cutting our safety net will make us more like Sweden?”

    Yep.

    You’re the economist Scott, it is the trend. The US will always be the more cowboy country, the trend away from Big Gov is the point.

    The pont s that Sweden gets even better cutting their safety net more.

    Scott, all roads lead to subsidizing and auctioning the unemployed online, it is the End of History.

    The US will get there first, but Sweden will come soon after.

  39. Gravatar of Morgan Warstler Morgan Warstler
    24. May 2012 at 21:09

    Also,

    I want to make sure as a libertarian who believes in Global Warming… you FIRST want to try out geo-engineering, so we can figure out the cost of viable alternatives before we even consider regulations.

    First we run a garden hose to the sky and ensure we can cool the earth at will right?

    I for one won’t be happy until we can turn a dial and adjust the color fo the sky.

  40. Gravatar of marcus nunes marcus nunes
    25. May 2012 at 06:27

    Scott- I don´t think Kocherlakota is that open minded. To him the problem is “structural” and there´s nothing much MP can do!
    http://thefaintofheart.wordpress.com/2012/05/25/fed-official-says-the-problem-is-structural-there%C2%B4s-not-much-monetary-policy-can-do-to-help-revive-the-economy/

  41. Gravatar of What The Fed Fears – Bears Chat – Wall Street Examiner Forums and Bears Chat What The Fed Fears - Bears Chat - Wall Street Examiner Forums and Bears Chat
    25. May 2012 at 07:34

    [...] Today, 08:28 AM SCOTT SUMNER and TIM DUY offer responses to yesterday's post on monetary policy and the fiscal cliff that [...]

  42. Gravatar of ssumner ssumner
    25. May 2012 at 09:57

    Mark, I’ve never bought that argument, I think we did a lot of fiscal stimulus. Some of these estimates include S&L government, which makes no sense to me. If those are to be included, then why not private investment? The truth is that the Federal government is the entity that makes stimulus decisions, both S&L and private spending decisions are endogenous.

    If you look at things like the payroll tax cut it’s very clear that the US is still engaged in stimulus. Things like full employment surpluses are useless as no one knows where trend output is right now.

    Britmouse, Thanks for that info.

    Morgan, You said;

    “I for one won’t be happy until we can turn a dial and adjust the color of the sky.”

    That’s coming soon with contact lens that adjust to tint the sky whichever way we like.

    Marcus, Thanks, he keeps changing his mind.

  43. Gravatar of Saturos Saturos
    25. May 2012 at 10:54

    Scott, Morgan,

    You’ve seen this right?

    http://www.youtube.com/watch?v=9c6W4CCU9M4

  44. Gravatar of Jim Glass Jim Glass
    25. May 2012 at 21:38

    First, you have the fact, contrary to popular belief, that America never really experienced a fiscal stimulus. The stimulus had an impact on growth in the first two quarters it was operative, in Q2 and Q3 of 2009. After that, state budget cuts basically canceled out whatever the stimulus provided. Every quarter since Q4 of 2009 has shown a negative contribution to growth from federal, state and local fiscal policy.

    If $800+ billion of stimulus produces no stimulus effect, then it only illustrates the ineffectiveness of it. Tyler Cowen made this point after Krugman made a very similar argument, that the stimulus was so small stimulus really wasn’t even tried. Well, if $800 billion is not even trying then one big enough to matter it would have to be so huge as to be totally impractical both politically and economically. And remember Summers’ analysis for Obama saying there was only really $300 billion of worth-while stimulus. This makes the whole fiscal stimulus project look bankrupt — before even considering the Sumner Critique.

    As to “state budget cuts”, state revenue (including stimulus funds from the feds) has never declined during the recession, and still hasn’t.

    http://research.stlouisfed.org/fred2/graph/?g=7uH

    So how states with increasing revenue enact budget cuts large enough to offset the entire rest of the federal stimulus is something to ponder.

  45. Gravatar of Mark A. Sadowski Mark A. Sadowski
    26. May 2012 at 13:02

    Scott wrote:
    “Mark, I’ve never bought that argument, I think we did a lot of fiscal stimulus. Some of these estimates include S&L government, which makes no sense to me. If those are to be included, then why not private investment? The truth is that the Federal government is the entity that makes stimulus decisions, both S&L and private spending decisions are endogenous.”

    That’s because you’re thinking like a Monetarist rather than a Keynesian. From a pure Keynesian perspective the only thing that’s exogenous is government spending, regardlessd of whether it is Federal or S&L.

    “If you look at things like the payroll tax cut it’s very clear that the US is still engaged in stimulus. Things like full employment surpluses are useless as no one knows where trend output is right now.”

    Yes, but the GS analysis isn’t looking at levels, it’s looking at changes in levels in terms of annual rates of change, so a reduction in stimulus actually shows up as a fiscal drag. (And none of this involves analysis of cyclically adjusted budget balances.)

    The point is that from a Keynesian point of view we have been experiencing a fiscal drag for ten quarters now, and despite that, real GDP has been growing at an average annual rate of 2.5% over that time period (not great, but not too shabby either). This sort of punctures the whole delusion of the liquidity trap doesn’t it?

    P.S. This sort of reminds me of a paper by E. Cary Brown (“Fiscal Policy in the ‘Thirties: A Reappraisal”, American Economic Review, 46: 857-879, 1956) which showed that only about 5% of the growth experienced from 1933-39 could be explained by fiscal stimulus. So where did the growth come from?

    @Jim Glass,
    I’m sorry but pointing out nominal S&L revenues never declined is next to useless. Lots of things didn’t decline on a annual basis measured in nominal terms this recession but they are still way below trend. For example Personal Consumption Expenditures on Services never declined. But in the ten years through 2007 they grew at an annual rate of 6.04% per year. As of 2011 they were over 12.6% below trend. Stretch out the time period and think about trends.

  46. Gravatar of Jim Glass Jim Glass
    26. May 2012 at 22:08

    Mark, the point isn’t “cuts” in state and local govt spending being “slower rate of growth”, the point is cuts being actual cuts — reduced purchases, using the increased receipts to pay down debt rather than on expenditures, etc. — that actually offset the federal stimulus spending.

    E.g.:
    http://media.hoover.org/sites/default/files/documents/2009-Stimulus-two-years-later.pdf

  47. Gravatar of ssumner ssumner
    27. May 2012 at 10:46

    Saturos, And I got my first cell phone a month ago–I feel like a cave man watching that video.

    Mark, You said;

    “That’s because you’re thinking like a Monetarist rather than a Keynesian. From a pure Keynesian perspective the only thing that’s exogenous is government spending, regardless of whether it is Federal or S&L.”

    Then Keynesians are wrong. It makes no difference if the Keynesian model says S&L spending is exogenous, in the real world it’s endogenous. Models don’t matter, reality matters. Obam and Congress make stimulus decisions based on reality, they can’t control S&L. If it’s really true that $800 billion did nothing, then 1.5 times $800 billion would have done approximately 1.5 times nothing. And $1.2 trillion is what people like Romer wanted.

    You said;

    “The point is that from a Keynesian point of view we have been experiencing a fiscal drag for ten quarters now, and despite that, real GDP has been growing at an average annual rate of 2.5% over that time period (not great, but not too shabby either). This sort of punctures the whole delusion of the liquidity trap doesn’t it?”

    The more advanced Keynesian models says the fiscal drag doesn’t matter, what matters for the multiplier is changes in the expected future path of spending, not the precise time that spending occurs. Woodford’s model says Obama’s stimulus should have been working in December 2008.

    I certainly agree about liquidity traps, although I think NGDP growth is the more relevant stat.

  48. Gravatar of Mark A. Sadowski Mark A. Sadowski
    27. May 2012 at 11:42

    Jim Glass,
    I see your point now. The John Taylor testimony is interesting.

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