DeLong on the fiscal multiplier

For the past 4 years I’ve been arguing that we should generally assume a zero fiscal multiplier, except under very unusual circumstances.  Brad DeLong makes a similar point in a recent post:

In trotting around the country giving versions of DeLong and Summers (2012), “Fiscal Policy in a Depressed Economy”, I have found that a point that seemed completely obvious to us is not obvious at all to many.

Here is the point: an optimizing central bank that cares only about inflation and unemployment because it does not find itself at the zero nominal lower bound and does not fear engaging in nonstandard monetary policy will engage in full fiscal offset: it will take care to make sure that if fiscal policy becomes more stimulative then it will make monetary policy less stimulative by the same amount.

Then DeLong provides a mathematical proof, before concluding:

The important point here is that m and g cannot enter into the objective function h directly, but only indirectly through their effects on inflation and unemployment.

For this reason this argument breaks down at the zero nominal lower bound. At the zero lower bound the central bank does [not?] care only about inflation and unemployment. It cares as well about the magnitude of the non-standard monetary policy measures it must take in order to achieve its net monetary policy impetus value m.

I think this is a very important point.  So let’s review the implications:

1.  Hydraulic Keynesianism is pretty useless—it tells us almost nothing about the monetary policy reaction function.  And that includes the “paradox of thrift” as well as models that evaluate the prospects for NGDP growth by looking at each sector (C, I, G, NX) in isolation.

2.  Empirical studies of fiscal stimulus that rely on cross-sectional data—particularly the local or state-level response to fiscal stimulus, are extremely misleading, as they fail to address the monetary policy reaction function.  Ditto for national studies within the euro.  They will grossly overestimate the aggregate fiscal multiplier.  This includes studies cited approvingly by Krugman and DeLong.

3.  Empirical estimates of fiscal multipliers are nothing more than estimates of central bank incompetence.  This means that “the” multiplier will depend on whether Bernanke had a bad nights sleep, or whether a member of the Board of Governors has a world class ability to be open-minded.  No mathematical model or empirical study can ever produce a reliable fiscal multiplier estimate.

4.  Because it is objectively false that the “costs and risks” of unconventional monetary policy are greater than the costs and risks of fiscal stimulus, most central banks have the wrong policy, and need to be instructed to target AD more aggressively.  In particular, the GOP should block any fiscal stimulus until the Dems agree to instruct the Fed to do all it can to maintain on-target AD.  And after that happens the GOP should block any fiscal stimulus since it would be useless.  (Yes, I know that the GOP doesn’t even favor an appropriate track for AD, I’m just saying that if they ever did come to their senses, then they should continue to block fiscal stimulus and instruct the Fed to “do the right thing.”)

5.  If the Fed uses QE to keep core inflation in the 1.7% to 2.0% range, but would allow higher than 2% inflation if it could be achieved with fed funds rate cuts, then fiscal stimulus might be effective.  But it also might not be effective.  For example, if the Fed does more or less QE as required to keep inflation within the 1.7% to 2.0% range, then marginal changes in fiscal stimulus might have little or no effect, although large changes might lead to higher than 2% inflation, and hence higher AD.  It depends on the type of unconventional monetary policy, and how the perceived cost of that unconventional policy varies with fiscal stimulus.  For instance, a Woodfordian “communication policy” might be seen by the Fed as having a fixed cost.  Or it might not.

6.  In countries where the central bank holds back due to public criticism of above target inflation (I’m looking at you Britain) fiscal stimulus and austerity will have no effect on RGDP.  If employment hits record highs while RGDP lags, then “it’s the productivity, stupid.”

I hope other bloggers will adopt DeLong’s enlightened approach.  Then we might finally be able to have a sensible debate over fiscal policy, instead of a inane shouting match between intellectually bankrupt “paradox of thrift” arguments and empirically unfounded “crowding out” arguments.

PS.  I assume there was a typo in the DeLong quotation, which is why I added “not?”

HT.  Lars Christensen


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64 Responses to “DeLong on the fiscal multiplier”

  1. Gravatar of foosion foosion
    18. February 2013 at 18:47

    Your commentary appears to ignore the key qualifier regarding the zero nominal lower bound. Given that we are at the zero nominal lower bound (for short rates), fiscal stimulus may be appropriate.

  2. Gravatar of Steve Steve
    18. February 2013 at 19:13

    The best argument against fiscal stimulus is the lack of imagination of the people proposing stimulus. Consider:
    – Ed Rendell advocates burying the power grid underground (so that storms like Sandy can’t knock out the power). Never mind the costs, or the implications of floods, earthquakes, and underground fires.
    – Elizabeth Warren advocates digging up all the old rusty sewer pipes and replacing them with brand spanking new ones. I know stainless steel is fashionable these days, but do we actually have a demonstrated problem with sewage leaks?

  3. Gravatar of ssumner ssumner
    18. February 2013 at 19:29

    foosion, Almost my entire post was focused on the issue of the fiscal multiplier at the zero bound. Indeed I discussed almost nothing else.

    Reread it, I think you’ll see.

  4. Gravatar of xtophr xtophr
    18. February 2013 at 19:30

    So, to the devil with fiscal stimulus. Every conservative knows in the blackest places of his heart that this is just a conspiracy to give away goodies to the [INSERT-THE-GROUP-YOU-HATE-HERE.]

    But what about fiscal pragmatism? Why in the world shouldn’t we be building roads and fixing crumbling bridges as fast as we can when the cost of money and labor are so ridiculously cheap? Who cares what effect it will have on GDP, R, N, or otherwise? The roads must be built, no? How can you argue otherwise?

    Or maybe we should wait until money and labor are dear, then the conservatives can cry “Waste! Waste! it’s all WASTE!” unless of course, the GOP has taken the White House.

  5. Gravatar of nickik nickik
    18. February 2013 at 19:32

    @foosion

    Any market monetarist will tell you that the ZLB is only a thing in the imagination of central bankers. Its a mental block central bankers have, they get hammered in that mental block by idiotic macro models.

    I know this sounds harsh but it is simply true, the ZLB does not change anything, it is actually completly usless to talk about the intrest rate at all. The intrest rate is a price that emerges out of the market, the central bank just ajust the money supply (and it makes it more efficent with managing expectations) in order to hit the target (for example nominal GDP).

  6. Gravatar of ssumner ssumner
    18. February 2013 at 19:34

    xtophr, Don’t you know that conservatives favor big government? Remember the Bush administration, when spending soared?

  7. Gravatar of Jon Jon
    18. February 2013 at 20:29

    Scott, good point that even on Brad’s terms the step the Fed might not tolerate is precisely the increase in inflation necessary to enable fiscal policy to work.

    The evidence ofthe public record really makes that one ring true. Hawkish FOMC members fear unconventional measures may spiral into future inflation but those same people abhor even more the idea of having more inflation today.

  8. Gravatar of Benjamin Cole Benjamin Cole
    18. February 2013 at 20:35

    Great blogging, and I admire DeLong for thanking about things.

    It does bring up a joke: You know what Austrians say about Market Monetarism?

    “Okay, Market Monetarism might work as a practical matter, but does it work in theory?”

    I think the same thing can be said about econometricians. They say, “Market Monetarism might work in real life, but does it work in my model?”

  9. Gravatar of Al Al
    18. February 2013 at 23:24

    This is an area where Krugman/DeLong have been more obfuscating than helpful. If you carefully follow them over time, their fiscal prescriptions imply some assumption about monetary inaction, but I can cite specific articles/blogs where they plunk all monetary recourse as being ZLB ineffective.

  10. Gravatar of Yaron Yaron
    18. February 2013 at 23:38

    Why not look at vice versa? The government can do whatever the fed can do. So let the government make it.

  11. Gravatar of PoachedWonk PoachedWonk
    19. February 2013 at 02:11

    What an absurd blog post this is.

    Misrepresent someone’s views, then attempt to mock it with terrible analysis…

    Oh well, if this is the best you have got then fine.

  12. Gravatar of Bill Woolsey Bill Woolsey
    19. February 2013 at 04:08

    “although large changes might lead to higher than 2% inflation, and hence higher AD.”

    Sounds like your causation is backwards.

    Large changes in fiscal policy would lead to higher AD if not offset by reduced private expenditure caused by the expectation that the Fed would prevent more than 2% inflation.

    Expectation that the Fed will allow more than 2% inflation will allow large changes in fiscal policy to increase aggregate demand.

  13. Gravatar of ssumner ssumner
    19. February 2013 at 04:53

    Bill, I agree. I didn’t mean to suggest that the higher inflation causes higher AD, just that it implies higher AD.

  14. Gravatar of Peter N Peter N
    19. February 2013 at 05:56

    Neither monetary nor fiscal policy will work well if the complementary policy is perversely uncooperative, and working together, they work better than either can alone.

    A central bank can obviously counteract a multiplier, but why would it want to if the spending is well targeted and well timed?

    Are you arguing that NGDP targeting will work so well that there will never be another financial crisis where fiscal intervention would be appropriate? History hasn’t been kind to people claiming their policies will cause endless moderation.

    Fiscal policy has the advantage that it can be finely targeted, but suffers from practical political problems. Builtin countercyclical fiscal po9licy seems to work well enough.

    Monetary policy is powerful, but it depends on the bank’s political independence (which is not unlimited. Congress changed the rules after 2008. It could do so again if the Fed is perceived to be exceeding the current congress’s view of its mandate.) I believe this is the reason for Bernanke’s caution. When he showed what the Fed could do in 2008, he scared a lot of people in congress.

    Also there are a number of versions of exactly what is considered monetary policy, and what isn’t.

    What sorts of instruments is the central bank permitted to trade, and where and how may it trade them?

    What regulatory powers of the central bank come under the head of monetary policy (consider China)?

    The broader your generalizations and the stronger your claims, the clearer must be the definitions of your terms and proposed policies.

  15. Gravatar of Geoff Geoff
    19. February 2013 at 06:46

    Benjamin:

    “It does bring up a joke: You know what Austrians say about Market Monetarism?

    “Okay, Market Monetarism might work as a practical matter, but does it work in theory?””

    Which Austrian accepts that MM might work in practise? As far as I can tell, they all reject it in theory and in practise.

  16. Gravatar of Philo Philo
    19. February 2013 at 06:56

    @ PoachedWonk:
    What a useless comment! Bad tempered, but without substance.

  17. Gravatar of Suvy Suvy
    19. February 2013 at 06:57

    Krugman and DeLong miss the essential point of the Keynesian theory when it comes to fiscal policy(this is because they aren’t true Keynesians). The whole advantage of fiscal policy is that it can be used to produce more. When you have people that aren’t working, you’ve got unused resources sitting on the sidelines. Using fiscal policy can put those resources to use. Printing money does not, and will never, produce more.

    “Hydraulic Keynesianism is pretty useless—it tells us almost nothing about the monetary policy reaction function. And that includes the “paradox of thrift” as well as models that evaluate the prospects for NGDP growth by looking at each sector (C, I, G, NX) in isolation.”

    This is because there is no asset market in their theories. There are two place to get demand from: goods and services or financial assets. Aggregate demand is not just NGDP; it is a mistake to think so.

    “Empirical estimates of fiscal multipliers are nothing more than estimates of central bank incompetence.”

    This will be true when central bankers (and money printing in general) start having the ability to put unused resources to work.

    “Because it is objectively false that the “costs and risks” of unconventional monetary policy are greater than the costs and risks of fiscal stimulus, most central banks have the wrong policy, and need to be instructed to target AD more aggressively.”

    Expansionary fiscal policy to increase production will work, but the monetary supply needs to be expanded for the fiscal policy to work.

    “If the Fed uses QE to keep core inflation in the 1.7% to 2.0% range, but would allow higher than 2% inflation if it could be achieved with fed funds rate cuts, then fiscal stimulus might be effective.”

    This is only true if the fiscal policy doesn’t increase the amount that is being produced by the economy. If fiscal policy increases production; there is no reason that fiscal policy should have to show up as price inflation.

    When you have 12 million people unemployed, fiscal policy can be a very effective tool. However, I think that in a situation like this, expansion on the fiscal side has to be combined with expansion on the monetary side. Fiscal policy is also a much better tool to improve things like household balance sheets than monetary policy(money printing) would be.

  18. Gravatar of Ron Ronson Ron Ronson
    19. February 2013 at 07:42

    I agree that both above and at the ZLB a CB could always override fiscal policy.

    Above the ZLB even Keynsian’s agree that monetary policy is the appropriate policy to stabilize AD and fiscal policy is needed by the govt for other (distributional) policy goals.

    Below the ZLB MMist correctly point out that the CB by creating money via unconventional policy can drive NGDP to any level it wants to. However it cannot control the distribution of this spending between C and I so even with stable NGDP RGDP may fall and inflation may increase. A brave CB could minimize the fall in RGDP by targeting nominal wages and tolerating a higher level of inflation.

    Fiscal policy can also increase AD and by using policies that more explicitly target I over C it can minimize the level of inflation that will result. For example using new (or borrowed) money to subsidize wages and investment spending will increase AD by increasing I more than C and so allow the increase in NGDP to consist of relatively more RGDP-growth and less inflation than monetary policy alone..

    Of course the CB could prevent this fiscal policy from operating by tightening in response – but why would it do so at the ZLB ? In fact a smart CB would probably want to use this kind of combined fiscal/monetary policy as an effective way out of the ZLB.

  19. Gravatar of TallDave TallDave
    19. February 2013 at 08:50

    I’ve been trying to explain to my GOP friends that the real debate is not about taxes vs. spending, but rather fiscal vs. monetary.

    The whole notion that ZLB is some sort of financial singularity is going to be remembered as the great error of our times, the real bills doctrine of the 21st. All ZLB conditions tell you is that your monetary policy (and its expectations) is too deflationary, irrespective of whatever witch’s brew you’re using to define “inflation.”

    BTW I assume everyone has seen the Harvard study that found a local negative multiplier for fiscal stimulus (this was during ZLB conditions). It seems pretty obvious this must be true for the economy as a whole, too — using guns to move money around to where you think it “should” be is rarely consequence-free. TANSTAAFL.

  20. Gravatar of Travis Allison Travis Allison
    19. February 2013 at 08:54

    I wouldn’t be against fiscal policy that passes some cost-benefit analysis, though I am always skeptical without price signals. What makes no sense is Krugman’s intellectual support for digging holes and refilling them. We already have that policy: it is called unemployment benefits. To the extent that we want holes dug and refilled, the US govt can mail a purchase order to every recipient to go into a backyard and dig/refill a hole. Classify that activity as GDP and voila! We have a suddenly booming economy.

  21. Gravatar of Geoff Geoff
    19. February 2013 at 08:59

    TallDave:

    “All ZLB conditions tell you is that your monetary policy (and its expectations) is too deflationary, irrespective of whatever witch’s brew you’re using to define “inflation.””

    That isn’t always true, TallDave. ZLB could also mean, under certain conditions, that monetary policy is too inflationary in the form of credit issuance, which could, under certain conditions, outstrip the inflationary effect that higher final output prices have on the inflation premium component of interest rates.

    Never reason from interest rates.

  22. Gravatar of Geoff Geoff
    19. February 2013 at 09:00

    TallDave:

    “It seems pretty obvious this must be true for the economy as a whole, too — using guns to move money around to where you think it “should” be is rarely consequence-free. TANSTAAFL.”

    And BOOM goes central banking.

  23. Gravatar of TallDave TallDave
    19. February 2013 at 09:05

    Geoff,

    No.

  24. Gravatar of Jim Crow Jim Crow
    19. February 2013 at 09:17

    Has Delong and/or Larry Summers even gone on record with their opinions on NGDP targeting? My understanding is that Krugman, at least, has expressed doubts regarding lower inflation when trend growth rises.

  25. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    19. February 2013 at 09:38

    ‘Empirical studies of fiscal stimulus that rely on cross-sectional data—particularly the local or state-level response to fiscal stimulus, are extremely misleading, as they fail to address the monetary policy reaction function. Ditto for national studies within the euro.’

    Somewhat related to that;

    http://www.voxeu.org/article/designing-federal-bank

    ———–quote———–
    A modern European equivalent to the Federal Reserve would be to create private sector-based regional central banks, for instance with Alpine, Baltic, North Sea, Atlantic, Danubian, and Mediterranean banks.

    The original (1914) Federal Reserve System closely resembles the interaction of national central banks in the international system of the gold standard in many ways. The 12 reserve banks controlled their own operations, and had their own discount policy.

    ….For Europe, the one-size-fits-all approach meant that in the 2000s interest rates in southern European countries were too low, and in northern Europe they were too high. Identical nominal rates with divergent real rates produced unsustainable credit booms in the south. By contrast, a gold-standard rule would have produced higher rates for the southern European borrowers, which would have attracted funds to where capital might be productively used, and at the same time acted as a deterrent against purely speculative capital flows.

    A modern equivalent to the gold standard/early Federal Reserve approach would require differing (higher) levels of collateral requirement for central banks operating in countries with a housing and credit boom (pre-2007 Spain or Ireland) than in countries with no credit boom (pre-2007 Germany) (Brunnermeier 2012).
    ————endquote———–

  26. Gravatar of TallDave TallDave
    19. February 2013 at 09:41

    Scott,

    xtophr, Don’t you know that conservatives favor big government? Remember the Bush administration, when spending soared?

    It’s probably fair to say that since the 1980s, the equation has been GOP is +defense -welfare, while Dems are +welfare -defense. Bush triangulated a bit on Part D and got a lot of his party to go along with “compassionate conservatism” (which was way less helpful than Clinton triangulating on free trade and welfare reform) but also ended up spending a lot more on defense, if arguably for exogenous reasons.

    Unfortunately for we minarchists, there aren’t a lot of -defense -welfare lawmakers out there (though the Tea Party has helped a bit). And the ones that are tend to be “sound money” pro-deflation types.

    We may be a while getting out of this mess.

  27. Gravatar of TravisV TravisV
    19. February 2013 at 09:49

    Is the Fed really planning to buy 75% of all new 30-year Treasuries? What’s going on here (See “Federal Reserve Holdings”)?

    http://www.zerohedge.com/news/2013-02-19/fed-buys-back-30-year-bond-auctioned-last-thursday

  28. Gravatar of OhMy OhMy
    19. February 2013 at 10:36

    SSumner,

    If the CB could offset the fiscal stimulus it doesn’t mean the multiplier is zero. It is what it is but the effect could be offset. It is like saying 4 is equal to zero because when I add -4 to it, it is zero. Nonsense. In the same fashion it doesn’t mean the monetary policy does nothing just because it can be offset by fiscal policy.

    But the fact remains that fiscal policy can trump monetary policy any time. The CB can jack up rates to infinity and the fiscal authority could increase deficits enough to offset the fact that no new loans are created at these interest rates.

  29. Gravatar of Tommy Dorsett Tommy Dorsett
    19. February 2013 at 10:51

    Scott, fantastic piece. Really good stuff. BTW, it really is a myth that Republicans favor smaller govt. Check out total federal spending growth in the first 16Qs of each president going back to JFK:

    http://research.stlouisfed.org/fredgraph.png?g=fIK

    Obama looks austere compared to Reagan and GWB. LBJ stands out as a particular disaster.

  30. Gravatar of TravisV TravisV
    19. February 2013 at 11:48

    Prof. Sumner,

    Yesterday, you told me that you prefer wage subsidies to a Guaranteed Basic Income. Does that mean that you’re a fan of the Earned Income Tax Credit and would like to see it expanded?

  31. Gravatar of TallDave TallDave
    19. February 2013 at 12:03

    Tommy Dorsett,

    That would only be true if Presidents were autocrats, and also faced no exogenous budget pressures (e.g. Pearl Harbor). In our system Congress generally has more power over the budget.

  32. Gravatar of Tyler Joyner Tyler Joyner
    19. February 2013 at 12:43

    OhMy,

    “But the fact remains that fiscal policy can trump monetary policy any time. The CB can jack up rates to infinity and the fiscal authority could increase deficits enough to offset the fact that no new loans are created at these interest rates.”

    Not true. Despite what Krugman might believe, there are real world limits to how much of a deficit the US government can run. Someone has to be there buying the debt they issue.

    On the other hand, while it might be unwise for the CB to increase rates to infinity, it is possible for them to do so.

    Your first point doesn’t really address Scott’s post, either. He’s saying that, assuming the central bank will pursue a fixed inflation target, any effect created by fiscal measures would automatically be offset by central bank action. He’s not claiming the offset happens by magic, but by design. The offset doesn’t happen because monetary policy *can* offset fiscal policy, but because an inflation target implicitly adjusts for any successful stimulative fiscal policy.

    Which is one of the reasons why he advocates targeting NGDP.

  33. Gravatar of Geoff Geoff
    19. February 2013 at 12:53

    TallDave,

    Yes.

  34. Gravatar of ChargerCarl ChargerCarl
    19. February 2013 at 12:58

    “Despite what Krugman might believe, there are real world limits to how much of a deficit the US government can run.”

    Despite what krugman might believe? Last time I checked that is what krugman believes…

  35. Gravatar of OhMy OhMy
    19. February 2013 at 13:34

    Tyler Joyner,

    It is obvious that you have no idea how bond sales work, but no wonder if you hang around this blog.

    “Someone has to be there buying the debt they issue.”

    You fail to understand that when the Treasury deficit spends 1T, there is exactly 1T more reserves in the banking system. The initial bond issue is absorbed by the primary dealers who must bid at auctions and since the banking system now has 1T more reserves the primary dealers will have no issue whatsoever selling these treasuries further.

    Recap: The deficit creates the funds the private sector uses to buy treasuries. Any other economic activity of the private sector cannot get rid of the extra 1T in reserves, only reshuffles them inside the banking sector. So the only way for the private sector to get rid of these is to buy bonds. Demand for bonds grows *exactly* in lockstep with supply.
    http://www.businessinsider.com/why-treasury-prices-are-so-high-despite-record-supply-2012-6

    Hence bond sales are essentially a rate maintenance operations, not funding operations.
    http://mosler2012.com/wp-content/uploads/2009/03/7deadly.pdf

    “Your first point doesn’t really address Scott’s post, either. He’s saying that, assuming the central bank will pursue a fixed inflation target, any effect created by fiscal measures would automatically be offset by central bank action. ”

    It can be offset when spending is rates-sensitive. But only housing market is very rates sensitive. So when the housing market is dead, the central bank is pretty powerless. The same way it cannot overcome a fiscal drag – it can lower rates all it wants but if people have too much debt, the housing market won’t move. The first premise of yours is also of course dead, as per above – yes, the govt can increase deficits as far as it wants.

  36. Gravatar of ssumner ssumner
    19. February 2013 at 17:20

    PeterN, You asked:

    “Are you arguing that NGDP targeting will work so well that there will never be another financial crisis where fiscal intervention would be appropriate?”

    Yes.

    Jim Crow, I think they both believe NGDPLT is worth a shot.

    TallDave, Good point. And notice what happens when Obama picks a Republican to run the Defense dept? What’s Hagel’s great sin? Questioning GOP militaristic orthodoxy. On the other hand Bush departs from orthodoxy by expanding Medicare and federal aid to education, and is still liked in the modern Republican party. It shows what they really care about, and it isn’t small government.

    OhMy, You said;

    “If the CB could offset the fiscal stimulus it doesn’t mean the multiplier is zero. It is what it is but the effect could be offset. It is like saying 4 is equal to zero because when I add -4 to it, it is zero. Nonsense. In the same fashion it doesn’t mean the monetary policy does nothing just because it can be offset by fiscal policy.”

    OK, and if crowding out of private investment prevents the fiscal stimulus from raising GDP by $1, it doesn’t mean the multiplier is zero, it means the positive effect is offset by the negative of crowding out of private investment. But whatever you call it, fiscal stimulus doesn’t lead to higher NGDP. It’s purely a question of semantics.

    You said;

    “But the fact remains that fiscal policy can trump monetary policy any time. The CB can jack up rates to infinity and the fiscal authority could increase deficits enough to offset the fact that no new loans are created at these interest rates.”

    If high interest rates were tight money, then your argument might make some sense. But ultra tight money is better described as a sharp fall in the money supply. If the Fed reduces the base to $1, good luck with your fiscal expansion. Monetary policy has nothing to do with “loans.” That’s credit.

    TravisV, Yes, I like the EITC, although my dream policy would be to linked the subsidy to hours worked. Still the EITC is a good substitute. I plead guilty to not being an expert here, but based on what I know I’d favor expanding it somewhat. I don’t claim to know the optimal level. I’d favor an EITC high enough so that a family with a full time low wage job could buy basic necessities (which is admittedly not easy to precisely define.)

  37. Gravatar of Morgan Warstler Morgan Warstler
    19. February 2013 at 17:36

    This also admits that when the CB is getting the economy it wants…

    We can make the real productivity gains we want in the public sector (less spending), and the private sector will be rewarded with lower borrowing rates.

    “Don’t worry, the Fed has agreed to make borrowing easier to stimulate the economy, if we agree to close the US Postal Service, so NOT ONLY are we wasting money killing trees, we could all get to buy cars and houses cheaper for making the wise choice!”

  38. Gravatar of OhMy OhMy
    19. February 2013 at 18:02

    Ssumner,

    You said: “OK, and if crowding out of private investment prevents the fiscal stimulus from raising GDP by $1, it doesn’t mean the multiplier is zero, it means the positive effect is offset by the negative of crowding out of private investment.”

    There is no mechanism for the fiscal stimulus to crowd out private investment. Fiscal deficit adds new assets (bonds, which are liquid and can be exchanged for reserves). Indeed, deficits crowd IN private investment. They add to spending dollar for dollar and improve business confidence too.

    “If the Fed reduces the base to $1, good luck with your fiscal expansion.”

    The monetary base is decided by the private sector, not the Fed, it is endogenous. Econometric studies show this and bankers are very clear on this too. If the private sector creates X loans, it will seek 0.1X in reserves, plus its cash demand. The Fed has no choice but to supply them or else the interbank interest rate skyrockets and solvent banks go bankrupt.

    “Monetary policy has nothing to do with “loans.” That’s credit.”

    Monetary policy sets the rate and this impacts credit, credit is the source of the majority of deposits in existence. So monetary policy acts though the volume of loans.

  39. Gravatar of TallDave TallDave
    19. February 2013 at 18:35

    “There is no mechanism for the fiscal stimulus to crowd out private investment.”

    Actually there are several. One is mentioned by the 40-year Harvard “pork” study: often the government provides a service that the private sector would otherwise have provided. They can actually cite specific instances of projects that were cancelled.

    http://hbswk.hbs.edu/item/6420.html?wknews=052410

    As they put it: “Some of the dollars directly supplant private-sector activity—they literally undertake projects the private sector was planning to do on its own. The Tennessee Valley Authority of 1933 is perhaps the most famous example of this.”

    And that’s illustrative of the larger problem with fiscal stimulus: why would anyone familiar with the 20th Century expect that moving more than 25-30% of the economy into the government would produce more growth? Contrary to popular myth, even the Nordic countries are moving away from the Nordic model (which only worked for them because they had exceptionally low rates of corruption and tended to apply market forces in places we don’t, i.e. fully voucherized education).

  40. Gravatar of OhMy OhMy
    19. February 2013 at 19:11

    TallDave,
    Wow, 40 examples, in a century? Not a lot.

    Did the private sector build the highway system? Sure it must have crowded out some private disjoint dirt road projects…

    The government can crowd out when there is full employment. Plus, if you are worried about specific projects, let the government run a deficit by taxing less or mailing checks to people – this cannot crowd out investment. Sumner probably thinks about the competition for funds, very popular but a totally false belief.

  41. Gravatar of TravisV TravisV
    19. February 2013 at 21:02

    Prof. Sumner,

    Yglesias says that the EITC subsidizes low-productivity employers too much. Do you think that that’s a concern?

    What do they do in Denmark and Sweden? Minimum wage? EITC?

  42. Gravatar of Saturos Saturos
    19. February 2013 at 21:56

    SCOTT you gotta check this out (hope it hasn’t been posted already): http://www.washingtonpost.com/blogs/wonkblog/wp/2013/02/15/stan-fischer-saved-israels-economy-can-he-save-americas/

  43. Gravatar of Saturos Saturos
    19. February 2013 at 22:04

    Oh, and this: http://www.euromoney.com/Article/3147944/ChannelPage/0/AssetCategory/14/Stanley-Fischer-should-be-a-contender-in-the-US-Federal-Reserve-leadership-contest.html?type=AssetCategoryArticle&ArticleId=3147944&PageID=0&CategoryID=14

    also this: https://twitter.com/TheStalwart/status/296294080575582208

  44. Gravatar of Saturos Saturos
    19. February 2013 at 22:05

    OhMy, you an MMTer yeah?

  45. Gravatar of Saturos Saturos
    19. February 2013 at 22:11

    Care to weigh in on this one Scott? http://econlog.econlib.org/archives/2013/02/spending_multip.html

  46. Gravatar of TallDave TallDave
    20. February 2013 at 05:27

    OhMy,

    It’s a 40-year study, not 40 examples in a century.

    Gov’t roads usually won’t crowd out a private investment in roads (except in special circumstances like logging/mining roads) because only gov’t has eminent domain, but they can easily be malinvestment. Japan found out what happens when you build roads and bridges as stimulus. They have one bridge that cost $1.2B. It’s much beloved by the dozen or so commuters that use it daily.

    The government can crowd out irrespective of full employment whenever it provides anything that isn’t a public good only the government could have provided. Generally speaking there are two possibilities: the government will crowd out and provide the same service less efficiently, or it will provide a service no one wanted (e.g. the investments in Solyndra, BeaconPower, and the dozen other “green energy” companies that promptly went bankrupt for lack of demand). Neither of these lead to economic growth.

  47. Gravatar of OhMy OhMy
    20. February 2013 at 06:12

    Tall Dave,

    I agree that the government can crowd out something the private sector wants to do, and can produce useless stuff too, just like the private sector. Yes, government financed research gave us the internet that crowded out private messengers and dove post. This is not how most of the deficit occurs though.

    The point remains: there is no principle that shows that all government deficit spending has to crowd out private spending. Increase the deficit by mailing checks or cutting payroll taxes and there is zero mechanism for this to crowd out anything the private sector wants to do. And this is how most of the deficit spending works, the government doesn’t start restaurants or apparel stores, it sends us more money and cuts our taxes.

  48. Gravatar of OhMy OhMy
    20. February 2013 at 06:18

    Saturos,
    No, I am someone who dislikes sloppy logic and magic thinking economics. Fiscal multiplier is not zero, SSumner has no argument otherwise, but nevertheless he repeats this fallacy to his followers on a weekly basis. He should go and preach this stuff in Greece, lol.

  49. Gravatar of J Mann J Mann
    20. February 2013 at 06:35

    OhMy,

    I’m just an unfrozen caveman in these circles, but let me ask you a few things.

    1) Sumner says that Krugman and DeLong agree with him that if [the central bank keeps the same inflation target it otherwise would have and is able to effectively move to that target]*, then the multiplier from fiscal stimulus is zero. *Apologies if I didn’t get that exactly right – anyone feel free to correct me.

    1.1) Do you agree with Sumner that Krugman and DeLong think that?

    1.2) Do you agree with that?

    2) Assuming we all agree with #1, that leaves whether the central bank is (a) able and (b) willing to meet its target when it is at or near the “zero nominal lower bound.” IMHO, DeLong is a little slippery whether he believes that the fed is unable to target inflation at the ZLB or just unwilling. It seems to me that Sumner has made a pretty good case that the bank is able to create inflation at the ZLB, but I haven’t followed the argument on whether it did in fact offset the stimulus.

    3) As to private crowding out, I think the consensus is that there is some crowding out but not complete under normal conditions (I.e., the multiplier is probably between zero and one, although there are some people who argue that under abnormal conditions, like a recession, it’s more than one.) Still, private crowding out is not necessary for Sumner’s argument.

  50. Gravatar of OhMy OhMy
    20. February 2013 at 07:17

    J Mann,

    1) DeLong has a toy model, starts with a sentence: “Suppose that we have a system in which future unemployment ut+1 is a function of variables V (which include past, present, and expected future unemployment and inflation rates), of the stimulative impact of monetary policy m, and of a shock:…”

    There is zero evidence we live in such a world. He *assumed* the monetary policy can move the world in any direction it wants to any degree it wants. In such a world when the fiscal policy is more stimulative it may increase inflation and the CB will automatically tighten, it is a trivial result of assumptions put into the model. I say this model tells you nothing about reality. Inflation won’t increase with a stimulus when there is a huge output gap, plus the central bank is not nearly as powerful as is assumed. So I said even if the CB *did* try to counteract, its influence can always be broken by the fiscal agent, because the fiscal agent can do expansionary policy even at infinite interest rates. SSummner countered that rates are beside the point because the CB could withdraw reserves – which in reality cannot happen without shutting down the banking system, something SSumner should know since 3 years ago: read the comment thread here: http://www.themoneyillusion.com/?p=5893

    But if you *assume* DeLong’s model is remotely relevant, then you are reduced to nonsensical defenses like “Japan’s CB wanted zero growth” despite it trying very aggressive policies like QE (these policies are actually completely impotent, because the quantity of reserves is irrelevant for the economy, but at least you cannot say the CB is trying to retrench in Japan, just the opposite).

  51. Gravatar of TallDave TallDave
    20. February 2013 at 07:31

    OhMy,

    If a private company produces something worthless, it loses money. That’s the difference between investment and Obama’s “investment.”

    “Government research” did not create the Internet, you’re confusing protocol standards with the actual Internet itself. At most something like 1% of the Internet was developed or produced with government funds. The vast majority of hardware and software that comprises the Internet was produced by private companies.

    “Increase the deficit by mailing checks or cutting payroll taxes”

    Well, that’s less bad than trying to out-invest the private markets, but it’s not consequence-free.

    “there is zero mechanism for this to crowd out anything the private sector wants to do.”

    Sure, except work, or borrow money. On the first, high MTRs are already one of the biggest problems facing the poor, so you can’t shovel money to people without reducing the marginal propensity to produce. On the second, bond markets are finite.

  52. Gravatar of Tyler Joyner Tyler Joyner
    20. February 2013 at 07:38

    OhMy,

    It is obvious that you have no idea how bond sales work, but having a clue would impede the fiscal irresponsibility you espouse, so willful ignorance is bliss in this case.

    The same logic you applied to the deficit could just as easily apply to Podunk City Bank. They issue debt, receive money, spend or lend the money, and total reserves increase.

    “Demand for bonds grows *exactly* in lockstep with supply.”

    That, right there, is like a massive ignorance bomb.

    Primary dealers are obliged to buy treasuries, but banks are not obligated to be primary dealers. Your argument is premised upon the false assumption that the US government will always have someone willing to buy their bonds at the price that they offer them at. Greece used to feel that way too. Turns out that while, yes, they can still get primary dealers to buy their debt, the interest rates they want are not quite so favorable these days.

  53. Gravatar of OhMy OhMy
    20. February 2013 at 07:38

    TallDave,

    ” On the second, bond markets are finite.”

    Nonsense.
    The size of the bond market is determined by… the deficit. If the deficit is 2T there is new 2T reserves in the banking system. The government offers for sale exactly as many bonds as many reserves its deficit net created. To the dollar. Plus, the government doesn’t need the bond markets, it could finance spending by simple issuance of reserves, this is not more inflationary than when coupled with bond issuance, actually slightly less.

    http://neweconomicperspectives.org/2009/11/what-if-government-just-prints-money.html

  54. Gravatar of TallDave TallDave
    20. February 2013 at 07:42

    you are reduced to nonsensical defenses like “Japan’s CB wanted zero growth”

    I didn’t actually see that sentence anywhere, that seems to a strawman of your own devising.

    despite it trying very aggressive policies like QE

    That was one mechanism in service to a particular policy. What if Japan had changed policy altogether and targeted NGDP growth of 5% instead? I don’t think it makes sense to argue that’s just impossible.

  55. Gravatar of OhMy OhMy
    20. February 2013 at 07:45

    Tyler Joyner,

    Podunk City Bank doesn’t issue currency we are required to pay taxes in, so it is a currency user not issuer, like the US. This difference is fundamental, so if you are trotting out the “government is like a household” fallacy it only shows who is the clueless here.

    As a monopoly supplier the US can always control the price of its bonds, the only thing that can adjust is the currency weakening. Plus again, the US needs the bonds markets for nothing, deficit spending by crediting bank accounts without bond sales works just as well.

    “Greece used to feel that way too.”

    Holy cow, you still haven’t caught up to the fact that Greece is a currency user and the US is a currency issuer. Greece is like a household or Podunk City Bank, sure it can go bankrupt. People who understood this difference predicted the Eurozone would collase into depression when a large shock came because the importer nations wouldn’t be able to resort to fiscal policy, something Sumner’s framework was unable to do.

  56. Gravatar of TallDave TallDave
    20. February 2013 at 07:52

    OhMy,

    Zimbabwe was a currency issuer. Monetizing didn’t work out well for them in the end, either.

    At any rate, monetizing is irrelevant because you can’t fix a private “output gap” with public spending. It doesn’t work. If gov’t were that efficient we’d all be Communists by now because that would the path to the highest living standards.

  57. Gravatar of Tyler Joyner Tyler Joyner
    20. February 2013 at 08:00

    TallDave, you forgot that the only reason Communism failed was because we didn’t have the real geniuses running the show. This time it will work!

  58. Gravatar of Scott Sumner Scott Sumner
    20. February 2013 at 08:38

    OhMy, You said;

    “There is no mechanism for the fiscal stimulus to crowd out private investment.”

    I never claimed there was. Reread my comment, which was about semantics, not economic causality.

    You said;

    “The monetary base is decided by the private sector, not the Fed, it is endogenous.”

    Not if the Fed targets the base. Again, reread my comment, I was giving you a hypothetical. Your response doesn’t address the point I made.

    Travis, I don’t agree with Yglesias on that point.

    Saturos, Yes, Soltas had some good posts on the job Fischer did at the Bank of Israel.

    I usually don’t comment on “multiplier” studies, as they generally ignore the monetary offset, and hence are meaningless.

    OhMy, You said:

    “But if you *assume* DeLong’s model is remotely relevant, then you are reduced to nonsensical defenses like “Japan’s CB wanted zero growth” despite it trying very aggressive policies like QE”

    Very aggressive? Surely you are joking. The BOJ raised interest rates in 2000 and again in 2006, when there was no inflation. They reduced the monetary base by 20% in 2006, despite no inflation. I have no idea why you think the BOJ wants inflation, when they clearly act like they do not. When the government suggested a 1% inflation target a few years back the BOJ had to be dragged kicking and screaming into this “high inflation” policy.

  59. Gravatar of TallDave TallDave
    20. February 2013 at 09:48

    That MMT site is certainly amusing. Among some other gems is a post claiming Treasury debt isn’t owed by taxpayers, but owned by them! It’s an asset!

    Oh my indeed.

  60. Gravatar of dtoh dtoh
    20. February 2013 at 10:24

    Scott,
    I agree with you and would just add that a convenient way to think about fiscal stimulus is that it works the same way as monetary stimulus. It is just a marginal increase in the exchange of financial assets (Treasuries) for real goods and services (whatever the government buys). The only difference is that monetary policy induces the exchange through financial asset prices and NGDP expectations, whereas fiscal stimulus mandates the exchange through legislative action.

  61. Gravatar of Tyler Joyner Tyler Joyner
    20. February 2013 at 10:55

    dtoh,

    Unless I’m mistaken, in a monetary scenario there is seigniorage and in the fiscal one there is not.

  62. Gravatar of Dtoh Dtoh
    20. February 2013 at 15:26

    Tyler,
    Assuming an equal increase in NGDP and no change in V, over the long run the increase in M will be the same in either scenario.

  63. Gravatar of Florarie online Florarie online
    20. February 2013 at 23:56

    Fiscal stimulus is almost always profitable from a political point of view, so the significance of the fact that another economist came to a more realistic assessment of fiscal policy is not important.

  64. Gravatar of A point on crowding out | Fifth Estate A point on crowding out | Fifth Estate
    2. March 2013 at 21:39

    [...] it might give the inference that I disagree with Sumner here (I [...]

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