Two more nails in the Keynesian coffin

To say that today was a bad day for Keynesian economics would be an understatement.   Two more developments undercut the entire rationale for fiscal stimulus.

1.  The ECB cut rates by another quarter point. For those not keeping score at home, here are the ECB rate cuts that have occurred since the summer of 2011:

Deposit rate down 75 basis points.

Main refinancing operations rate down 125 basis points.

Lending rate down 150 basis points.

Recall that in 2011 Keynesians like Paul Krugman were saying the fiscal austerity was slowing growth in the eurozone, but only because the ECB was stuck at the zero bound. I suppose some people might try to argue that 1% or 1.5% interest rates are fairly close to the zero bound. Sorry, but that argument won’t work. As long as the ECB is raising and lowering interest rates they are effectively steering aggregate demand, and fiscal policy is fully offset by monetary policy. You might not like the direction in which the ECB was steering inflation and nominal GDP.  I certainly agree with Krugman that it was far too contractionary. But the fact remains that as long as they are steering aggregate demand then fiscal policy is completely ineffective.

2.  And there’s more bad news from the United States, or should I say “good news” that’s bad news for Keynesians. It was reported that real GDP grew 2.8% in the third-quarter. Here are the quarterly growth rates of real GDP over the last 7 quarters, official and the Philly Fed’s GDPplus:

Date       Official        GDPplus

2012:1      3.7%         3.58%

2012:2     1.2%          0.88%

2012:3     2.8%          1.32%

2012:4     0.1%          3.37%

2013:1     1.1%          2.66%

2013:2    2.5%           2.67%

2013:3    2.8%           2.82%

Note that according to official figures RGDP grew at a 1.95% rate in 2012.   At the end of 2012 the government raised income tax rates, capital gains tax rates, dividends tax rates, and payroll tax rates. In the spring government spending was reduced sharply under the sequester. After all that fiscal austerity, RGDP is growing at 2.13% so far in 2013. Due to the government shutdown Q4 growth will probably come in on the low side, but even so growth is likely to be almost identical to 2012, just as I predicted.

If you use the GDPplus data, RGDP growth averaged 2.29% in 2012 and has averaged 2.72% so far in 2013.

Note that the most dramatic difference between the two figures is in 2012:4. Because QE3 was announced in September 2012, some people cite the relatively slow real GDP growth in 2012:4 and 2013:1 as evidence that QE3 was ineffective. I certainly don’t think it had a major effect, but the new data suggest the economy did better than the official figures suggest.  RGDP has grown at nearly 3%/year since QE3 was announced (actually 2.88%). And monetary offset wins using either set of data.

The Keynesian model tells us nothing about fiscal austerity in the eurozone, because they have not been at the zero bound for most of the past five years. And it tells us nothing about fiscal austerity in the United States because (despite the zero bound) the Fed has used QE and forward guidance to offset the fiscal austerity of 2013.

The good news is that most Keynesians will not be upset by these developments, because they live securely inside a bubble. They will never even hear the arguments against fiscal stimulus, and will go on thinking that the last few years have been a glorious triumph for Keynesian economics. So there’s no need to feel sorry for them, they’re doing just fine.

PS.  In earlier comment sections Mark Sadowski showed that the Keynesian model predicted a sharp slowdown in 2013.

HT: Vaidas


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74 Responses to “Two more nails in the Keynesian coffin”

  1. Gravatar of Cory Cory
    7. November 2013 at 14:02

    I guess I just don’t understand the dispute.

    Moody’s for example predicted less than 2% growth if the Sequester stayed in place and 3% growth if it went away.

    http://www.bizjournals.com/louisville/news/2013/03/05/moodys-analytics-sees-gdp-growth-of-4.html?page=all

    This turns out to be wrong because the FED offsets any contractionary effect with Forward Guidance and QE.

    Don’t we agree that even if Forward Guidance and Quantitative Easing can offset contractionary fiscal policy that it would’ve been better to have expansionary fiscal policy, say, a full payroll tax cut, as well?

    It seems to me the only people who are wrong are people would say Monetary Policy is totally worthless to offset contractionary policy. Who are those people? Ron Paul?

    Seems to me that even those folks who want only expansionary fiscal policy and think QE and Forward Guidance is a Placebo would acknowledge that QE can work because even Placebos “work”.

    Seems to me growth is higher than it otherwise would’ve been because of QE and forward guidance but also lower than it otherwise would’ve/could’ve/should’ve been without the sequester + tax raises.

    I don’t know. I’m not an economist. Maybe you’re just trying to hammer home the point that in some more perfect would expansionary fiscal policy would be unnecessary and Keynesians would be better served to fight for that world rather than for tax cuts or spending increases (depending on their politics).

  2. Gravatar of SG SG
    7. November 2013 at 14:17

    Cory,

    I think Scott’s point is that without the sequester and tax raises that the Fed likely would have taken actions to limit inflation, thereby limiting NGDP growth and RDGP growth.

    I think the Fed’s dalliance with, and retreat from, the taper is compelling evidence that Scott is correct.

  3. Gravatar of Philippe Philippe
    7. November 2013 at 14:44

    “I think Scott’s point is that without the sequester and tax raises that the Fed likely would have taken actions to limit inflation, thereby limiting NGDP growth and RDGP growth.”

    I don’t get this point. Are you saying that if more expansionary fiscal policy had resulted in a higher rate of growth and thus slightly higher inflation, the Fed would have taken actions to reduce growth and inflation? Aren’t they desperately trying to get *more* growth and inflation?

  4. Gravatar of W. Peden W. Peden
    7. November 2013 at 15:11

    Philippe,

    “Aren’t they desperately trying to get *more* growth and inflation?”

    No. In fact, they are planning on having less-than-target inflation.

  5. Gravatar of Philippe Philippe
    7. November 2013 at 15:32

    “No. In fact, they are planning on having less-than-target inflation.”

    Do you mean that is what their current policy will result in, or do you mean that that is what they actually want?

  6. Gravatar of W. Peden W. Peden
    7. November 2013 at 15:35

    Philippe,

    That is what they forecast, and they have no announced plans to change policy such that they could forecast a different result. So the latter.

  7. Gravatar of SG SG
    7. November 2013 at 15:44

    Phillipe,

    Did you read Scott’s post? We’re now living in a world where the fed is chronically allowing the one macro variable over which it has total control–inflation–to run well below target, notwithstanding the most severe postwar recession having already caused unemployment to jump so much that it still remains higher than any point during the dot-com “recession.”

    Every Econ textbook teaches there is a short-run trade off between inflation and unemployment. The fed is behaving as if it doesn’t know this.

  8. Gravatar of Philippe Philippe
    7. November 2013 at 15:44

    you’re making the assumption that they could, if they wanted to, have anything they want.

  9. Gravatar of W. Peden W. Peden
    7. November 2013 at 15:45

    Philippe,

    No, I’m making the assumption that they could, if they wanted to, do more QE and/or forward guidance.

  10. Gravatar of Philippe Philippe
    7. November 2013 at 15:52

    ok. So if fiscal policy were to become more expansionary, they wouldn’t have a reason to act against it, would they?

  11. Gravatar of W. Peden W. Peden
    7. November 2013 at 15:54

    Philippe,

    Yes they would: inflation would then, ceteris paribus, be more than what they want.

  12. Gravatar of Philippe Philippe
    7. November 2013 at 16:03

    you lost me. You’re saying they want growth and inflation to be below their stated target?

  13. Gravatar of W. Peden W. Peden
    7. November 2013 at 16:10

    Philippe,

    Exactly. Hence they forecast that, and don’t act in such a way as to make them forecast hitting their targets.

  14. Gravatar of benjamin cole benjamin cole
    7. November 2013 at 16:14

    Not only is the Fed undershooting its inflation target for years on end (recession years no less) but the chances of higher inflation are much reduced from the 1960s-1970s.
    Gone is Big Labor, Big Steel, the Big 3, price-setting retailers (Sears). Then, little foreign trade.
    Top tax rate then 90 percent. Transportation, telecommunications rate regulated. OPEC.
    No Internet (price discovery).
    Even with Arthur Burns as Fed chief we barely hit double digit inflation back then.
    Actually, we need Burns as chief now…

  15. Gravatar of Philippe Philippe
    7. November 2013 at 16:18

    “Exactly. Hence they forecast that, and don’t act in such a way as to make them forecast hitting their targets.”

    That is ludicrously circular.

    1. They set an inflation target.
    2. They then forecast that the target won’t be achieved.

    3. Therefore, if fiscal policy becomes more expansionary, they will act against it to try to make sure that the target is not achieved.

    That sounds like a dumb argument to me.

  16. Gravatar of Philippe Philippe
    7. November 2013 at 16:19

    really dumb.

  17. Gravatar of Philippe Philippe
    7. November 2013 at 16:24

    sorry, that was a bit rude.

  18. Gravatar of W. Peden W. Peden
    7. November 2013 at 16:32

    Philippe,

    You miss out a key stage in the argument-

    1. The Fed has an (implicit) target.

    2. They forecast that they won’t hit that target AND they don’t take additional measures, which they could take, to try and hit it.

    3. Therefore, they don’t intend to hit their target. They intend for their forecasted outcome, which is not their target, to occur.

    4. Therefore, fiscal stimulus would raise the Fed’s forecast, such that inflation would be higher than what they intend, and the Fed can act to offset this fiscal stimulus.

    That’s not to say that fiscal stimulus would have no effect: it’s primary effect would be to crowd out private borrowing and spending, as if the Treasury model were true.

  19. Gravatar of @YoungEcon @YoungEcon
    7. November 2013 at 16:48

    It is my impression that some inside of the Fed are afraid. They think that there is a risk that they won’t be able to withdraw all the liquidity that they have put in the system when the economy really starts to pick up. They don’t want a gotcha from everyone who said they were going to cause hyperinflation, not that hyperinflation is even a possibility. They want to cut and run the first chance they get, because of politics. They don’t want to rock the boat any more than their unprecedented policy has already done. Yes, I think this is a little odd based on the data we have on inflation expectations, but it is one way I can make sense out of the asymmetric approach to the inflation “target”, being usually under. (Alternatively they are afraid of financial instability caused by QE, see the link below.)

    I don’t know if I am convinced that the fiscal multiplier is always 1, but right now I think it most likely is, if not lower.

    http://blog.supplysideliberal.com/post/65499463118/ben-bernanke-the-fed-does-less-monetary-stimulus-than

  20. Gravatar of @YoungEcon @YoungEcon
    7. November 2013 at 16:53

    I should note worrying about financial instability at this point is like fighting a new war like the last.

  21. Gravatar of Philippe Philippe
    7. November 2013 at 16:59

    Peden,

    why would they state a target and then actively try to not achieve that target?

  22. Gravatar of W. Peden W. Peden
    7. November 2013 at 17:08

    The Fed’s inflation target is implicit (unlike, say, the ECB or the BoE) and thus it has never actually been stated.

    Apart from that (rather minor) point, there is much more to a central banker’s utility function than hitting targets. For example, the Fed gets very little flak these days for having persistently sub-target inflation, but you can bet that persistently above-target inflation would result in even more outcry from those worried about high inflation than already exists.

  23. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. November 2013 at 17:19

    W. Peden,
    I largely agree with wht you are saying, but the Fed’s implicit inflation target became an explicit 2.0% PCEPI target in January 2012:

    http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm

  24. Gravatar of Dustin Dustin
    7. November 2013 at 17:21

    Peden,
    Fed targets 2% inflation. We are well under that target. The reason is A) the Fed secretly wants to undershoot stated targets, or B) the Fed doesn’t really know how to fine tune inflation in the current economic condition (if ever).

  25. Gravatar of Philippe Philippe
    7. November 2013 at 17:32

    “Following their December 2012 meeting, Federal Reserve policymakers indicated that they anticipated that a target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than 1/2 percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

    Policymakers said they viewed these thresholds as consistent with their earlier date-based guidance, which stated that they anticipated exceptionally low levels for the federal funds rate were likely to be warranted at least through mid-2015.”

    http://www.federalreserve.gov/faqs/money_19277.htm

  26. Gravatar of Mark A. Sadowski Mark A. Sadowski
    7. November 2013 at 17:33

    Phillippe,
    “why would they state a target and then actively try to not achieve that target?”

    The FOMC is a political organization, and regardless of the FED’s official inflation target and maximum employment mandate, many FOMC members have their own policy preferances.

  27. Gravatar of Elwailly Elwailly
    7. November 2013 at 17:35

    W. Peden,

    “4. Therefore, fiscal stimulus would raise the Fed’s forecast, such that inflation would be higher than what they intend, and the Fed can act to offset this fiscal stimulus.”

    This assumes the Fed is rational and functional. I think they would welcome inflation being pushed higher to their target by fiscal policy because they lack the political courage to do it themselves. This is evidenced by statements from Bernanke in the past warning congress that austerity is counterproductive.

  28. Gravatar of Philippe Philippe
    7. November 2013 at 17:44

    New York Federal Reserve President William Dudley:

    “We have established a threshold of 6.5 percent for the unemployment rate as long as we do not expect inflation to exceed 2 ½ percent at a one-to-two year horizon and inflation expectations remain well-anchored. It is likely to take a considerable amount of time to reach the 6.5 percent unemployment rate threshold. Moreover, because the 6.5 percent unemployment rate is a threshold, and not a trigger, depending on the economic circumstances, we might wait a long time after we breach the threshold before we begin to raise our federal funds rate target.”

    http://www.newyorkfed.org/newsevents/speeches/2013/dud130923.html

  29. Gravatar of Geoff Geoff
    7. November 2013 at 18:07

    This blogpost is misleading of Sumner’s beliefs.

    The title suggests that Keynesianism suffered a blow empirically, that is, due to specific past observations and relations between variables.

    But Sumner’s actual view about monetary policy is a priori. For when he says:

    “I certainly agree with Krugman that it was far too contractionary. But the fact remains that as long as they are steering aggregate demand then fiscal policy is completely ineffective”

    He is not actually claiming fiscal policy effectiveness is conditional on monetary policy “steering” or “not steering” aggregate demand. Despite the argument, in his view monetary policy is always steering aggregate demand. Even if the captain is asleep and the wheel is left idle, aggregate demand is still being determined by the arbitrary movements of the wheel as the ship coasts along at sea.

    So let’s not pretend that Sumner’s view on fiscal policy is conditioned by observable data. It is instead a method of interpreting any data whatever.

    Fiscal policy to Sumner is always “ineffective” because the “real” controller is the Fed, not the Treasury. The Fed decides NGDP, not the Treasury.

    (Nothing of the above is an endorsement…)

  30. Gravatar of ssumner ssumner
    7. November 2013 at 18:09

    Cory, What’s the point of fiscal policy if it’s offset by the Fed?

    Philippe, You said;

    “Aren’t they desperately trying to get *more* growth and inflation?”

    I refuse to believe they are that incompetent. If they don’t know how to create inflation with fiat money, I’d be glad to show them how. Of course they do know how, which is why they are considering tapering. They don’t want to do too much.

    You said;

    “Do you mean that is what their current policy will result in, or do you mean that that is what they actually want?”

    It doesn’t matter what they really want, it matters what they do.

    Mark, You said;

    “The FOMC is a political organization, and regardless of the FED’s official inflation target and maximum employment mandate, many FOMC members have their own policy preferences.”

    This is a really important point, and it means that one must be careful talking about “what the Fed wants.” (And yes, I’m guilty sometimes.)

    Everyone, I am not claiming the fiscal multiplier is zero in each and every case. I am claiming:

    1. It is zero if the Fed is rational.
    2. The data for 2013 is consistent with a zero multiplier.

    One can draw up plausible scenarios where there is some positive effect from fiscal stimulus. But I think it’s a pretty weak argument without stronger empirical support. In any case, we pundits need to push for monetary stimulus, which is a far more effective and far more rational stabilization policy (as compared with counting on Congress.)

  31. Gravatar of ssumner ssumner
    7. November 2013 at 18:10

    BTW, No one mentioned the ECB, which is a much bigger embarrassment for the Keynesian anti-austerity position. They haven’t even been at the zero bound!

  32. Gravatar of Andrew Andrew
    7. November 2013 at 18:12

    Hi Scott,

    I’m curious as to whether you have any theories as to why Euro stocks were down sharply today despite the “surprise” rate cut. Still too tight? Or other factors at play? Or both?

    Thanks!

  33. Gravatar of Philippe Philippe
    7. November 2013 at 18:19

    Scott,

    “Everyone, I am not claiming the fiscal multiplier is zero in each and every case. I am claiming:

    1. It is zero if the Fed is rational.”

    it seems to me that what you are saying is the fiscal multiplier is zero in an alternative world where the Fed follows your prescriptions exactly and it turns out that they work exactly as you think they would.

  34. Gravatar of Mike Sax Mike Sax
    7. November 2013 at 18:27

    Keynesianism must have a very big coffin Scott. Every three posts you’re jubilating over another nail in its coffin.

  35. Gravatar of Geoff Geoff
    7. November 2013 at 18:45

    “1. It is zero if the Fed is rational.”

    So “rational” must mean the Fed is stabilizing NGDP.

    If “offset” is defined in terms of NGDP, then it’s a tautology.

  36. Gravatar of Steve Steve
    7. November 2013 at 18:52

    “Two more nails in the Keynesian coffin”

    Doesn’t a bed of nails become more comfortable with the addition of more nails?

  37. Gravatar of Philippe Philippe
    7. November 2013 at 18:57

    “rational” seems to mean that the Fed does exactly as Scott says, and everything that Scott says is absolutely correct.

  38. Gravatar of Mike Sax Mike Sax
    7. November 2013 at 19:26

    Is there any news or data that could possibly disprove your claims here about fiscal policy? If not then Geoff is right.

  39. Gravatar of Dustin Dustin
    7. November 2013 at 19:31

    The argument isn’t that the Fed doesn’t know how to achieve inflation. Rather, the Fed isn’t confident inflation can be dialed in at 2% without accompanying risk of much greater levels inflation…. Pandoras Box, if you will.

    The Fed does prefer 2% inflation, but under target is better than over target (in their view).

  40. Gravatar of Edward Edward
    7. November 2013 at 20:13

    I’m not a Keynesian Scott, but If i were one, I would respond like this:

    Ceteris paribus, Without fiscal austerity, growth would have been higher than it was. And if you’re talking about contractionary offset, remember, we’re far below where we need to be even by the Fed’s pathetic criteria, so offset wouldn’t have applied, and fiscal policy would have provided an extra boost to get to where the Fed wanted to go.

    “I refuse to believe they are that incompetent. If they don’t know how to create inflation with fiat money, I’d be glad to show them how. Of course they do know how, which is why they are considering tapering. They don’t want to do too much.”

    Either they’re incompetent or sadistic. Either thought is depressing.

  41. Gravatar of Don Geddis Don Geddis
    7. November 2013 at 20:44

    Edward: “we’re far below where we need to be even by the Fed’s pathetic criteria, so offset wouldn’t have applied

    Nope. All the talk of the “taper” made it clear that many voices on the Fed already wish to make policy more contractionary, even though the economy is far below target.

    The Fed is not currently “out of ammunition”, and the economy is below target, yet the Fed is already consciously choosing not to make policy more expansionary. You need to explain that current behavior, before you can credibly make a prediction about what the Fed “would do” if fiscal stimulus had provided an “extra boost”.

  42. Gravatar of Don Geddis Don Geddis
    7. November 2013 at 20:49

    Philippe: “the fiscal multiplier is zero … where the Fed follows your prescriptions exactly and it turns out that they work exactly as you think they would.

    Not at all. The behavior of both the ECB and the Fed in the last few years (and Japan in the last couple of decades) have given clear examples of monetary offset to fiscal stimulus (or austerity), without coming anywhere close to Sumner’s call for NGDPLT. The central banks all have the power to offset fiscal changes; they don’t need to be heading towards Sumner’s targets in order to force a zero multiplier.

  43. Gravatar of Don Geddis Don Geddis
    7. November 2013 at 20:56

    Geoff: “in [Sumner's] view monetary policy is always steering aggregate demand. Even if the captain is asleep and the wheel is left idle, aggregate demand is still being determined by the arbitrary movements of the wheel as the ship coasts along at sea.

    Not at all. Lots of things influence aggregate demand, just as ocean currents and wind and storms will influence where the ship hits land, not just the arbitrary movements of the wheel.

    Sumner’s point is that the wheel gives the captain the power to hit whatever target he wishes to hit, regardless of currents and wind and storms. Also, that there’s no such thing as “not using monetary policy”, because the wheel always has some setting.

    But for your strange central bank that chooses random monetary policy, aggregate demand is not determined solely by looking only at monetary policy. In that case, lots of other factors in the economy would also affect the final level of aggregate demand.

  44. Gravatar of Geoff Geoff
    7. November 2013 at 21:15

    “Sumner’s point is that the wheel gives the captain the power to hit whatever target he wishes to hit, regardless of currents and wind and storms. Also, that there’s no such thing as “not using monetary policy”, because the wheel always has some setting.”

    That is precisely why my first paragraph that you quoted:

    “in [Sumner's] view monetary policy is always steering aggregate demand. Even if the captain is asleep and the wheel is left idle, aggregate demand is still being determined by the arbitrary movements of the wheel as the ship coasts along at sea.”

    Is true.

    “But for your strange central bank that chooses random monetary policy, aggregate demand is not determined solely by looking only at monetary policy. In that case, lots of other factors in the economy would also affect the final level of aggregate demand.”

    Not at all. Aggregate demand here would be a function of the random movements of the steering wheel.

    The location of the ship at sea can be understood SOLELY by the movements the wheel makes. We can imagine the movements the wheel makes when there is nobody behind it, to be identical with the movements it would make with a drunken sailor behind it. In both cases, aggregate demand will be solely determined by the wheel movements.

    It does not follow from the wheel being moved a particular way rather than another (i.e. someone behind the wheel as opposed to nobody behind the wheel), that aggregate demand is sometimes determined by the movements of the wheel and sometimes not, depending on the movements themselves.

    A random monetary policy, like you said, it still “a” monetary policy, and as such, will determine aggregate spending.

    If you imagine that under a random monetary policy that an implementation of government spending can change aggregate demand, then like Sumner has pointed out endlessly, the resulting aggregate demand was determined by “monetary policy ineptitude”, NOT the government spending itself.

    You might not like this, but the “cost”, if you will, of believing in the notion that “rational” monetary policy totally offsets all other actions that would seem to move money in another way, is that monetary policy totally offsets all other actions that would seem to move money under ALL scenarios.

    Don’t get confused with the correlations between government spending and aggregate demand under a “random” monetary policy. Monetary policy is still determining aggregate demand, by acting in such a way, or rather, not acting in such a way, that exactly mirrors the government spending changes.

  45. Gravatar of Geoff Geoff
    7. November 2013 at 21:19

    Edward:

    “Ceteris paribus, Without fiscal austerity, growth would have been higher than it was.”

    Ceteris paribus, if government austerity were even larger, then growth would have been higher than what it was.

    Is there a way to decide which of the above two theories are correct, given that they are both 100% consistent with history as it transpired?

  46. Gravatar of Doug M Doug M
    7. November 2013 at 22:35

    Real growth was 2.8% but much of that was “involuntary inventory accumulation” and real final demand was only 2.0%

  47. Gravatar of Saturos Saturos
    7. November 2013 at 23:45

    The Chicago Fed on Bitcoin: http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2013/cfldecember2013_317.pdf

  48. Gravatar of Ralph Musgrave Ralph Musgrave
    8. November 2013 at 02:20

    Scott, Your argument that if the central bank is steering demand, then fiscal policy is ineffective is a bit like saying pressing on the accelerator in a car won’t increase speed if someone else has their foot on the brake and is determined to stop the car accelerating. That’s not a good argument against having accelerators in cars designed to enable to the driver to speed the car up.

    I think fiscal policy is a good way of implementing stimulus, and when I say “fiscal policy” I certainly assume the central bank is not deliberately thwarting that fiscal policy. Moreover, I assume that fiscal policy (i.e. having government borrow and spend) will raise interest rates, and given that SOME SORT OF stimulus is desirable, I assume the central bank will at the very least stop any such interest rate rise. Indeed, assuming stimulus is needed, the CB will probably be REDUCING rates.

    The argument here is over the dividing line between or definition of fiscal and monetary policy, isn’t it?

  49. Gravatar of Ralph Musgrave Ralph Musgrave
    8. November 2013 at 02:37

    In fact Keynes specifically said that having the government / central bank machine print and spend was a viable alternative to “borrow and spend”, so I assume that “Keynsianism” includes enough monetary boost to stop the interest rate increases that might otherwise stem from a pure “borrow and spend” policy.

  50. Gravatar of W. Peden W. Peden
    8. November 2013 at 03:43

    Mark A. Sadowski,

    Thanks for the update.

    Dustin,

    “Fed targets 2% inflation. We are well under that target. The reason is A) the Fed secretly wants to undershoot stated targets, or B) the Fed doesn’t really know how to fine tune inflation in the current economic condition (if ever).”

    Both of those can be true, and both are true. All I need to assume to prove that the Fed doesn’t want <2% inflation is the fact that they forecast undershooting that target over the next few years and have no announced plans to introduce countervailing measures. That's what you have to disprove to show that the Fed "desperately wants more inflation and growth".

    Elwailly,

    "This assumes the Fed is rational and functional. I think they would welcome inflation being pushed higher to their target by fiscal policy because they lack the political courage to do it themselves. This is evidenced by statements from Bernanke in the past warning congress that austerity is counterproductive."

    Would they have the political courage to maintain stimulus if inflation was higher? If so, it's hard so see why they wouldn't be willing to contemplate greater stimulus, especially given that they've been willing to introduce QE2 and QE3 in the past. Anyway, even if what you're saying is true, then it's still false to say that the Fed "desperately wants more inflation and growth" – it clearly doesn't want to pay the political price of pursuing 2% inflation.

    Don Geddis,

    "The Fed is not currently “out of ammunition”, and the economy is below target, yet the Fed is already consciously choosing not to make policy more expansionary."

    Exactly. The Fed doesn't seem like a central bank that's willing to tolerate inflation much above 2%, and therefore wouldn't tolerate fiscal stimulus. Keynesian fiscal policy is utterly irrelevant in the contemporary US.

  51. Gravatar of Brian Brian
    8. November 2013 at 04:40

    Ralph Musgrave – Monetary stimulus is both the accelerator and the brake. Fiscal stimulus is trying to speed up or slow down a truck by throwing the cargo off with enough velocity to change the speed of the vehicle. Monetary is free, Fiscal is not.

  52. Gravatar of Andy Andy
    8. November 2013 at 06:11

    So Scott claims that fiscal austerity hasn’t had any effect on US growth this year because Fed has offset. Krugman claims that austerity has had effect because Fed hasn’t got enough tools at the zero bound. Both are fair claims and both SS and PK are declaring victories of their ideas.

    However, is there actually any way to be sure which claim is true? How can we for example know that growth wouldn’t have been even better if fiscal stimulus had taken place?

  53. Gravatar of Edward Edward
    8. November 2013 at 08:24

    Geoff,

    We have a natural experiment in fiscal austerity+monetary minuscule laxity, (the U.S.) vs fiscal and monetary austerity.

  54. Gravatar of Don Geddis Don Geddis
    8. November 2013 at 09:21

    Brian: “throwing cargo off” LOL. Love the analogy.

    Andy: “Fed hasn’t got enough tools” That’s just objectively false. We already know lots and lots of actions that the Fed could take, to be more expansionary, that they are choosing not to take. Look no further than all the talk of “tapering”.

    Geoff: “the “cost”, if you will, of believing in the notion that “rational” monetary policy totally offsets all other actions that would seem to move money in another way, is that monetary policy totally offsets all other actions that would seem to move money under ALL scenarios.

    Nope, unfortunately you still don’t understand. The economy is a car, and the Fed is the gas pedal. A “rational” driver can use the gas pedal to maintain constant speed, regardless of up or down hills in the road. But if the driver chooses not to use the gas pedal in that way, well then it’s foolish to claim that the hills have no effect on the car’s speed. With random inputs to the gas pedal, the car will (on average) go slower uphill, and faster downhill.

    The Fed only has the power to offset other nominal factors (like fiscal stimulus). You’re simply wrong to believe that no other factors have any influence at all. Monetary policy only (fully) determines NGDP, if the Fed wishes it to be so. If they don’t choose to control it, then lots of factors influence NGDP, not just monetary policy.

  55. Gravatar of Edward Edward
    8. November 2013 at 09:47

    “vs fiscal and monetary austerity.”

    In Europe

  56. Gravatar of Ralph Musgrave Ralph Musgrave
    8. November 2013 at 10:01

    Brian,

    Monetary is free in the sense that the central bank prints money (which costs nothing) and buys securities.

    Fiscal is also free, at least in the sense that can consist of the government / central bank machine printing money and spending it on roads, education and the usual public spending items. Or government can cut taxes. Certainly that is presumably what Keynes meant when he said that one option for government in a recession is to print money and spend it. The latter policy also tends to be advocated by MMTers, and is advocated by the following lot:

    http://www.positivemoney.org.uk/wp-content/uploads/2010/11/NEF-Southampton-Positive-Money-ICB-Submission.pdf

  57. Gravatar of ssumner ssumner
    8. November 2013 at 11:07

    Andrew, Good question, perhaps someone else can answer:

    1. Were they down sharply on the ECB announcement?
    2. Was there any other news they seemed to react strongly to?

    Philippe, It’s the expected multiplier that matters for policy, so whether things turn out as expected is much less important than what is expected.

    Mike, You said:

    “Keynesianism must have a very big coffin Scott.”

    There are a lot of Keynesians that need to be buried, and some of them are rather obese.

    Ralph, You said:

    “That’s not a good argument against having accelerators in cars designed to enable to the driver to speed the car up.”

    But it is a good argument against pressing the accelerator and wasting gas when the brake is engaged.

    Regarding your other point, Keynes said everything at one time or another. Don’t confuse what Keynes said with Keynesian economics, which is what Keynes said in 1933-38

    Andy, You said;

    “However, is there actually any way to be sure which claim is true?”

    Read my next post, and Paul Krugman will explain how we find out which theory is true. Krugman is right about the method, but you won’t hear him discuss the outcome of the experiment he proposes.

  58. Gravatar of Brian Brian
    8. November 2013 at 14:15

    Ralph – Point taken. In my mind though, the printing of money is monetary stimulus and that is a separate event from what you do with it. Not sure if that is correct. The cost of the fiscal stimulus is the opportunity cost of what you are giving up to do it.

  59. Gravatar of Alex Hummel Alex Hummel
    9. November 2013 at 02:06

    Hello Mr. Sumner!

    Dont’t you think, that you attribute too much significance to the ECB policy rates? When someone speaks about the zero lower bound in the US they usually mean, that the Federal Funds Rate is near 0%, which it actually has been since December 2008. The counterpart of the Federal Funds Rate in the euro zone is EONIA (Euro OverNight Index Average), which has been around 0,1% since September 2012. And even bevore September 2012, since at least 2009, it has been significantly below the MRO rate. So, I think, one can safely say, that the euro zone hat been at the ZLB for at least 1 year.

  60. Gravatar of ssumner ssumner
    9. November 2013 at 08:29

    Alex, Sorry, but the markets say you are wrong. The euro fell sharply on the recent rate cuts.

  61. Gravatar of Mike Sax Mike Sax
    9. November 2013 at 08:53

    “There are a lot of Keynesians that need to be buried, and some of them are rather obese.”

    OhmyGod Scott. A shot about someone’s weight? Do you have any for instances?

  62. Gravatar of Alex Hummel Alex Hummel
    9. November 2013 at 13:36

    “Alex, Sorry, but the markets say you are wrong. The euro fell sharply on the recent rate cuts.”

    Hmm sorry,but unfortunately I don’t understand how me being wrong follows from the euro’s tumbling after the MRO’s cut. Yes, “the markets” have probably understood the rate cut as a (powerful) signal that the ECB will increase the monetary base again (Mr. Draghi in his press conference actually mentioned the possibility of new LTRO’s along with negative deposit rates and another similar magic gimmics) and therefore weaken the euro, but how does this contradict my statement, that the euro zone is at the ZLB?

  63. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. November 2013 at 15:15

    Alex Hummel,
    “The counterpart of the Federal Funds Rate in the euro zone is EONIA (Euro OverNight Index Average), which has been around 0,1% since September 2012. And even bevore September 2012, since at least 2009, it has been significantly below the MRO rate. So, I think, one can safely say, that the euro zone hat been at the ZLB for at least 1 year.”

    Some banks are getting unsecured overnight funds at the EONIA rate but many banks, especially banks on the periphery, which is about a third of the eurozone by NGDP, are partially or totally cut out of the unsecured interbank market and can only finance themselves through the ECB’s operations at the MRO rate.

  64. Gravatar of Alex Hummel Alex Hummel
    10. November 2013 at 01:36

    @Mark A. Sadowski

    I agree in principle, but would rather say that there are SOME banks, who are cut out of the interbank market, while MANY (a big majority) either don’t need liquidity at all or can refinance themselves at the at the EONIA rate. This it of course only a kind of gut feeling, because I wasn’t able to find any numbers about that, do you have any ? But I think too, that most “zombies” reside at the periphery.

    The only indirect hint I have is the fact, that the number of the participants at the MRO-tenders has dropped from ca. 350 prior to the finacial crisis, to only ca. 70 today.

    So I think, that today the role the MRO-rate plays, if it plays any at all, is rather comparable to the FED discount rate – the rate for the banks, who are anable to refinance themselves at the market rate.
    One can also say, that the MRO’s today are being used as partly supplement partly replacement for the marginal lending facility

  65. Gravatar of Mark A. Sadowski Mark A. Sadowski
    10. November 2013 at 08:37

    Alex Hummel,
    “This it of course only a kind of gut feeling, because I wasn’t able to find any numbers about that, do you have any ?”

    The information I have is very sketchy and comes primarily from private investment firms.

    For a general discussion see pages 5-6:

    http://fulcrumasset.com/datasource/FRN201301.pdf

    For a discussion providing some specifics on how bad the Spanish and Italian situation is see this:

    http://www.alhambrapartners.com/2013/04/28/liquidity-perspective-europe/

    The latter seems to indicate that the refinancing situation in the lion’s share of the periphery is, if anything, even worse than it was two years ago.

    “The only indirect hint I have is the fact, that the number of the participants at the MRO-tenders has dropped from ca. 350 prior to the finacial crisis, to only ca. 70 today.”

    Can you provide a link?

    “So I think, that today the role the MRO-rate plays, if it plays any at all, is rather comparable to the FED discount rate – the rate for the banks, who are anable to refinance themselves at the market rate.”

    I completely disagree.

    In the US depository institutions have absolutely no difficulties refinancing themselves. The Fed Funds rate is effectively the rate at which depository institutions borrow unused reserves from GSEs and international institutions who have accounts with the Fed but who are not eligible for interest on reserves. Thus US depository institutions are in a highly advantageous position with respect to refinancing.

    In the Euro Area, in contrast, a very large proportion of depository institutions are completely cut out of the unsecured interbank market.

    “One can also say, that the MRO’s today are being used as partly supplement partly replacement for the marginal lending facility.”

    Well, I would not be surprised if the MLF is hardly being used at all right now, but that is not a testament to how easily refinancing is obtained. It is a testament to how incredibly fragmented the Euro Area financial markets have become.

  66. Gravatar of Monday Morning Links | timiacono.com Monday Morning Links | timiacono.com
    11. November 2013 at 03:01

    [...] Job Market Doldrums Continue – Econospeak Two more nails in the Keynesian coffin – Money Illusion Q3 GDP Investment: Residential rises, commercial low – Calculated Risk [...]

  67. Gravatar of ssumner ssumner
    11. November 2013 at 06:33

    Alex, If the economy is at the zero bound then the central bank cannot depreciate the currency by cutting the policy rate. That’s standard Keynesian theory. But the ECB just did that.

  68. Gravatar of Alex Hummel Alex Hummel
    11. November 2013 at 11:37

    @Mark A. Sadowski

    Thanks for your links, especially the second. Is indeed very interesting, but unfortunately the too provide only patchy data (without sources).

    As I see it, our diskussion is now mainly about the question whether ALL the banks in the periphery are cut out of the interbank market and rely on the ECB for the refinancing instead or it’s only a minority, albeit probably a sizable one. Because we can’t definitely answer this question, we have no choice as agree to disagree ?

    Perhaps we could agree that the banks in the core aren’t cut out from the market, so that one can at least say, that the core euro countries are now at the ZLB (EONOA = 0,1%), while the periphery countries are possibly not and could perhaps be stimulated by the MRO-rate cut (though your second links doubts it)?

    P.S Here ist the link to the historical data about the MRO tenders (I used “Data as presented in the Monthly Bulletin”).

    @ssumner

    Sorry, but I still can’t follow your reasoning. If the central bank cuts it’s policy rate (which can be the overnight interest rate like in the US or something different), then it usually leads, under normal conditions, to the drop of the overnight interest rate and then via impact on the whole interest rate structure to the depreciation of the currency. That is indeed the standard theory (at least how I see it, I’m no expert). But if the overnight interest rate is already zero, which you can see from the market fixings, and other short term rates too, like in the euro zone today, the central bank then cuts it’s policy rate and the currency depreciates – what do you conclude from that? That the short term rates weren’t zero in the first place? But they were, you can see it!

  69. Gravatar of Alex Hummel Alex Hummel
    11. November 2013 at 11:40

    @Mark A. Sadowski

    Here ist the link again: http://www.ecb.europa.eu/mopo/implement/omo/html/top_history.en.html

  70. Gravatar of Vince Cate Vince Cate
    11. November 2013 at 15:50

    Krugman is cheering Japan on in their extreme deficit spending and extreme money printing. I think they are only a few months from hyperinflation. If I am right, then Keynesian theory should really die.

  71. Gravatar of European Central Bank Lowers Interest Rates, Trumping "Zero Lower Bound" Theory | The Foundry: Conservative Policy News Blog from The Heritage Foundation European Central Bank Lowers Interest Rates, Trumping "Zero Lower Bound" Theory | The Foundry: Conservative Policy News Blog from The Heritage Foundation
    12. November 2013 at 12:32

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  72. Gravatar of European Central Bank Lowers Interest Rates, Trumping “Zero Lower Bound” Theory | European Central Bank Lowers Interest Rates, Trumping “Zero Lower Bound” Theory |
    12. November 2013 at 12:41

    [...] So when the ECB lowered rates on Thursday, it proved that rates had not been at the lower bound and that the ECB was not permanently unwilling to lower interest rates. Economist Scott Sumner called the move a nail in the coffin of Keynesianism. [...]

  73. Gravatar of European Central Bank Lowers Interest Rates, Trumping “Zero Lower Bound” Theory | Tony Johnson European Central Bank Lowers Interest Rates, Trumping “Zero Lower Bound” Theory | Tony Johnson
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    [...] So when the ECB lowered rates on Thursday, it proved that rates had not been at the lower bound and that the ECB was not permanently unwilling to lower interest rates. Economist Scott Sumner called the move a nail in the coffin of Keynesianism. [...]

  74. Gravatar of The ECB rate cut was driven by the needs of Germany, not the needs of the Eurozone | British Politics and Policy at LSE The ECB rate cut was driven by the needs of Germany, not the needs of the Eurozone | British Politics and Policy at LSE
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