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.