What is “the” fiscal multiplier? It depends.

This is from today’s WSJ:

Central bankers elsewhere are strongly indicating that they are preparing to open credit spigots to reflate their economies at a time when fiscal policy is stalled or contracting.

Not just “at a time,” but also “because.”  The multiplier is often described as the increase in GDP resulting from a fiscal stimulus, holding monetary policy constant.  But of course that’s not what we are interested in.  We want to know the increase in GDP that will occur, compared to the likely path if fiscal stimulus does not occur.  And that’s a much trickier proposition.


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75 Responses to “What is “the” fiscal multiplier? It depends.”

  1. Gravatar of Samuel O. Samuel O.
    6. October 2010 at 08:55

    On the issue of on of your previous postings on Stiglitz etc.:

    New article by Stiglitz: http://www.project-syndicate.org/commentary/stiglitz130/English (2010-10-06)

    And, in contrast, a nicely written blog article by Krugman: “Monetary Versus Fiscal” http://krugman.blogs.nytimes.com/2010/10/06/monetary-versus-fiscal/

  2. Gravatar of Benjamin Cole Benjamin Cole
    6. October 2010 at 08:56

    Oh, you are letting professional obligations get in the wayt of blogging? Jeez, next we will hear that your family wants to see you. What next?

    Excellent blog. I sense the tide is turning in your favor. I look forward to more blogs when they come.

    BTW, some of us slow-pokes are still reasoning though your earlier blogs, so a respite is fine with me!

    Go monetary bulls!

  3. Gravatar of Dustin Dustin
    6. October 2010 at 09:55

    I’m with Benjamin, yet again. I can’t believe Sumner is going to put professional obligations before this blog. How cruel. Alas.. I might as well go back to early blog posts and start reading.

  4. Gravatar of marcus nunes marcus nunes
    6. October 2010 at 12:09

    They try hard (maybe a waste of time) but fail to find a positively sloped AD curve!
    http://www.frbatlanta.org/documents/news/conferences/10cqer_braun.pdf

  5. Gravatar of TravisA TravisA
    6. October 2010 at 12:18

    All those studies trying to estimate the multiplier are absolutely useless. I’d hate to be someone who devoted significant amounts of my career to that goal.

    Hopefully one lesson learned from this recession is that monetary policy is the only lever needed, even at the zero bound.

    Another lesson is for the Fed not to fall behind the curve by mistaking interest rates for ease or tightness of monetary policy.

    The third lesson is that Scott should be Fed chairman.

  6. Gravatar of Morgan Warstler Morgan Warstler
    6. October 2010 at 12:26

    “Hopefully one lesson learned from this recession is that monetary policy is the only lever needed, even at the zero bound.”

    If Scott can be the guy who convinces liberals to give up on Fiscal Stimulus… he will get a Nobel.

  7. Gravatar of Morgan Warstler Morgan Warstler
    6. October 2010 at 12:35

    Because the next step is liberals FINALLY figuring out deficit spending ceased to be a winning gambit for them when Reagan adopted a “spend it all first,” defense.

    The right would gladly trade military spending for a balanced budget amendment… but they won’t until they are guaranteed that less guns won’t mean more butter. People are fat enough as it is.

    I used to think we’d have to wait another generation or so for liberals to learn to love a BBA, but with many suddenly turning towards Monetary… this might be the first step to get them there.

  8. Gravatar of Benjamin Cole Benjamin Cole
    6. October 2010 at 12:43

    BTW, whether by Sumner’s doing or otherwise, QE is suddenly everywhere. Krugman’s last two posts are on QE, and the WSJ print version today has a profile on St. L. Fed President James Bullard, and his conversion to QE.

    Monetary Bulls unite! Smite the prim Japan Wingers!

  9. Gravatar of Lee Kelly Lee Kelly
    6. October 2010 at 12:47

    Surely the fiscal multiplier is the fraction by which government spending grows as a proportion of GDP from year to year, right? Makes more sense, in any case.

  10. Gravatar of Liberal Roman Liberal Roman
    6. October 2010 at 13:17

    @Benjamin Cole,

    Actually one of Krugman’s recent post had a not so veiled attack at Sumner:

    “So I didn’t and don’t think that we can count on monetary policy to do the job; blithely declaring that the Fed should target nominal GDP misses the difficulties. And that means we need fiscal policy.”

    http://krugman.blogs.nytimes.com/2010/10/06/monetary-versus-fiscal/

    I think Krugman is wrong on that point, but I do think he is right on something else:

    “My guess is that the market is expecting more than the Fed will deliver. But I’d be happy to be proved wrong.”

    http://krugman.blogs.nytimes.com/2010/10/06/the-market-believes-in-qe2/

    We are getting very optimistic here at this blog, overly so in my opinion. I fear, 6 months from now, we are going to be sitting here depressed and reading speeches by Fed officials saying that they are worried about too high inflation expectations.

  11. Gravatar of ssumner ssumner
    6. October 2010 at 13:41

    Benjamin and Dustin, If I had someone new come to my blog, I suggest he read the February 2009 posts. It’s the quickest way to get a sense of where I’m coming from.

    Marcus, Thanks, I’ll take a look. Of course I’ve always been skeptical of that idea.

    TravisA, I agree with your first two points. I don’t want to sound modest in a phony way, so let me say this with complete sincerity. I do believe my ideas would be useful to the Fed, so I think they’d benefit from having me talk to them. But I wouldn’t be a good Fed chairman, because my focus is very narrow. I don’t study commercial banking, and during the financial crisis knew very little about the complex stuff going with derivatives, etc. The Fed Chairman has to have broader knowledge than someone like me has. Of course I’d never be picked, but even if I was a top economist at Harvard, I wouldn’t be a good pick. I seem to recall that Krugman recommended nationalizing the banks, and DeLong quickly said that wouldn’t work. In that sense Krugman’s a bit like me, a very good understanding of monetary principles, but not enough knowledge of the real world for a position like Fed Chairman.

    I’d never be asked because I’m not well known, but even if I was well known, it wouldn’t be the job for me. The job I’d want is chief economist advising Bernanke on monetary affairs.

    Morgan, Fed Chairman, Nobel . . . you guys have got to stop inflating my ego. I already sound too much like a know-it-all in my posts. I’m constantly striving to emulate people like Nick Rowe and David Beckworth who sound more modest.

    Benjamin, This is great news, I haven’t had time to read Krugman yet.

    Lee, It’s supposed to be the ratio of the rise in output divided by the rise in government spending.

  12. Gravatar of ssumner ssumner
    6. October 2010 at 13:53

    Samuel O, So Krugman says that all non-Keynesian explanations are basically supply-side? What happened to the quasi-monetarists he was just talking about the other day?

    Liberal Roman, I understand where Krugman is coming from. It’s a matter of fact that the Fed probably won’t do enough, but the same is true of Congress. It is far more likely that the Fed changes it’s mind and does real stimulus, than it is that the Congress suddenly does another trillion in stimulus.

    The market isn’t expectating all that much, if they were expecting a lot the Dow would rise 2000 points.

    Don’t say “we” are getting optimistic, I’m still pessimistic, just a bit less pessimistic than in August.

    Overall I mostly agree with your comment.

  13. Gravatar of Morgan Warstler Morgan Warstler
    6. October 2010 at 14:50

    Scott, I’m giving you your post route to run…

    Focus on proving fiscal has no multiplier, win over the liberals… get them grasping at your QE, and right when you got ’em thinking they found nirvana, we’ll get them on a BBA, and then start using targeted NGDP as the reason to take money OUT of the economy.

    It’ll be glorious.

  14. Gravatar of Randall Randall
    6. October 2010 at 15:27

    Scott-
    I really enjoy your blog. I’m no economist, and generally don’t feel qualified to comment on your post. But on this issues, as a 20 year investment banker, I can say with confidence the proposed QE is a bad idea if the goal is to create jobs. Here is why, besides having ZERO affect- it will most likely have a negative affect by diluting the dollar and inflating hard assets while reducing household liquidity. The problem is AD and the problem with AD is the lack of consumer credit worthy borrowers. QE by he Fed will just add capital to bank balance sheets and thats where it will stay until increase appetite for risk and reduce credit criteria. Liquidity of banks is not the problem today- look at their balance sheets. The problem risk avoidance by the financial community.

  15. Gravatar of Fed Up Fed Up
    6. October 2010 at 15:37

    This question is for everyone and might be hard for Scott since I think he does not believe that the demand deposits created from debt are medium of exchange/money.

    Is all NEW (emphasize NEW) medium of exchange/money from debt?

  16. Gravatar of Benjamin Cole Benjamin Cole
    6. October 2010 at 16:21

    Liberal Roman:

    Sumner has succeeded by getting QE on the table.

    Not everyone is going to like QE; but before it wasn’t even getting ink (or pixels). More and more releavnt people are considering QE and even a monthly QE program.

    That is why I encourage monetary bulls to participate in every forum you can. Ideas rule the day not only on merits but on presentation and convention.

    The more QE can be seen as somewhat accepted and conventional, the better. The more it is talked about, the better.

    Don’t underestimate the influence you can have. QE is a very small niche of the policy-making world. Not a lot of people are interested in this topic.

    Sheesh, what minute percent of the population evens knows what is QE? I bet we are trying to influence 1000 people or less.

    Give me a PR budget of $100k and I would win this argument. (I have worked in financial PR).

  17. Gravatar of TravisA TravisA
    6. October 2010 at 16:39

    Krugman’s post at least somewhat explains his contradictory posts about monetary policy in the past.

    http://krugman.blogs.nytimes.com/2010/10/06/monetary-versus-fiscal/

    It’s so ironic that he has utter faith in the efficacy of fiscal policy (“…if the government goes and buys a trillion dollars’ worth of stuff, that will create a lot of jobs.”) and such doubt about monetary policy. Really? Japan didn’t do enough for you, Paul. What if we need more? What if two trillion isn’t enough? Three trillion?

    According to Paul, monetary policy is supposedly tricky at the zero bound. How is the economics of monetary policy any different at the zero bound rather than at the non-zero bound? You could paste and cut all his arguments about monetary policy and apply them to cutting short term interest rates.

    Paul writes about the hoary chestnut of housing not being able to pull us out of a recession. The same argument could be applied to argue for the inefficacy of his fiscal policy. We could spend $2 trillion in publics works, but if housing doesn’t come back we won’t have a self-sustaining expansion. So we will have spent $2 trillion for nothing. You can’t have it both ways.

    People vastly overestimate the importance of housing to our economy. It’s as if those people in housing construction couldn’t find or produce productive jobs in our economy even if housing were free as sunshine. It’s ironic to have a Nobel prize winner saying effectively, “We have too many houses. We’re doomed!”

    Basically, Krugman’s argument is: we’ve rarely been in this position before, so it’s scary. But the economic mechanism of monetary policy is EXACTLY the same as when rates are above the zero bound.

  18. Gravatar of TravisA TravisA
    6. October 2010 at 17:30

    Scott,

    Isn’t it ironic that Krugman’s comment about housing not being able to pull us out of a recession as a reason to doubt the efficacy of monetary policy puts him in the camp of ‘structural unemployment’ and skill mismatches?

    Krugman is the gift that keeps on giving for blogging posts 😉 He’s like Fox news for Jon Stewart’s The Daily Show. The jokes just write themselves.

  19. Gravatar of Liberal Roman Liberal Roman
    6. October 2010 at 17:46

    Ben,

    I am hoping for the best, but I am ready for the worst.

    And eventhough QE is finally getting some good press, it has very predictably caused some backlash. I already pointed out the unusual reactions from Stiglitz and Reich. But what? You think the conservatives have forgot about the “You can’t print your way to prosperity”, “OMG, hyper-inflation, hyper-inflation!” mantra. Sorry.

    http://finance.yahoo.com/tech-ticker/markets-soaring-but-the-world-is-worse-off-jimmy-rogers-says-yftt_535479.html

    http://www.bloomberg.com/news/2010-10-06/drinks-are-free-as-bartenders-refill-punchbowl-william-pesek.html

    I can probably come up with a dozen more.

  20. Gravatar of Lee Kelly Lee Kelly
    6. October 2010 at 17:46

    Scott,

    Thank you, but I know what the fiscal multiplier is. I was just joking …

  21. Gravatar of Fed Up Fed Up
    6. October 2010 at 19:27

    “And eventhough QE is finally getting some good press, it has very predictably caused some backlash.”

    I see it as only helping the bankers and the rich asset holders.

  22. Gravatar of Fed Up Fed Up
    6. October 2010 at 19:32

    Here is a good post about:

    Fed: We Can Support Asset Prices for the Public Good

    http://www.ritholtz.com/blog/2010/10/fed-we-can-support-asset-prices-for-the-public-good/

    I like jjay’s comment.

  23. Gravatar of ScottN ScottN
    6. October 2010 at 19:50

    Scott, I think you and your friends are getting some traction. Check out this WSJ article: http://goo.gl/bn6X

  24. Gravatar of Liberal Roman Liberal Roman
    6. October 2010 at 22:01

    Fed Up,

    It helps everyone holding any assets. They believe that they are richer because their assets become more valuable in dollars and then they believe their balance sheets are in better shape and they are less willing to hoard dollars and more willing to spend.

    They key to understanding this crisis is that there is nothing REAL about this crisis. Most people are trying to come up with real reasons why the economy is in such bad shape: policy uncertainty, tax uncertainty, too much regulation, etc., etc. But those things have been around forever and even though they are sometimes a drag on growth, they are not the reason that we have 10% unemployment.

    As you can read in Scott’s FAQ at top of the page, the best passage that he has which I think completely explains our current situation is this:

    “Isn’t the real problem . . . ?

    NO, the real problem right now is not a “real” problem. The real problem is a nominal problem.”

    This is so important to understand. The only problem we have is nominal. Meaning it is a problem of how people perceive their balance sheets. It is a problem of what their future inflation expectations are. The Fed has the tools and power to correct this. Will they? We’ll see…

  25. Gravatar of W. Peden W. Peden
    7. October 2010 at 03:11

    By the way people, I will be speaking with the UK Business & Trade Secretary tonight.

    Are there any questions that anyone would like answered?

  26. Gravatar of mbk mbk
    7. October 2010 at 03:15

    Scott, and everybody,

    the comments section is getting too many cheers and not enough knowledgeable critical comments. I’m serious. It’s a pity that the relevant heavyweights in this discussion all have their own blogs and tend to do little cross-commenting.

    Now I may not be the best qualified but let me throw a stone in the pond just to get some things off my chest and to have at least some controversy here.

    We’ve been through this many times but I am still not convinced that the problem was just nominal. What if the collapse of 2008 was analogue to the collapse of Enron, a sudden realization that the emperor is naked, that no nominal measure could have stopped (maybe slowed down). What if the US economy was rather like Enron, a seemingly healthy and growing entity that suddenly lost the confidence of its shareholders (and banks of course) because they realized the underlying reality was not there? On the surface it may have seemed like a confidence, liquidity, i.e. a nominal problem (as Enron’s executives also insist on even now). But what if the overextension in credit growth was simply real, the unproductive liabilities too large? What if it all had to come to a stop at some point, whatever it was that triggered the eventual avalanche? What if the worldwide slowdown that ensued was just like a large corporation’s bankruptcy dragging with it its suppliers, customers, creditors? What about NGDP targeting? What if NGDP targeting was successful, in the sense of, what if it succeeded in masking the real problem through nominal measures? What if NGDP targeting completely messed up the price system, making calculation and thus investment much harder? What if such targeting ended up with a nominal solution (say 5% NGDP growth achieved) but real absurdities (5% NGDP growth achieved through 3% real contraction and 8% inflation)?

  27. Gravatar of W. Peden W. Peden
    7. October 2010 at 03:24

    Mbk touches on a problem that has concerned me re. NGDP targeting. It’s essentially the roll-on problem of cross-annual inflation targeting: in a 2% inflation targeting regime, what does one do when, as is quite likely, in one year inflation goes up to 4%? Does one then target 0% the next year? 1% for two years running? 1.5% for four years? 1.75% for eight years? etc.

    I’m not sure how cross-annual NGDP targeting avoids this problem. That doesn’t mean there isn’t a case for NGDP targeting on an annual basis, but it seems that cross-annual targeting of any figure risks instability tomorrow to “compensate” for instability today.

    However, as I look at this, I suspect that I’ve misunderstood what you’re proposing.

  28. Gravatar of mbk mbk
    7. October 2010 at 03:41

    As far as I’m concerned, there are several issues with NGDP targeting on a system theoretic level.

    First off, it’s circular (negative feedback: overshoots get slowed, undershoots get accelerated). Counter to intuition this does not guarantee a thermostat-like stability. The classic example is the logistic equation in discrete time steps – if the growth rate is high it leads to endless over- and undershoots. W. Peden, your comment on the appropriate time scale for intervention relates to this.

    Second, the self referenced component is based on an expectation and EMH nonwithstanding it would be just as vulnerable to manias as black tulips.

    Third, it targets nominal things which operationally is the whole point (getting credit to flow etc) but is only half the story – eventually we’d like real results.

    Fourth, constantly manipulating the unit of account on the basis of an expectation may not be the best thing to optimize firms’ abilities to calculate. How can the price system and calculation work if inflation is potentially allowed to flop around wildly to ensure NGDP growth stability under varying GDP growth conditions?

  29. Gravatar of scott sumner scott sumner
    7. October 2010 at 06:28

    Thanks Morgan, I’ll do my best.

    Randall, Diluting the dollar is the ONLY WAY to create more AD. Just draw as AS/AD diagram. Shift AD to the right. Prices rise. If prices don’t rise (diluted dollar) you’d get no more AD.

    Fed up, DDs are a medium of exchange, just not money.

    TravisA, Krugman keeps missing the point. He confuses easy and tight money. He thinks money in Japan has been easy for 15 years–and failed. Actually they’ve been targeting 0% inflation, or slightly below.

    Sorry Lee, I get so many comments of such differing backgrounds that I sometimes miss the humor. If I say “what a joke” and they aren’t joking, it’s a kind of insult.

    Fed up, Thanks for the link.

    Scott A, That’s encouraging.

    mbk, Don’t worry, that’ll change soon enough. I usually get lots of critical comments.

    NGDP is best precisely when the problem is supply shocks. In that case you want 8% inflation and 3% RGDP decline. That would keep nominal wages anchored and employment at the natural rate. There was zero chance of that happening, however.

    W. Peden. The reason it seems a bad idea for price level targeting (your 4%/0% example) is precisely why price level targeting is a bad idea–it doesn’t handle supply shocks well. If the 4% was a demand shock, you’d want 0% inflation to bring unemployment back UP to the natural rate.

    mbk, Level targeting solves the instability problem you discuss.

    Monetary policy can’t affect real variables long term, so you need a nominal anchor.

    NGDP instability is what causes macro disequilibrium, not inflation instability. Indeed “inflation” as defined by the government does not correspond to anything meaningful in the real world. It is full of concepts like “imputed rent” that have no impact on the economy. Contractors don’t stop building houses because imputed rents fall, they do it because actual house prices fall.

  30. Gravatar of Bob O’Brien Bob O'Brien
    7. October 2010 at 08:31

    I think mbk makes a lot of good points. Scott said:

    “NGDP is best precisely when the problem is supply shocks. In that case you want 8% inflation and 3% RGDP decline. That would keep nominal wages anchored and employment at the natural rate. There was zero chance of that happening, however.”

    I don’t see how this addresses mbk’s third point:

    “Third, it targets nominal things which operationally is the whole point (getting credit to flow etc) but is only half the story – eventually we’d like real results.”

    How do we get real results. How do we reduce the large amount of debt in the economy that is likely to drag us down over an extended period of time?

  31. Gravatar of Benjamin Cole Benjamin Cole
    7. October 2010 at 08:56

    Liberal Roman-
    Verily, the idea that we are “printing money” and that it will led to inflation, not growth (despite huge current slack) is deeply embedded in the American right. Add to that the an undercurrent of anti-Obamaism.
    If George Bush was prezzy, and said we have to gear up for a war, the printing presses would be on meltdown mode. Dallas Fed prezzy Richard Fisher would be in his overalls pouring ink into the presses from large buckets.

  32. Gravatar of Randall Randall
    7. October 2010 at 09:19

    Scott- I understand AS/AD. But I’m not sure you understood my post. QE addresses bank liquidity but that is not the problem, its really a consumer credit problem. Credit criteria is very tight and does not change based upon capital on banks balance sheet. Adding cash to bank balance sheets does nothing if they don’t have credit worthy borrowers. Also QE would dilute the dollar, raise prices and increase asset values, but income lags inflation, so would that not suppress purchasing power?

  33. Gravatar of Liberal Roman Liberal Roman
    7. October 2010 at 09:53

    @Randall, read through Scott’s Q&A. There is a link to it on top of the blog.

    @Ben,

    Yes, I think we were talking about this a month or so ago. About how many Fed officials think that there is nothing that can be done when a liberal is in power, but if a conservative is in power they suddenly always see the need for more monetary stimulus if the economy is sputtering.

    Speaking of Richard Fisher, I know we are all looking forward to Charles Evans becoming a voting member next year, well guess who else becomes a voting member next year. This guy:

    http://www.dallasfed.org/news/speeches/fisher/2010/fs101007.cfm

    Sigh…

  34. Gravatar of Fed Up Fed Up
    7. October 2010 at 10:28

    W. Peden, I think the UK has a trade deficit. If so,

    current account deficit = gov’t deficit plus private deficit

    If there remains a current account deficit, the gov’t lowers its deficit or even balances its budget, and the private sector is smart enough to not go into deficit, what happens? Does GDP fall?

  35. Gravatar of Joe C Joe C
    7. October 2010 at 11:03

    @ Randall

    I would reply that only, as of april 2010, 25% of consumers have relatively low credit scores. I dont know the figures for businesses but I would imagine it would be similar. So, I would say that your argument is partly correct and should be addressed but the other larger part of the economy still wants to borrow and invest but there is tight money currently so not everyone can get the loans they wish for. Thus, more liquidity needs to be provided by either, lowering the interest on reserves to 0 or QE.

  36. Gravatar of JimP JimP
    7. October 2010 at 11:15

    At least Eichengreen understands what is going on. If only Krugman and Wolf did.

    He wants shock and awe from the Fed. That he won’t get – sadly.

    http://www.foreignpolicy.com/articles/2010/10/06/financial_shock_and_awe?page=full

  37. Gravatar of Morgan Warstler Morgan Warstler
    7. October 2010 at 11:25

    Joe C,

    GOOD: that’s simply not true. IF you are buying a house 25% below market price with 30% down – you are virtually guaranteed a loan.

    BAD: beyond that… I’m hearing about 3% FHA loans be written with $35K in them for repairs… once again we have people taking money out of the loan when they close.

    The reality is this… housing prices are TOO HIGH. great quote from Michael Milken today:

    “Consider how many more jobs small businesses would have created if they’d enjoyed the same terms we gave homeowners””easy access to 30-year, government-guaranteed loans at near-prime rates with no prepayment penalties. Those terms encouraged larger houses””the average size doubled in a generation to 2,500 square feet, even as family size shrank.”

    http://online.wsj.com/article/SB10001424052748704631504575531894174441102.html

    SO PLEASE stop moaning we aren’t doing enough to pump up housing prices.

    We can inflate JUST A BIT for NGDP, but not to save housing prices.

    —–

    All of you are actually very funny… the REASON Scott’s effort to target NGDP is so much fun, is because of what happens when inflation runs at 2.5% for 3 years, it means we HAVE to tighten up money – no matter what is happening on employment.

    Ultimately he IS IN COMPLETE AGREEMENT that the cost of money / credit needs to be higher in mid and long term, and just maybe lower in the near term.

    Scott, is very much like Fisher, you guys get all hotted up at their argument for printing money, but in real practice, you miss that for most of the time, they are advocating a far more staid and boomless Fed.

    And what does a higher cost of credit get us:

    1. DEEP cuts in Federal Spending.
    2. Capital formation that rewards savers.

  38. Gravatar of Adam P Adam P
    7. October 2010 at 11:28

    Scott,

    you might like this, if you haven’t seen it yet:

    {http://faculty.chicagobooth.edu/john.cochrane/research/Papers/big_stick.html}

    No hat tip to you though.

  39. Gravatar of Adam P Adam P
    7. October 2010 at 11:28

    http://faculty.chicagobooth.edu/john.cochrane/research/Papers/big_stick.html

  40. Gravatar of Morgan Warstler Morgan Warstler
    7. October 2010 at 11:34

    “This is the best evidence you can find that deflation risk has evaporated. The question now is not how low inflation will be, it’s how high it will be in the years to come.

    As I’ve been arguing for a long time, when you take deflation risk off the table, you automatically brighten the economic outlook, even though inflation is not typically good for economic growth. I think that explains, in part, why stocks have rallied over 10% since the end of August. The other reason stocks are up is that the prospects for a Republican landslide have improved, and with them, the chances of an extension of the all the Bush tax cuts have risen considerably. Just the idea that Republicans now stand a good chance of “stopping all the bad stuff,” as John Boehner recently put it, is reason for cheer considering how gloomy the prospects have been since early last year.

    So once again I’m left with this thought: if the prospects for the economy are improving and inflation expectations are rising, why in the world would the Fed proceed with QE2, when it would only complicate things in the long run?”

    http://scottgrannis.blogspot.com/2010/10/bond-market-is-bracing-for-return-of.html

    thx J Tap

  41. Gravatar of Joe C Joe C
    7. October 2010 at 12:00

    Morgan:

    How many folks out there have 30% or even 20% to put down?

    Plus, I was thinking more along the lines of overall investment throughout the economy, not just housing.

    I do agree that housing prices are still a bit too high still but the overall economy does not depend solely on housing. Honestly, I really dont care about housing prices.

    For the record, Im not a strict monetarist; I actually do think the fed can do some more but I also think part of the problem is structural (mismatch between supply and demand of labor) QE can increase AD but I dont believe ALL of the slack in the economy can be soaked up by the increase in AD.

  42. Gravatar of Fed Up Fed Up
    7. October 2010 at 12:10

    W. Peden, here is another question.

    I believe that calculatedrisk had a post about someone in monetary authority in the UK who basically said that interest earned on savings is less from lower interest rates, but the savers should spend the same or more by dipping into principal.

    Does this person you are talking to believe that, and does this person believe people in the UK are as angry about those kinds of statements as I am as a person in the USA?

  43. Gravatar of Fed Up Fed Up
    7. October 2010 at 12:13

    W. Peden, here is the post and from:

    http://www.calculatedriskblog.com/2010/09/bank-of-england-official-to-savers.html

    From the Telegraph: Savers told to stop moaning and start spending

    [Bank of England deputy governor Charles Bean said] “Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.”

    Mr Bean said that encouraging Britons to spend was one reason why the Bank had cut interest rates.
    In the U.K., savers are receiving about £18 billion a year less in interest. In the U.S., using the monthly personal interest income data from the BEA, interest income is off about $143 billion from the peak – and falling …

  44. Gravatar of JimP JimP
    7. October 2010 at 12:24

    That Cochrane paper strikes me as real important.

    begin quote
    Instead, the Fed can target the thing it cares about – expected CPI inflation – rather than the price of gold. To do it, the Fed can target the spread between TIPS (Treasury Inflation Protected Securities) and regular Treasurys, or CPI futures prices. Here’s a simple example. Investors buy a CPI-linked security from the Fed for $10. If inflation comes out to the Fed’s target, they get their money back with interest, $10.10 at 1% interest. If inflation is 2 percent below target, the Fed pays $2 extra — $12.10. This pumps new money into the economy, with no offsetting decline in government debt, just like the helicopter drop. If inflation is 2 percent above target, investors only get back $8.10 – the Fed sucks $2 out of the economy at the end of the year. If investors think inflation will be below the Fed’s target, they buy a lot of these securities, and the Fed will print up a lot of money, and vice versa.
    end quote

    That sounds like something quite close to NGDP futures targeting.

  45. Gravatar of marcus nunes marcus nunes
    7. October 2010 at 13:48

    @JimP
    And something that SS talked about even before the time of the link below:
    http://www.cato.org/pubs/journal/cj10n3/cj10n3-8.pdf

  46. Gravatar of marcus nunes marcus nunes
    7. October 2010 at 13:52

    How daft (as the British would say) can you get. From Fisher and Hoenig:
    “While none of us are satisfied with the current pace of economic expansion and job creation, presently it is not clear that conditions warrant further crisis-like deployment of the Fed’s arsenal,” Richard Fisher said, in text prepared for delivery before the Economic Club of Minnesota in Minneapolis.

    Countering the increasingly popular view that the Fed may again buy long-term assets to help spur growth, Federal Reserve Bank of Kansas City President Thomas Hoenig said, “I don’t think we should go that way at all.” The official repeated his previous call that the fed funds rate should be raised off its de facto zero-percent level, saying, “I don’t want high interest rates” and “I want non-zero interest rates.”
    And VERY WRONG (from Fisher):

    “If you happened to read the obituary of former Fed Governor Sherman Maisel in today’s New York Times, you might have noted a relevant quote from his repertoire: “In my view, changes in monetary policy may be desirable, but they should be used only to a limited degree in attempts to control movements in demand arising from non-monetary sources.”[8] There are limits to what monetary policy can accomplish if fiscal policy blocks the road”.
    If FP “blocks the road” hahaha

  47. Gravatar of Morgan Warstler Morgan Warstler
    7. October 2010 at 13:55

    Joe C, MILLIONS of people have 30% to put down.

    The problem you may be struggling with is that you don’t want them to own the houses.

    What we’re talking about the wealthy in every small town buying up CHEAP the houses in foreclosure. That’s like 6-10M deeply discounted sales, and 6-10M families now renting instead of owning…. the very people we WANT to become mobile.

    This is what astounds me about the more fervent of Scott’s supporters:

    In a world where $400B+ suddenly comes off the sidelines, as say $1T in assets get swooped up.

    Suddenly we have MILLIONS of happy local wealth patting themselves on the back for their best deal ever, they are looking at their balance sheets, and thinking, “man, the world is finally bending to ME.”

    Much like politics, there’s just no underestimating the value of guys with cash having a good outlook on their situation.

    But the “monetarists” shrug like this isn’t reality.

  48. Gravatar of Benjamin Cole Benjamin Cole
    7. October 2010 at 16:12

    FYI

    James Hoard
    Media Relations
    Federal Reserve Bank of Dallas

    Dear Mr. Hoard:

    Good Day.

    I want to include Richard Fisher, Dallas Federal Reserve President, in my upcoming book, “Profiles in Timidity.”

    He has shown true caution in the face of sinking inflation and sagging growth. He has demonstrated the central banker’s prim concerns with inflation, even as output stagnates, and deflation becomes a possibility.

    I most admire him for this: He equates the psychic income he derives from zero inflation with the real income lost by American in obtaining that goal.

    Fisher was at his most enfeebled, when he stated that structural impediments erected by the Obama Administration had rendered his monetary policy impotent.

    Please inform Mr. Fisher of this tremendous opportunity to be remembered by his countrymen for his contributions.

    Sincerely,

    Benjamin Mark Cole
    Owner
    Sportsbartables.com
    213 259 5598
    sevencontinents@mindspring.com

  49. Gravatar of Joe C Joe C
    7. October 2010 at 16:58

    Morgan:

    How many of those millions WANT to buy a house?

    I should have been more clear: many people have enough to put down but many people who would like to own cant afford even 10% down.

    This is not a major issue with me though. Also, I dont have any problem with anyone owning anything: as long as they can afford it.

  50. Gravatar of Morgan Warstler Morgan Warstler
    7. October 2010 at 21:43

    Joe C, you STILL seem to blow right by the point…

    ALL of the 6-10M houses will sell to qualified buyers – the price will simply be low enough make them WANT to buy. And the deals they get! They will be PSYCHED!

    Who cares about the other people? They should be renters. Saving their money – because rents will go down.

    This is basic supply / demand.

    Stop worrying about people without the resources not being able to buy overpriced houses. It’s completely illogical.

  51. Gravatar of Fed Up Fed Up
    7. October 2010 at 22:27

    scott sumner said: “Fed up, DDs are a medium of exchange, just not money.”

    Why are demand deposits medium of exchange but not money? Not a store of value? If so, why? Something else that makes them not money?

  52. Gravatar of Fed Up Fed Up
    7. October 2010 at 22:30

    In most economies, are there basically two mediums of exchange, currency and demand deposits created from debt?

  53. Gravatar of W. Peden W. Peden
    8. October 2010 at 02:19

    Fed Up,

    No, because there would be no factor of GDP (public spending + private spending + investment + (imports – exports)) which would have been reduced.

    I left to meet him before you asked your second question, but I would imagine that savers are in the position that they are usually in during times of crisis: real interest rates are below inflation. Inflation, especially with low interest rates, makes riotous living profitable. The one consolation is that savers have a means of escaping the effects of low real interest rates by bringing forward consumption. Borrowers have no such choice: there is a limit to which one can delay consumption to handle high real interest rates. Anyway, in the long run, savers have every stake in QE and recovery, because it accelerates the process of getting back to a situation of normal saving rates.

    My thoughts on Vince Cable: very economically literate for a politician, which probably has something to do with being a former economist. He can handle concepts like the exchange rate, interest rates, regulatory capture and so on better than most. He still has a bit of a tendency to think in terms of credit rather than money and his views on the Euro are crude, but he fully recognised the need for more QE and understood the effects of payroll taxes better than any politician I have ever met. He gave a lecture before I spoke with him which mentioned reserve requirements, which is one of the first times a politician has mentioned them in my presence.

    Sadly, as to the question whether there are plans in the pipeline to review the BoE’s targets, he didn’t divulge any and preferred instead to praise the Euro. The UK government is very focused right now on fiscal policy and seems happy to leave monetary policy to the BoE, except insofar as fiscal policy keeps down lending rates. However, Vince Cable did agree that interest rates had been too low over the last 8 years and that this had been a key cause in the housing bubble. So my quest to slay the beast of CPI targeting probably has some way to go yet.

  54. Gravatar of Randall Randall
    8. October 2010 at 04:38

    Scott- I disagree that money is tight. I’m an investment banker and I have never seen so much capital sitting around waiting to go to work. Banks and most finance firms are setting on huge sums of cash. They lack a place that is credit worthy, which is why risk rates are so low. QE adding cash to banks wont improve lending so long as credit criteria remains the same and everyone is so risk adverse. In today’s market, there is not structure for laying off risk which we would do before with synthetic derivative instruments like ABS/CDO’s. The embedded criteria which traditionally allowed for the syndication of risk is now correlated for parity to the market, which defeats the purpose of risk syndication. Today there are to many dollars chasing to few deals, so QE will only exacerbate that problem.

  55. Gravatar of Joe C Joe C
    8. October 2010 at 07:16

    Morgan:

    I see the point. The point Im trying to make is just because the price is very low doesnt mean all the over-supply of houses will be bought up by those with the cash. Price is not the only factor in someone’s decision to purchase something. I would encourage folks to buy up the supply of houses but I dont foresee the type of investment in housing like we had previously, especially given housing historically is not near as profitable of an investment as stocks or even bonds. I agree in your point…its just I dont think we should focus solely on housing like that would be some cure all for the economy.

  56. Gravatar of Scott Sumner Scott Sumner
    8. October 2010 at 08:18

    Bob, Monetary policy can’t address debt, I’ve advocated fiscal reforms to do that.

    Randall, QE can’t raise prices unless it boosts AD. So how can you argue it would boost prices but not boost AD?

    And QE does not work by making credit easier, it works (if all all, which is questionable) by boosting future expected NGDP.

    JimP, Yes, Eichengreen understands the need for currency depreciation in many countries.

    Adam P. Thanks! I did a new post.

    Fed Up, They should be encouraging people to hold less cash, not to save less.

    JimP, Yes, check out my new post–it is very similar.

    Marcus, Yes, check my new post.
    Those Fed statements are depressing.

    Benjamin, Yes, far too timid.

    Fed up, The base is the aggregate controlled by the Fed, so it is the most useful definition of money. I understand that others include DDs, I just don’t find that definition as being convenient. Any medium of account can theoretically be used.

    Randall, It’s not about credit, it is about money supply and demand. There is too much demand for money relative to supply, they need to increase the supply and reduce the demand. Demand can be reduced through lower IOR and a higher NGDP growth target (or a higher inflation target.)

  57. Gravatar of Morgan Warstler Morgan Warstler
    8. October 2010 at 10:03

    Joe C, think of it this way: at $1, all the houses will sell. Remove the price supports, makes those underwater go jingle mail, refuse to bail out banks, I’d like to the MBS all unwound and the toxic assets sold off.

    There is no such thing as “over-supply” there are only prices “too high.”

    Let the losers take the their losses. Be done with it. It is the moral thing.

  58. Gravatar of Richard W Richard W
    8. October 2010 at 19:34

    W. Peden
    7. October 2010 at 03:11

    ‘ By the way people, I will be speaking with the UK Business & Trade Secretary tonight.

    Are there any questions that anyone would like answered? ‘

    Q/1 Why do you insist on being a populist, Mr Cable?

    Q/2 When are you resigning?

    W. Peden
    8. October 2010 at 02:19

    ‘ He can handle concepts like the exchange rate, interest rates, regulatory capture and so on better than most… but he fully recognised the need for more QE… ‘

    When the BoE were initially commencing QE he called it “the Robert Mugabe school of economics”

    ‘ However, Vince Cable did agree that interest rates had been too low over the last 8 years and that this had been a key cause in the housing bubble. So my quest to slay the beast of CPI targeting probably has some way to go yet. ‘

    How does he know interest rates were too low and what is his evidence? Credit was too loose but that was issues to do with bad regulation of the banking sector. If the BoE base rate was too low why was there a significant higher differential between the Bank rate and the Fed and ECB rate? If the BoE rate was too low why was the effective sterling exchange rate so strong during this period? There is no evidence that the BoE monetary policy was inappropriate for the macro condition of the economy until they started to screw up in late 2007.

  59. Gravatar of Randall Randall
    11. October 2010 at 05:08

    Scott- prices would rise because more dollars chasing the same number of deals and that would create a seller premium. I totally disagree about credit worthiness. QE will have no affect on the ratios used to determine credit worthiness and as a result no new borrowers will be created, just more capital setting on bank balance sheets. I’m no economist, but I do work in the real world and in this market we don’t have a lack of liquidity for deals, we have a lack of credit worthy borrowers. Example, I manage 1B US Capital mezzanine debt fund, my treasurer could call me and say they are adding 500m to my line, my problem has not changed, I dont have credit worthy customers to lend this money to and the few that I have now have there phones ringing by every banker with the same problem. So borrower demands better terms reducing rents and increasing cost.

  60. Gravatar of scott sumner scott sumner
    11. October 2010 at 05:46

    Randall, Your mistake is too assume QE doesn’t work, and then to argue that if it doesn’t work, it won’t work. For instance, QE might raise equity prices. Indeed most economists seem to be assuming that the mere expectation of QE has already raised equity prices. When equity prices rise, corporations have more incentive to do new investment. They also have more ability to raise funds in the stock market. Ditto for home prices. I agree that if QE doesn’t work, fails to raise NGDP growth expectations, then all the worries you raise will be 100% true. But you are actually assuming the answer. I would never argue that QE works by providing lenders with more money to lend.

  61. Gravatar of Fed Up Fed Up
    11. October 2010 at 23:07

    Scott, here is a good link about not investing. I believe it would apply to stock financing as well as bond financing.

    http://www.calculatedriskblog.com/2010/08/ceo-no-need-to-invest-right-now.html

    “I could borrow $2 billion tomorrow for 3 1/2 percent. But what am I going to do with it?”

    David Speer, CEO of Illinois Tool Works which has 60,000 employees worldwide in more than 800 business units and $14 billion in sales.

    The above quote is from an article by Neil Irwin in the WaPo: With consumers slow to spend, businesses are slow to hire

    There is no reason to invest when there is excess capacity in most industries (and excess supply in housing). This excess capacity or lack of demand – and therefore lack of new investment – is a key reason why the recovery is sluggish.”

  62. Gravatar of ssumner ssumner
    12. October 2010 at 05:16

    Fed up, You are confusing cause and effect. The problem is low AD. If you boost AD then investment will rise. The low level of investment is an effect of the recession, not a cause.

  63. Gravatar of Fed Up Fed Up
    12. October 2010 at 20:19

    “Fed up, You are confusing cause and effect. The problem is low AD. If you boost AD then investment will rise. The low level of investment is an effect of the recession, not a cause.”

    Actually, I was replying to this:

    “For instance, QE might raise equity prices. Indeed most economists seem to be assuming that the mere expectation of QE has already raised equity prices. When equity prices rise, corporations have more incentive to do new investment. They also have more ability to raise funds in the stock market.”

  64. Gravatar of Fed Up Fed Up
    12. October 2010 at 21:47

    Here is some more on QE2:

    http://www.nakedcapitalism.com/2010/10/auerback-you-can-thank-ben-bernanke-for-higher-food-prices.html

    Higher prices for commodities and stocks aren’t going to fool me into thinking there is a real recovery going on so I can be “tricked” into going into debt.

  65. Gravatar of Fed Up Fed Up
    12. October 2010 at 21:55

    “I would never argue that QE works by providing lenders with more money to lend.”

    It seems to me that it leads to excess reserves that can be converted to required reserves if more loans are made.

    It seems to me that moving an asset (loan) with a capital requirement to a “bank” that has no capital (the fed) would free up some capital. At least that is how someone explained it to me.

  66. Gravatar of Fed Up Fed Up
    12. October 2010 at 22:06

    “Fed Up, They should be encouraging people to hold less cash, not to save less.”

    They should be looking at rich people and rich corporations then, not the lower and middle class and most retirees.

    Randall said: “They lack a place that is credit worthy, which is why risk rates are so low. QE adding cash to banks wont improve lending so long as credit criteria remains the same and everyone is so risk adverse.”

    The credit criteria should remain the same. If entities don’t qualify, tough. In fact, I don’t see any reason why a basically all currency economy is not possible.

  67. Gravatar of Fed Up Fed Up
    12. October 2010 at 22:12

    I said: “If there remains a current account deficit, the gov’t lowers its deficit or even balances its budget, and the private sector is smart enough to not go into deficit, what happens? Does GDP fall?”

    W. Peden said: “Fed Up,

    No, because there would be no factor of GDP (public spending + private spending + investment + (imports – exports)) which would have been reduced.”

    I guess I wasn’t clear. By “the gov’t lowers its deficit or even balances its budget”, I mean either lower public spending or taxes go up so that private spending goes down.

  68. Gravatar of Fed Up Fed Up
    12. October 2010 at 22:23

    Liberal Roman said: “Fed Up,

    It helps everyone holding any assets. They believe that they are richer because their assets become more valuable in dollars and then they believe their balance sheets are in better shape and they are less willing to hoard dollars and more willing to spend.”

    What about the many people who have few or no assets?

    I believe people should pay attention to their budgets and not asset prices, especially when low interest rate debt can be used to manipulate asset prices.

    And, “They key to understanding this crisis is that there is nothing REAL about this crisis. Most people are trying to come up with real reasons why the economy is in such bad shape: policy uncertainty, tax uncertainty, too much regulation, etc., etc. But those things have been around forever and even though they are sometimes a drag on growth, they are not the reason that we have 10% unemployment.”

    IMO, there is something real about this crisis. It is a lack of real earnings growth for most workers and now most savers. Add in most goods/services are now demand constrained and not supply constrained.

  69. Gravatar of Randall Randall
    14. October 2010 at 13:13

    Scott- For QE to succeed it would have to impact borrowing correct?

  70. Gravatar of ssumner ssumner
    15. October 2010 at 15:30

    Fed up, Higher prices will make commodity producers produce more commodities.

    Randall, No you don’t need more borrowing, you need less demand for money and more supply. As a practical matter you are likely to get more borrowing if NGDP increases, but that’s true of car sales and lots of other data.

  71. Gravatar of Fed Up Fed Up
    15. October 2010 at 17:59

    “Fed up, Higher prices will make commodity producers produce more commodities.”

    Not in the USA. They will notice that final quantity demanded is near the same or lower. They will sell the same amount for higher prices and use it for corporate profits and excess salaries of the few top management.

    Second, how about OPEC? I believe I remember someone from the Middle East saying that they would take higher prices and leave oil in the ground as a “future” investment for the next generation.

    Another problem is a lot of the commodities are outside the USA.

    Fourth, the lower and middle class see wages flat. Higher food and higher oil prices means they should be spending less according to their budget.

    I can see the scenario from the CEO above.

    Interviewer: Prices are up. Shouldn’t you produce more?

    CEO: Not until I see some final demand growth.

  72. Gravatar of ssumner ssumner
    17. October 2010 at 06:06

    Fed Up, You said;

    “”Fed up, Higher prices will make commodity producers produce more commodities.”
    Not in the USA. They will notice that final quantity demanded is near the same or lower. They will sell the same amount for higher prices and use it for corporate profits and excess salaries of the few top management.”

    Time to review EC101. Commodity producers produce where P=MC, in the US or anywhere else.

  73. Gravatar of Fed Up Fed Up
    22. October 2010 at 22:51

    “Time to review EC101. Commodity producers produce where P=MC, in the US or anywhere else.”

    Do oligopolies that are trying to maximize the stock price do this?

    I’m thinking they won’t respond to the “artificially” higher prices unless they see final demand growth.

    If they do respond, will it be above their productivity rates?

    If it is above their productivity rates, will most of the employment be outside the USA?

    Here is Niall Ferguson and from:

    http://www.cnbc.com/id/39646116/Debt_Crisis_Will_Hit_Japan_Next_Then_US_Historian

    “The British historian says further quantitative easing from the U.S. Federal Reserve will not help the economy, as the extra liquidity is unlikely to stay within the country.

    “All that liquidity ends up not where it is supposed to be, which is magically creating jobs for American workers in Michigan. It doesn’t do that at all. It ends up pumping up commodity prices on the other side of the world, with lots of unforeseen consequences,” Ferguson cautioned.”

  74. Gravatar of Scott Sumner Scott Sumner
    23. October 2010 at 06:07

    Fed up, Ferguson doesn’t say commodity output wouldn’t rise, and in any case even oligopolistic commodity producers raise output when prices rise.

  75. Gravatar of Fed Up Fed Up
    27. October 2010 at 17:32

    I guess we will just have to wait and see if real final demand develops. And if so, how much and where.

    By real final demand, I don’t mean commodity speculators and people trying to use commodities as a savings vehicle because interest rates are supposed to be negative real terms.

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