Throughout this crisis there have been a few paleo-Keynesians arguing that monetary policy is out of ammunition at the zero bound, and hence we must rely on fiscal stimulus. Then there is a more enlightened group of Keynesians (Krugman, DeLong, Duy, Yglesias) that favor monetary stimulus, but also think fiscal stimulus can help. They use what in philosophy is called a “God of the gaps” argument. If the Fed wants 5% NGDP growth, and the Fed currently expects only 3% NGDP growth, then fiscal stimulus may be able to boost growth by 2%, before being neutralized by offsetting Fed tightening.
I have mixed feeling about this argument (mostly skeptical), but whatever relevance it might or might not have had for 2009-10, it certainly doesn’t seem to fit the current policy environment. Here’s Ryan Avent:
But to move toward the point, the latest employment report has some economists wondering whether the Fed will keep to its planned QE2 purchases. The message of that report was far from clear, but the changes in the household survey, including the near 600,000 job rise in employment and the drop in the unemployment rate to 9.0%, seem meaningful. This has Macroeconomic Advisers increasing its inflation forecasts and reiterating its warning that Fed tightening may come sooner rather than later. And Tim Duy has the Fed shifting its bias from more easing to tightening. Are they right?
I wish they weren’t, but I suspect that they are. If we go back to January of last year, when economic figures were improving, and the Fed was mostly talking about its exit strategy preparations, we see a Fed forecast for 2011 unemployment of between 8.2% and 8.5%—almost identical to the forecast in November of 2009. I think we have to conclude that the Fed was basically happy with the trajectory of falling unemployment that it saw at that time. I think it was wrong of the Fed to be happy with this level of unemployment, but that’s beside the point.
It’s my feeling that the Fed will quickly grow concerned about inflation if the unemployment rate drops to 8.5% during the first half of the year. Ben Bernanke isn’t going to draw any conclusions about policy from the mixed January report, but I agree with Mr Duy that his biases may have shifted, and February and March data will quickly indicate whether the January trend is real. Again, I think the Fed should still be biased toward expansion, and that it should tolerate a period of catch-up inflation, but that’s beside the point.
That doesn’t sound much like the paleo-Keynesian vision of the Fed, a group taking a nap on the beach until the “liquidity trap” is over, planning on waking up when rates rise above zero and they can “start doing monetary policy” again. And it doesn’t even seem much like the enlightened Keynesian vision; a Fed active, but for whatever reason not willing or able to produce desired nominal growth. Here’s Richmond Fed President Jeffrey Lacker:
The Federal Reserve should seriously reconsider its bond purchases now that the U.S. economy looks stronger, a top Fed official said Tuesday.
Richmond Federal Reserve President Jeffrey Lacker said he expects the economy to expand close to 4.0% this year, lifted by robust consumer spending.
Can we please stop talking about fiscal stimulus? Does anyone seriously believe that a fiscal initiative aimed at boosting NGDP growth would not be offset by a quicker exit strategy at the Fed?
BTW, The same Ryan Avent post contains a Paul Krugman quotation that discusses the ‘God of the gaps’ approach much more eloquently than I can:
…if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.
HT: Marcus Nunes
PS. BTW, last year Marcus Nunes was just a commenter at blogs like this one. Now he’s in the big time, getting quoted by Fortune magazine. David Beckworth is also quoted.