But big government can be about fiscal policy. Let’s see why:
In 2001 President Bush said we needed to cut taxes to give the economy a boost. Paul Krugman opposed the tax cut. At the time I supported it for supply-side reasons, although in retrospect it was probably a mistake. What can we infer from all this?
1. Fiscal stimulus need not involve any increase in the size of government. Indeed it can lead to smaller government. In the long run if the government collects less revenue it will have to spend less (yes, “starve the beast” is true as a long run proposition.) From my perspective, what I now think made Bush’s tax cut a mistake was that it was a missed opportunity to do tax reform, and also he boosted spending sharply, running up substantial deficits during the boom years (when the government should run surpluses.)
2. But what about fiscal stimulus done in the form of more government spending, surely that means big government? Not at all. Suppose the government spends 4% more as a share of GDP during recessions than booms. Thus instead of spending 22% of GDP all the time, it spends 20% in booms and 24% in recessions, where the average is still 22%. A conservative Keynesian could easily argue for both small government, and also recommend that government projects like dams and highways should be built in recession periods, not boom periods. You’d move spending around, without changing the average.
3. Some might argue that there is an asymmetry, as monetary policy is enough when you need to restrain AD, but fiscal policy is needed when you need to boost AD. Doesn’t that bias you toward big government? No, for the reason I just mentioned. If government spending is countercyclical then it will be above average during recessions and below average during booms. Why? Because that’s what the word ‘average’ implies. It’s logically impossible to have a fiscal regime where spending is above average during recessions and average during booms. In any case, you can always cut taxes during recessions.
4. Despite all of the above, it’s certain possible that fiscal stimulus can be associated with big government. But that would not be fiscal policy causing big government, it would be the desire for big government leading to a particular type of fiscal policy. For instance, Larry Summers recently argued that the problem today is not the business cycle, but rather secular stagnation. He suggests that even if monetary policy could fix this problem, it would lead to such low real interest rates that the Fed would end up blowing up serial bubbles. And the resulting investment would be wasteful. So he wants more government investment, which he believes will be more efficient. He doesn’t want tax cuts, which would lead to (wasteful) in his view) private spending.
Summers can certainly make this argument, and perhaps it’s even true (although I doubt it.) But this is very far away from the textbook Keynesian fiscal stimulus with the various multipliers, nudging the economy toward the natural rate of output when actual output is too high or too low. That traditional sort of fiscal policy has no relationship to big government.
When people really want to do something, they can always find a justification. You’ve probably seen those famous phrases like “never let a crisis go to waste” and “now more than ever we need to invest more in . . .” For me it’s “now more than ever we need to legalize drugs and establish a NGDPLT regime and a progressive consumption tax.” And it doesn’t matter what happened, I’ll find some way to connect it up to my pet causes. For instance, the cover of this week’s Economist magazine complains that there are 2.3 million Americans in jail or prison. That makes me bring up drug legalization, even though “only” 400,000 are in there for drugs. Or if structural unemployment is discussed I’ll bring up occupational licensure, minimum wages, vouchers for education, or any other pet cause that is even tangentially related to structural unemployment.
To summarize, you can obviously find ways to do fiscal stimulus in a way that leads to bigger government. But I guarantee that if there was a Republican in the White House right now, and they were doing tax cuts to boost the economy, nobody would be equating fiscal policy and big government.
Some people wrongly think I believe fiscal policy is ineffective for ideological reasons. Sorry, but that doesn’t even pass the laugh test. Consider:
1. I recently provided some of Mark Sadowski’s graphs that show fiscal stimulus can work when countries lack their own central bank, as in the eurozone.
2. I’ve argued that fiscal stimulus can work if a central bank is not targeting inflation or NGDP.
3. I’ve argued that even under inflation targeting, VAT and employer-side payroll tax cuts work, by reducing prices and forcing the central bank to stimulate to hit their inflation target.
4. I’ve argued that massive government spending programs can work even under inflation targeting, by lowering private consumption and making people work harder (as in the early 1940s).
5. I’ve argued that cuts in MTRs can work for supply-side reasons.
6. I’ve argued that fiscal stimulus can work even under inflation targeting if the central bank in incompetent in a certain way (say frightened of a large balance sheet and also reluctant to do forward guidance.)
Six exceptions—does that sound like an ideologue that thinks fiscal stimulus can never work? I just think the world would be better off if we thought of monetary policy as the normal way to control AD, and I’m pushing to achieve that sort of world. Ironically we pretty much had that sort of world from 1984 to 2007. And double ironically Paul Krugman is also pushing to create that sort of world when he advocates a 4% inflation target.
People who think there’s some vast ideological different between me and Krugman on fiscal policy simply don’t know what they are talking about. We simply differ on whether the Fed could and/or would offset fiscal stimulus right now. That’s a small technical issue.
PS. I have a post responding to Krugman over at Econlog.
Update: Nothing in this post should imply I disagree with Russ Roberts’ claim that ideological bias can affect how some people feel about issues like fiscal stimulus. I think he’s right. I am just trying to point out that there are many aspects of the fiscal policy question that are highly technical, and that go far beyond ideology. There is no necessary logical connection, but many people certainly perceive a connection, as Russ indicates. For instance, I favor carbon taxes, but some other libertarians disagree with me on this issue. Ideology is not the only factor that goes into policy views.