Strange new respect from Krugman

I guess I did not need to worry about shutting down my blog for two weeks, as others are very effectively making many of the same points.  I spent yesterday reviewing what other bloggers had been up to, and as usual, noticed a number of comment-worthy posts from Paul Krugman.   Before examining where we disagree, I’d like to highlight the (increasing) similarities in our perspectives on monetary policy.  Here is Krugman:

Reading Jon Hilsenrath’s column today, I was initially a bit skeptical about this assertion:

“When Japan fell into deflation in the 1990s, Mr. Bernanke, then a Princeton professor, urged the Bank of Japan to set an objective of 3% to 4% inflation. The reason: With interest rates pinned at zero, rising inflation would mean that the real cost of borrowing, which is nominal interest rates minus inflation, would be falling. In theory that would spur demand.”

I knew that I had pushed that option(pdf); I was less sure that Bernanke had, since he often focused more on quantitative easing. But Hilsenrath is right: Bernanke did say that, in a paper poignantly titled Japanese Monetary Policy: A Case of Self-Induced Paralysis?

Krugman needs to read my blog more often, as I must have done a half dozen similar posts, going over Bernanke’s writings on Japan with a fine tooth comb.  (Here and here and here, from January 2010, for instance.)   Krugman ends his post with this sarcastic comment:

But things would be very different if only Ben Bernanke were Fed chairman!

Sound familiar?  One of my posts last May was entitled “What if Ben Bernanke were in charge?

Of course this is really no surprise.  Any two bloggers who look at things in a similar way will tend to have similar reactions.  For instance, I was about to do a post discussing Phelps’ recent claim that there is no evidence of deficient AD, when I noticed that Krugman had already done an almost identical post, and as usual expressed his ideas in a more pithy and effective fashion:

And where did I learn that high unemployment should lead initially to falling inflation, rather than to immediate deflation? I learned it from this guy.

But if it is no surprise that we often reach similar conclusions on monetary policy, then why are Krugman’s links to me always negative?  In contrast, Matt Yglesias generally has positive comments on my monetary policy views.  All three of us think that the Fed can and should do more than it is currently doing.  Why does Yglesias accentuate the positive whereas Krugman accentuates the negative?  I’ll leave that question to my readers.

Of course there are some areas where Krugman and I do disagree.  He is a strong advocate of fiscal stimulus once rates hit zero, whereas I prefer to continue relying on monetary stimulus.  He thinks fiscal stimulus can be highly effective at zero rates, whereas I have my doubts. 

One of the tenets of the new Keynesian mainstream, circa 2005, was that fiscal policy was not a good stabilization tool, for all sorts of reasons.  Thus at the elite levels of macroeconomics (although not in the intro texts) all the discussion of AD management focused solely on monetary policy rules.  And new Keynesians like Ben Bernanke and Lars Svensson even had foolproof unconventional policies to be rolled out if rates hit zero.  I naively thought they were serious, that central banks would switch to unconventional policies once rates hit zero, just as smoothly as a Prius shifts from gas to electric.  To his credit, Krugman noticed much earlier that central bankers were a pretty conservative bunch, and hence were unlikely to try these “risky” new strategies.  (Of course the real risk is passivity.)

Last year Arnold Kling suggested that I was just about the only economist still adhering to what had until recently been the orthodox view.  I feel like the little boy who shows up to gym class and finds nobody around.  He wasn’t told that there was a field trip today.  Has new Keynesianism been cancelled, and no one told me?  Consider this off-hand comment by Krugman:

And I don’t understand at all [Koo’s] argument that monetary expansion is positively harmful. He seems to be making up arguments on the fly here; he’s so determined to defend the primacy of fiscal policy that he has to insist that anything else is a very bad thing. (In that sense, I guess, he’s the anti-Scott Sumner).

Imagine that!  When Krugman is trying to find someone to represent the standard new Keynesian view that monetary stimulus is the proper response to demand shortfalls, he can’t think of anyone other than an obscure Bentley professor.  Hence the title of this post.  I’m flattered, but at the same time it makes me feel kind of weird.  Like the general marching off to war who turns around and finds his army has deserted him. 

Now let’s get more serious and examine why Krugman and I disagree on this point, and also why Krugman is steadily moving in my direction.

1.  We both agree that fiscal policy is ineffective if the Fed is targeting inflation and monetary policy is not constrained by the zero bound.  In that sense Krugman is much closer to me than he is to Koo.

2.  We both agree that there are unconventional things the Fed can do to stimulate demand when rates hit zero.

3.  He has generally been a bit skeptical of the prospects for unconventional monetary stimulus at the zero bound.  One problem he cites is the “expectations trap,” the idea that central bank promises to inflate today might not be believed if the public expects future central bankers to revert back to their low inflation preferences as soon as the crisis is past. 

4.  I have argued that this problem is even more applicable to fiscal stimulus, as future central bankers would be more likely to sabotage fiscal stimulus than monetary stimulus.  It would look very awkward for a future Ben Bernanke to renege on a very public and explicit promise to shoot for a higher inflation target. Krugman criticized (actually misunderstood) this argument.

In early 2009 Krugman put all his eggs in the fiscal policy basket, arguing that it was our only hope.  He noted that the amount was inadequate, but basically bought into the conventional multiplier analysis.  This is where things get a bit tricky, so read closely.

I argued that the multiplier approach was wrong, because (as Tyler Cowen points out) the monetary authority is the last mover in the policy game.  Without fiscal stimulus the Fed would have been far more aggressive than it actually was.  Traditional fiscal multiplier models hold monetary policy constant.  What does it mean to “hold monetary policy constant?”  The traditional view is that it means steady interest rates.  Thus Krugman argued that the Fed wouldn’t sabotage fiscal stimulus, because rates were stuck at zero and likely to remain there.  He was right about rates, but wrong in assuming that this meant monetary policy could be held constant.  The Fed has all sorts of other tools like QE, interest on reserves, and most importantly, signals of future policy intentions.

In numerous previous posts I argued that the regional Fed presidents were sabotaging fiscal stimulus with all their chatter about exit strategies and the need for “price stability” (very different from 2% inflation.)  According to Tim Duy, there is a widespread impression within the Fed that Bernanke does not want a deeply split FOMC, and hence is reluctant to take aggressive action as long as there is a significant minority of dissenting votes.  Thus even a few hawkish voices can shift policy expectations.  (But as Jim Hamilton points out, those hawks do respond to new macroeconomic developments, which supports my skepticism about fiscal stimulus.)

The other thing that divided Krugman and I was the issue of political feasibility.  I thought fiscal stimulus was quite weak, and that a sufficiently large fiscal stimulus package was politically impossible.  In early March 2009 I called upon Krugman to start pushing the Fed to move more aggressively, arguing that it was our only hope.  He seemed to think the Fed was like a stubborn mule, and that fiscal stimulus was our only hope

How have things changed since March 2009?  Many of my commenters have pointed out that Krugman has recently been sounding much more like me—banging the drum for more monetary stimulus.  Of course Krugman would (correctly) say there was no inconsistency; he’d favored monetary stimulus all along, and moved his emphasis in that direction when it was clear that Congress would not provide sufficient fiscal stimulus.

But when I returned from vacation, I noticed two other very revealing changes in his views—both of which move him much closer in my direction.  First, although the Fed is still pretty stubborn, Krugman now says that they do respond to public pressure:

So why am I even slightly encouraged? Because the critics did, at least, succeed in moving the focal point. Not long ago gradual Fed tightening was the default strategy; but as I said, at this point the Fed realized that continuing on that path would have unleashed both a firestorm of criticism and a severe negative reaction in the markets.

What we need to do now is keep up the pressure, so that at the next FOMC meeting the members are once again confronted by the reality that not changing course would be seen as dereliction of duty. And so on, from meeting to meeting, until the Fed actually does what it should.

I know: it’s a heck of a way to make policy. In a better world, the Fed would look at the state of the economy and do what was right, not the minimum necessary. But wishing for that kind of world is like wishing that Ben Bernanke were running the place.

If so, then my crusade to put more pressure on the Fed might not have been a waste of time.   How’s my March 2009 open letter to Krugman looking now?  A chorus of complaints from Krugman and other prominent bloggers in early 2009 might have put a bit more pressure on the Fed.

Even more revealing was Krugman’s admission in this column that the chatter from the hawkish regional Fed presidents was effectively making monetary policy more contractionary. 

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact.  But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.

Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly “” his nominees still aren’t in place “” the Fed might be less passive.

Precisely.  That is exactly the argument that I have been using as to why the standard multiplier analysis is not even justifiable when rates are zero (remember that only the intro texts still assume it applies to a positive interest rate environment.)  Indeed it is precisely the argument I used to show why the expectations trap argument is even more applicable to fiscal stimulus than to monetary stimulus.  The Fed can and would be expected to shoot for its preferred rate of inflation.  Fiscal stimulus can only work if it can raise the expected rate of inflation.  But there is no reason why the central bank would let fiscal policymakers raise the expected rate of inflation.  I’ve never claimed the offset was necessarily one for one.  I doubt they would completely sabotage fiscal stimulus.  But the problem is very real, and is the main reason why even though the Bush-Obama budget deficits are twice as big as under Reagan (1982-1983) the current recovery is less than half as rapid as during the first 6 quarters of the 1983-84 recovery. 

BTW, last year who complained most vociferously about those unfilled Fed positions?

PS:  As an aside, here’s why Krugman’s mention of my name (even if with negative connotations) actually makes me feel pretty good:

1.  Suppose all the pressure from the blogosphere and pundits increases the Fed’s chances of easing by 10 percentage points.

2.  Suppose that easing would produce social welfare gains of $1 trillion.  That’s actually conservative, as world stock markets only need to rise a few points to generate those sorts of gains.  And that ignores the much more important gains associated with putting people back to work.

3.  And suppose that each of the bloggers pushing for monetary stimulus (me, Avent, Duy, Beckworth, Rowe, Harless, Woolsey, etc, etc) contributed 1% toward that total pundit pressure on the Fed.  Perhaps it’s a stretch for me to claim I am as much as 1% of the total pundit pressure for more monetary stimulus, but if the famous Paul Krugman thinks I am the name to cite when you need an economist with a single-minded focus on monetary stimulus, then surely I have had some impact.  And then there is the recent Financial Times piece that mentioned me and two others who are pressing the Fed to eliminate IOR.

I think you see where I am going.  If monetary stimulus can produce $1 trillion in expected gains (and I think it can do much more than that) then the expected value of the output of my blog is (1/10)*(1/100)*($1 trillion) = $1 billion.

So far, I have earned nearly $200 from ads.  That suggests I may have produced positive externalities of $999,999,800.  Heh, I’m underpaid!  And if I do get paid my social MRP, I promise to share some with commenters like Marcus, JimP and Statsguy.)

PPS:  What does this imply about the costliness of Krugman’s relative silence (indeed skepticism) on monetary stimulus when we most needed it?  As Krugman recently argued, silence can be very costly when there is a lot at stake:

And props too to Joe Klein, for acknowledging frankly that he sinned by not taking a stand against the Iraq war.

Mea culpas.  Easy to recommend to others.

PPPS:  I have lots more to comment on, but when will I find the time?

HT:  Marcus, JimP.  I couldn’t do this blog w/o all the links they provide.



24 Responses to “Strange new respect from Krugman”

  1. Gravatar of Benjamin Cole Benjamin Cole
    23. August 2010 at 10:38

    Another excellent blog from our erstwhile leader, now returned to the saddle.

    I absolutely agree with the idea that anyone who believes in a non-passive monetary policy should apply “pressure.”

    Of course, this is a vast democracy, and about all we ordinary joes can do is write letters.

    I have e-mailed letters to the Federal Reserve, the Los Angeles Times, and the Dallas Fed, and posted where appropriate on blogs.

    I encourage all followers of Scott Sumner to do the same, to keep up “the buzz” that monetary policy is too restrictive given current circumstances.

    Futile? Perhaps–but certainly less futile than doing nothing. Silly? Naive? So what?

    Start sending your e-mails!

  2. Gravatar of How many lives does this blog save? | The Incidental Economist How many lives does this blog save? | The Incidental Economist
    23. August 2010 at 10:47

    […] on the “How many lives does insurance save” brouhaha from earlier this year). Today Scott Sumner estimated the value of his blog thus, 1. Suppose all the pressure from the blogosphere and pundits […]

  3. Gravatar of JimP JimP
    23. August 2010 at 11:53

    Well welcome back. We missed you.

  4. Gravatar of Jeff Jeff
    23. August 2010 at 12:02

    Glad you’re back, Scott. This blog is a welcome break from the hysteria about gay Mexican Muslims in much of the blogosphere.

  5. Gravatar of Lorenzo from Oz Lorenzo from Oz
    23. August 2010 at 13:40

    Welcome back. Very much 🙂

    You said Fiscal stimulus can only work if it can raise the expected rate of inflation.
    At the risk of being the sleepy boy at the back of the class who asks the dumb question, why?

  6. Gravatar of Lorenzo from Oz Lorenzo from Oz
    23. August 2010 at 13:54

    In news from Downunder, the one incumbent Government in the developed world which could reasonably claimed to have successfully done fiscal stimulus has just become the first Federal Oz Government to lose its majority in the House at the end of its first term since the Scullin Government in 1931. (And the Scullin Government had the Great Depression and an acting Treasurer who defected to lead the Opposition.) So we have a hung (Federal) Parliament for the first time since 1941-3.

  7. Gravatar of JL JL
    23. August 2010 at 14:51

    Glad you’re back!

    My analysis on Paul Krugman is that he has a split personality.
    Part of him is an excellent economist (he won a noble prize), the other part is a die-hard liberal (he names his blog “The conscience of a Liberal”).
    (Gregg Mankiw has the opposite problem: conservative politics.)

    This works out excellently when liberal politics and economics are in agreement, but causes him too make very elaborate twists in logic when they don’t.

    From a purely economic perspective deficit spending and inflationary policies could both get us out of the slump.

    Krugmans liberal politics cause him to greatly prefer deficit spending. The necessary future taxes on the rich to pay for that kind of spending are a great benefit in his thinking.

    The fact that monetary policy could just as well get us out of the slump, without requiring large tax increases, is an inconvenient truth for his preferred politics.
    Better to push deficit spending and ignore monetary policy.

    But because deficit spending is quickly becoming unlikely, much to his chagrin, he’s starting to push monetary policy. Because the second best option is still better than a second great depression.

    I also think that he does this deliberately: he knows that his opinions carry a lot of weight, much like Keynes and Friedman in their time.

    And he would much rather be a Keynes, and nudge the world towards the progressive politics of the 1930s-1970s, than be a Friedman, who nudged the world towards the neoliberal politics of the 1980s till now (Reaganism, market fundamentalism, etc.)

  8. Gravatar of JL JL
    23. August 2010 at 14:58

    Oh I forgot: That’s why he ignores you and gives you negative links. Your too much of a Friedmanite. The timing of your open letter, blog and crusade was most unfortunante.

    If he would have affirmed your assertions regarding monetary policy back when stimulus was still on the table, it would hurt the stimulus cause and thus, ultimately, his personal cause.

    I do believe he is well intentioned, but he can’t be upfront regarding his intentions, because then it wouldn’t work.

  9. Gravatar of Rafael Rafael
    23. August 2010 at 15:22

    Hi Scott,

    Its good to have you back.

    Congratulations, you won. If only Ben Bernanke was the Fed chairman…

  10. Gravatar of Richard W Richard W
    23. August 2010 at 15:33

    Some of us outsiders thoroughly enjoy reading both of you. The contemporary US has got so ideological that some of you do not realise that you are really not that far apart.

  11. Gravatar of JKH JKH
    23. August 2010 at 16:12


    My impression is that Krugman has been pretty consistent in the logic of his approach to fiscal/monetary policy mix.

    He promoted much stronger fiscal action than was actually taken and promoted it early and constantly – until the political cycle (i.e. mid-terms) overtook the value (probability of success) of such efforts.

    His first choice has always been fiscal policy, second choice monetary policy.

    The strength of his more recent promotion of monetary policy has been inversely related to the fuse on the political cycle. He’s ramped up his monetary policy agenda as the likelihood of stronger fiscal policy implementation in the near term has receded. I think he said something about this sort of rationale in one of his blog posts.

    He’s converging to your views to the degree he is, at this time, because his second choice is in his view an intelligent act of desperation, again at this time, given the converging to zero probability of success in getting his first choice implemented, and his hip pocket views on monetary policy. This will probably be the case at least until the 2010 current political cycle gets completed and digested. Until then, the risk of not attempting something on monetary policy is too great in his view, whatever the probability of its success in his view, given the near term hopelessness of his campaign for his first choice of fiscal policy, and the potentially catastrophic consequences of doing nothing at all.

  12. Gravatar of Bonnie Bonnie
    23. August 2010 at 16:18

    Welcome back! I really missed my daily Sumner bits to chew on.

    I just want to point out something about this quotation:

    “Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly “” his nominees still aren’t in place “” the Fed might be less passive.”

    The word “neglect” used here is pretty strong. I’m no fan of Obama, but he doesn’t strike me as being a complete moron, either. It’s just speculation on my part, but perhaps it was advice he was receiving that the Fed is impotent at the zero bound as priorities were being set for establishing his administration that caused the delay. Why be in such a rush to make appointments for the FOMC when the there’s a pervasive belief that the Fed can’t do anything anyway and there are tons of other appointments that are viewed as having more of an impact on the situation?

    In my view, Obama got hosed by his economic advisors. As much as I like to paint him as an ideologue in political discourse, he does have a personal stake in the quality of what his administration delivers which does require a certain amount of rationality to end up on top. It likely was not his intention to fall down regarding what’s going on with the Fed. Actually, I think if he had a clue he (and the rest of the country) was being worked over by a bunch of bankers, intentionally or not, he’d be in their faces in ways we could only imagine.

  13. Gravatar of scott sumner scott sumner
    23. August 2010 at 16:51

    Benjamin, Thanks.

    JimP, Thanks for all those links in the other thread. I will use some more in tomorrow’s post, where I take on conservative economists.

    Jeff, While on vacation I watched TV news for the first time in about 10 years. All CNN and Fox had were debates over the location of mosques and the true religion of our president. I think I’ll wait another 10 years before tuning in again.

    Lorenzo, Fiscal stimulus of the sort Krugman favors is demand side, meaning it shifts the AD curve to the right. This will increase the price level (as the SRAS slopes upward.) If inflation expectations don’t rise, the market is telling you that they don’t expect it to work. And since I favor targeting expectations, that’s my benchmark.

    Lorenzo#2, I saw that election result. No worries mate, the lucky country always lands on its feet. I just read you have the best performing stock market over something like 100 years.

    JL, Those are good points, and I mostly agree. He does favor bigger government, and that probably slightly biases his views (consciously or unconsciously.)

    You said:

    “I do believe he is well intentioned, but he can’t be upfront regarding his intentions, because then it wouldn’t work.”

    I think you need to be upfront about your real views, and let the chips fall where they may. Tomorrow I will criticize conservatives on exactly this point.

    Thanks Rafael, I haven’t won until policy changes. But for the first time I feel like I am having at least a slight effect on the debate. (Of course the final comment was a throwaway joke, I doubt my effect was THAT big.) But I truly believe it was worthwhile.

    Richard W. Thanks. That’s why I like reading Yglesias. I often disagree, but he is smart and idealistic.

    JKH, That is a reasonable view, but:

    1. Also read JL’s comments.
    2. I bent over backward to be fair, and did admit that he could claim a sort of consistency. But his early 2009 rhetoric was often misleading, leading most readers to assume he thought there was nothing more the Fed could do. When he needs the Fed to save the Obama adminstration, he is suddenly much more assertive in arguing that they can and should do more. So I think at least the shifting emphasis was a bit misleading to many readers.

    Bonnie, Thanks.

    I completely agree, and in an earlier post acknowledged that the President can’t be expected to understand the fine points of unconventional monetary policy. But in the end the buck stops at the top, and he will be blamed for bad advice from people like Larry Summers, just as Bush was blamed for bad advice from Rumsfeld and Cheney. That’s how things work. (I’m not saying the cases are completely comparable, BTW.)

  14. Gravatar of Doc Merlin Doc Merlin
    23. August 2010 at 18:49

    We have been doing unconventional monetary policy since 2007 when the NY Fed began buying assets that weren’t treasury securities. We continued doing “unconventional monetary policy” for quite some time since then. The statement you made about bankers being conservative isn’t true at all for the NY Fed, obviously.

  15. Gravatar of Ben Crain Ben Crain
    23. August 2010 at 19:01

    I’m very interested in your views/analyses, but you should present them more succinctly. Recall, brevity is the soul of wit. And I don’t give a whit about what Krugman, or anyone else, writes. You should ignore them and write what you think. Too often your blogs seem to be about score-settling or one-upsmanship vis-a-vis other bloggers. Too often there’s a dredging of past quotes to establish who said what, when, and who was therefore right or wrong then or now. Ok, include a link to some that you think worth reading, but, otherwise, just tell us what You think! I didn’t read this particular posting. I looked at the title and concluded it was another tit-for-tat in an imaginary duel with Krugman. If I want to read Krugman, I’ll read Krugman. If I want to read you, I’ll read you. But I don’t want to read you about Krugman. I want to read you about monetary policy. Period.
    Moreover, this posting is just too damn long! Write what you think, be concise, and be done with it!

  16. Gravatar of Andy Harless Andy Harless
    23. August 2010 at 20:10

    You’re clearly right that Krugman should have advocated for more aggressive monetary policy early on.

    But as to the view that fiscal policy is ineffective because it will be counteracted by monetary policy even at the zero lower bound, I don’t see how that’s consistent with what we’ve observed. For over a decade, the Fed was succeeding in hitting a 2% inflation target (a target to which they still pay lip service in their long-range projections) and keeping the unemployment rate low. Now that we’ve hit the zero lower bound, they’ve had almost 2 years to get back to their target, and yet they’re missing it dismally. Surely — unless you argue that fiscal policy is ineffective for some other reason — a more aggressive fiscal policy would have helped close that gap.

    Apparently, the Fed’s reaction function is something like: “As long as the short-term interest rate is above zero, use short-term interest rate policy to keep the inflation rate close to 2% and the unemployment rate as low as possible given that constraint; when the short-term interest rate goes to zero, use unconventional policies to keep the inflation rate positive and the unemployment rate below 12%.” So there’s a region of indeterminate monetary policy, when the short-term interest rate is at zero, the inflation rate is between zero and 2%, and the unemployment rate is below 12%. Within that region, aggregate demand is determined by fiscal policy.

    It’s also possible that the natural real interest rate is below negative 2%, in which case inflation rates up to 2% are not feasible equilibria. In that case, fiscal policy will be effective by raising the natural interest rate, which could then make a 2% inflation rate feasible. Perhaps the Fed is playing blackjack, trying to keep the inflation as close to 2% as it can without going over. If what Krugman had in mind was a negative 3% natural interest rate and a blackjack reaction function, then it made sense for him to advocate fiscal policy, based on the reasoning that any intensification of fiscal policy would have an impact on the margin, whereas monetary policy would only have an impact if there were a discontinuous change, which he judged to be highly unlikely.

    The counterargument would be that marginal changes in fiscal policy, even though effective, weren’t a good idea, because fiscal policy is temporary, and the only ultimate solution is to force a discontinuous change in monetary policy. Basically, the sooner we get to actual deflation, or to severe depression, the better, because that’s the only way to get the Fed to see its error.

  17. Gravatar of Mike Sandifer Mike Sandifer
    24. August 2010 at 05:37

    Welcome back.

    These points on how Krugmans’s public perspectives have moved closer to yours did occur to me.

  18. Gravatar of Nick Rowe Nick Rowe
    24. August 2010 at 07:27

    An appalling thought: the Hotelling theory of bloggers. “Now that SS has vacated his turf on the policy beach, maybe I should move my own ice cream stall half way towards where his stall was?”.

    Nope, a bad thought. It’s good to read your posts again.

  19. Gravatar of scott sumner scott sumner
    24. August 2010 at 09:03

    I put a lot of effort into this post, and most of the comments are going to the throwaway Rajan post. 🙁

    Doc Merlin, Good point. They are not conservative when it comes to bailing out bankers, but they are conservative when it comes to bailing out workers.

    Ben, I’m sorry you didn’t like the post. I thought it did contain some of my ideas. If you had read it you might have had a different opinion.

    Andy, You said;

    “Surely “” unless you argue that fiscal policy is ineffective for some other reason “” a more aggressive fiscal policy would have helped close that gap.”

    Isn’t it very possible that if Obama had done a much bigger stimulus in February 2009, then the Fed would not have adopted QE in March 2009? That’s what I am talking about.

    You said;

    “Apparently, the Fed’s reaction function is something like: “As long as the short-term interest rate is above zero, use short-term interest rate policy to keep the inflation rate close to 2% and the unemployment rate as low as possible given that constraint; when the short-term interest rate goes to zero, use unconventional policies to keep the inflation rate positive and the unemployment rate below 12%.” So there’s a region of indeterminate monetary policy, when the short-term interest rate is at zero, the inflation rate is between zero and 2%, and the unemployment rate is below 12%. Within that region, aggregate demand is determined by fiscal policy.”

    I’ve never denied that there aren’t scenarios where fiscal policy can have some effect. But I think the window may be very small. Again, the Fed was doing unconventional things in March 2009.

    The natural rate scenario you discuss is also possible, although US fiscal policy has been shown to have relatively little effect on world interest rates. There are many possible scenarios, as you note. Some of those lead to a negative fiscal multiplier. Suppose that Congress did no fiscal stimulus in early 2009. This leads the Fed to do something really aggressive. I believe that fiscal policy is weaker than we assume and monetary policy is stronger than we assume. So if the Fed did something aggressive, it might well have done even more than the fiscal stimulus. I’m not saying this would definitely happen, but it is a plausible scenario.

    Thanks Mike and Nick.

  20. Gravatar of Michael Meyers Michael Meyers
    24. August 2010 at 19:29


    Good to have you back, but I have to tell you that I find Rajan’s argument for zero real rates cogent, and your argument against fuzzy. There is a real cost to negative real rates as Rajan states. As for a stock market crash if the Fed raises rates slightly… that’s just speculation on your part.


  21. Gravatar of Mattias Mattias
    25. August 2010 at 04:26

    I understand that most economist consider independent central banks as a good thing. But should independent also mean untouchable?

    I think that central banks should be left alone to fulfill certain goals (like your idea with 5% NGDP growth) BUT if they consistently underperform they should be fired.

  22. Gravatar of ssumner ssumner
    25. August 2010 at 07:33

    Michael, The market sets real rates, not the Fed. We know from 1931 that if you try to raise real rates through tight money the economy will go downhill and real rates will fall to even lower levels. My policy would lead to MUCH higher real rates than Rajan’s, because it would lead to much more rapid real growth, whereas his would lead to depression–which ALWAYS reduces real rates.

    His idea is like saying that because high fevers are a sign of sickness, a person with the flu should be put in the freezer. He is confusing cause and effect. Yes, low real rates are a sign of something wrong, but don’t fix the problem with tight money.

    Mattias, Is is very dangerous to have an independent central bank with no explicit target. And that’s what we have. We need to give them an explicit target, and hold them accountable.

  23. Gravatar of Kien Kien
    25. August 2010 at 18:33

    Dear Scott – I wonder if you might do a post on whether fiscal stimulus would help reduce the “short-term” spike in unemployment, where “short-term” is sufficiently long to leave a significant number of workers unemployed in the long-term (perhaps permanently). My limited reading of your posts would suggest that you think fiscal stimulus doesn’t help in the long-term, but you might be more open the view that fiscal stimulus will help limit the increase in unemployment. Might that be correct?

    If an economist cared about the long-term consequences of a temporary spike in the unemployment rate, might that economist then have good reason to strongly advocate fiscal stimulus?

    Thanks, Kien

  24. Gravatar of ssumner ssumner
    27. August 2010 at 13:04

    Kien, I am skeptical about fiscal stimulus both short and long term. I concede it might work, but monetary policy is much more effective and much cheaper.

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