Summers and DeLong explain why Yellen is the better choice

[I did this a while back but never posted it.  I suddenly feel like I “shoulda hit Summers even harder.” So even though he has dropped out, I’ll take one more shot.]

I just read Summers and DeLong’s paper on fiscal stimulus.

The argument that normal-times policy-relevant fiscal multipliers should be presumed to be very small can be made more general. Optimizing central banks will be expected to offset shifts in discretionary fiscal policy””and thus lead to multiplier estimates near zero””under relatively unrestrictive conditions. Consider a government choosing monetary policy so as to achieve the best economic outcome from the set of outcomes attainable by policy P. A change in fiscal policy from baseline would change the relationship between monetary policy and the economic outcome. But unless the change in fiscal policy opens up access to an outcome not in the set P that is superior, or eliminates access to the best economic outcome in P, the government will shift its monetary policy so that it still picks the same economic outcome. It will thus engage in full monetary offset.

Note that for this point to hold, the choice of monetary policy m and the choice of fiscal policy g cannot themselves be part of the outcome the government values. A central bank that values a smooth path for interest rates (as did the pre-1979 Federal Reserve) or has preferences about the size of its balance sheet (as did the Federal Reserve under Paul Volcker) will not engage in full monetary offset. Monetary and fiscal policy must enter into the central bank’s objective only through their effects on economic outcomes for full monetary offset to hold.

So a sensible central bank will have a zero fiscal multiplier.  By “sensible,” I mean a central bank that focuses like a laser on inflation and employment, and does not put the stance of monetary policy into the objective function.  Bernanke and Yellen are a bit difficult to read.  They may have some reservations about a large balance sheet, but on the other hand monetary stimulus can be achieved without increasing the current size of the balance sheet—by forward guidance for instance.  So there’s no particular reason to believe the fiscal multiplier would not be zero, although of course it might be higher.

At the opposite extreme is someone like Larry Summers, who worries that low interest rates and a bloated balance sheet might lead to bubbles, and misallocation of investment.  In that case fiscal policy could be “effective.”  That sort of central banker would essentially be holding the economy hostage, much as the GOP radicals in the house are accused of doing.  A central banker with that objective function would intentionally hold NGDP below the optimal path, unless and until the Federal government would assure him or her that the extra NGDP growth would be in the public sector, where (unlike the private sector) the expenditures would not be wasted on foolish projects driven by a bubble mentality.  The Federal government spends money very wisely, especially when under pressure to quickly ramp up investment during temporary slumps in the economy.

PS.  Lars Christensen has a very good post on why the Japanese should not try to artificially push wages higher.


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14 Responses to “Summers and DeLong explain why Yellen is the better choice”

  1. Gravatar of Geoff Geoff
    29. September 2013 at 16:44

    “That sort of central banker would essentially be holding the economy hostage”

    All central bankers hold the economy hostage.

    A central banker who did what you wanted them to do, would be holding the economy hostage by way of bringing about bubbles that lead to inevitable correction the costs of which are born by innocent people who must work and live among the federal reserve system’s actors.

  2. Gravatar of Geoff Geoff
    29. September 2013 at 17:07

    When the current credit bubble collapses, and people who explained the mechanics are again right, and we again hear chirping from the dull-minded that it was all luck, let it not be said that nobody saw it coming.

    The next bust is going to make 2008 look like a hiccup. And why? It is because the collection of accumulated errors is even larger than it was by 2008. Since 2008, the Fed has inflated once again to stop the corrections, and in so doing, has misled investors to an even greater degree. Did anyone really believe that the Fed can paper over problems?

    Market monetarists believe it can, and they believe it can by way of rejecting the incredibly important mechanism of cash holding and spending deflation acting as correcting mechanisms to existing problems. By advocating against market driven spending deflation, they are indeed calling for a “papering over of problems.” They just refuse to accept this because they believe that spending is supposed to “naturally” rise over time, that if it doesn’t, then something is inherently wrong with the market. They don’t grasp that a healthy recovery takes place on the basis of deflation. They confuse the unemployment and idle resources as inherent evils, when they are in fact symptoms of the cure taking place.

    If a house builder realizes he made errors, and he temporarily stops paying his workers and stops buying the same inputs, then market monetarists would claim that this is an inherent evil that should be avoided by papering over the problems. They of course deny this, because they claim that because this is an isolated example, that such symptoms during the correction process are justified. But they don’t accept this basic logic if these corrections are numerous enough. Of course, it is quite arbitrary to accept the economics of individual corrections, but not multiple corrections.

    If an individual should correct their incorrect behavior, why not 100 million in a division of labor? Is it because of fear of the political fall-out? Well, be that as it may, don’t pretend to be economists when you argue for inflation to stop numerous corrections that take place in an environment of deflation. Call yourselves political strategists.

    Once you start to think like an economist, you’ll realize that your political solution only reinforces the very errors that have accumulated because of the political solution of inflation you advocated in the first place.

    I hope that you realize this sooner, where the corrections, while painful, won’t encourage or exacerbate existing anti-capitalist tendencies, instead of later, where the corrections will be so acute that anti-capitalist ideology will dominate market-based ideology.

  3. Gravatar of Edward Edward
    29. September 2013 at 19:04

    It is remarkable how foolish you are .

    What’s significant about rebalancing for one sector is qualitatively different about other sectors is because if their is an apparent overproduction if goods and services in every sector, it means there must be underproduction if at least one unknown sector because Says Law always holds. Money is on the other side of every transaction in every sector, therefore, there must be an overproduction of G and S and not enough money in circulation.
    This isn’t complicated stuff. JS Mill understood it a century before Keynes and Frideman.
    Don’t say Says Law is about demand being infinite because human wants are infinite. That’s desire not demand. Demand is a willingness to exchange x for y. Actual tangible things in existence, not mere “desire”

    You are free to call sustainable growth unsustainable, just as you are free to call drinking orange juice the same as cocaine because both raise blood sugar and stimulate the body, but don’t expect the rest if us to share your weird definitions.

  4. Gravatar of Geoff Geoff
    29. September 2013 at 19:29

    “What’s significant about rebalancing for one sector is qualitatively different about other sectors is because if their is an apparent overproduction if goods and services in every sector, it means there must be underproduction if at least one unknown sector because Says Law always holds. Money is on the other side of every transaction in every sector, therefore, there must be an overproduction of G and S and not enough money in circulation.”

    False in two respects.

    One, money is a means to exchange. Any quantity of money can facilitate a practically infinite number of exchanges of real goods.

    Two, there can never be an overproduction of G. A general overproduction is impossible because the desire for goods is practically unlimited. As long as humans act, there can only be a partial relative overproduction of some goods here, and a partial relative underproduction of goods there.

    More money will not satiate the desires of those who want to earn more money. What is meant by a desire to earn more money is actually a desire to earn more purchasing power, which is a function of real goods production, not the amount of money in existence.

    “This isn’t complicated stuff. JS Mill understood it a century before Keynes and Frideman.”

    Then why are you having so much difficulty with it?

    “Don’t say Says Law is about demand being infinite because human wants are infinite. That’s desire not demand. Demand is a willingness to exchange x for y. Actual tangible things in existence, not mere “desire”.”

    It doesn’t matter that demand is not desire, for the above argument. What people lack in the aggregate is not money, but capital. That is what is in scarcity.

    “You are free to call sustainable growth unsustainable, just as you are free to call drinking orange juice the same as cocaine because both raise blood sugar and stimulate the body, but don’t expect the rest if us to share your weird definitions.”

    Right, because it is impossible for a collection of 300 million individuals to make any mistakes concerning the availability of capital in a division of labor such that a widespread set of corrections are required that only a reversal of the cause of the problems can bring about.

    Once again, your post makes no attempt to address the argument presented.

  5. Gravatar of Edward Edward
    29. September 2013 at 19:48

    (Sigh)
    It’s been addressed as infinitum. You just refuse to open your mind to the answers.

    And no, any quantity if money IS NOT sufficient to purchase any quantity if goods not at all. (Price stickiness?) even Hayek and the GMU Austrians see the problems with “secondary deflation”

    Also the problem you seem fixated on in the last post is no problem at all.

  6. Gravatar of John John
    29. September 2013 at 20:19

    This argument about what personality is best to plan the economy should be any good economist’s worst nightmare. In politics, you can argue over the rule of law over the rule of men and people seem to get the point. However, it seems that the economy is “too important” to leave to market forces so we are left haggling over which unelected economic dictator would be better. It’s difficult to see how people can argue that this is better than a rule-based or private money system with a straight face.

    At least Friedman wanted to remove economic authority away from people and simply follow some variable. Scott wants to do the same. This discretionary policy, parsing every word of the Fed statements, market convulsions at hints of future policy, etc. is simply intolerable. There will not be a halfway decent Fed chair until they simply decide on a target and hit it. There hasn’t been a halfway decent one yet because that position requires a lust for power and breeds incredible arrogance.

  7. Gravatar of Suvy Suvy
    29. September 2013 at 23:50

    My views about these issues are constantly in flux, but I am starting to agree with you that in today’s scenario, what we need is a strong monetary stimulus combined with a fiscal tightening. If we keep going down this road and we don’t deal with these long-run fiscal issues, we will run into major problems. However, a strong monetary policy would keep a major fiscal tightening from causing demand side issues while helping destroy the real value of the debt and making sure that the income is there to pay off the debt.

    When central banks take rates down to zero and people are unwilling to borrow at 0% interest rates, it takes a much larger amount of “money printing” to create inflation. The primary mechanism through which this “money printing” functions is, in my eyes, through the FX mechanism. QE does destroy the value of the currency, which makes debts easier to pay down.

    Also, I think the market is clearly telling us there’s a major debt problem out there. When people aren’t borrowing at 0% interest rates even though NGDP growth has been right around 3.5-4%, what does that tell us? That’s a negative lending rate of almost 3.5-4%, but there’s no borrowing that’s happening. The private sector is clearly telling us that it’s really, really sick!

  8. Gravatar of libertaer libertaer
    30. September 2013 at 01:33

    Scott, totally off-topic, but I would be very interested in your opinion on the danger of the US government defaulting on its debt (see Krugmans new op-ed). Krugman says it could be worse than Lehman.

    Market Monetarists seem to say that a financial crisis wouldn’t translate into a recession as long as the FED is doing its job (NGDP level targeting at best). So, could the US default without causing any problems?

  9. Gravatar of Prakash Prakash
    30. September 2013 at 01:34

    Geoff,

    Getting out of a depression via the liquidationist route is expected to follow the following route. The CB stops making money cheap. The riskiest entrepreneurial ventures fail. The spending made by these people reduce. More ventures fail. The spending further reduces. The safest asset (money itself) gets hoarded, until the savers achieve financial independence/ great wealth and start feeling wealthy enough to start spending again, starting a new virtuous cycle. If the standard is a commodity, then more and more people and resources get involved in extracting or manufacturing the commodity in question. The harder the commodity, the slower this particular escape valve is.

    But it is the second to last point that really makes the difference in a fiat money driven economy. In the presence of a central bank and continuously increasing poverty due to the unraveling of the division of labour enabled by the boom, never can the savers be completely assured that the money they save will maintain their value. The central banks credibility of continuing the monetary standard will be in question. This will lead to the savers never stopping the accumulation of money. Perhaps a bitcoin like system is the correct one for this where everyone has an agreement that the money in the system will not exceed a certain amount.

    In the MM scenario, the riskiest entrepreneurs are failing all the time, but the overall spending is not dropping. General prosperity is not hampered. If a central bank has shown credibility by maintaining NGDP path, then its reputation is that much more solid.

    The rest of the story is actually the same. If the credibility of the CB is not solid, the holders of the safest assets, in this case Tbonds, are the ones who are benefited, when QE occurs.

    Given the general expectation within a growing economy that the system will benefit everyone, and keeping credibility of the CB the same, a market monetarist policy is better than one targeting a commodity. Given the same starting point, the CB following MM policies will gain in reputation and credibility, as prosperity continues, while the one targeting a commodity will be under attack due to the growing poverty around it.

  10. Gravatar of Benjamin Cole Benjamin Cole
    30. September 2013 at 02:11

    Geoff-

    They don’t grasp that a healthy recovery takes place on the basis of deflation. They confuse the unemployment and idle resources as inherent evils, when they are in fact symptoms of the cure taking place.–Geoff

    This may be the most perverted reasoning I have ever read.

    I suggest you are confusing the illness with the cure.

    Yes, unemployment and idle resources are evils, destructive and should be avoided, and even aggressively attacked.

    Deflation? Try Japan It doesn’t work.

    One reason inflation is stupid evil incarnate is that banks lend on real estate.

    You get deflation in real estate and you have just crushed your banking sector. The rest goes downhill from there. Banks do not lend on deflating assets, so they deflate some more, meaning banks do not lend on deflating assets…Maybe if you have 50 years the cycle will play out, it never did play out in Japan, counting on 20 years….

    You get the same results as deflation with some mild inflation, and the banks get healthier too…

    The peevish fixation on inflation, really a perverted obsession with a index of prices, is myopic. Prices can never be stable anyway, and even measuring inflation is highly subjective.

    A better idea is to place prosperity first, and price stability second. If we prosper continuously, the rest does not matter. Prosperity is the point of macroeconomic policy—a radical contention in some circles, but I stick with it.

    Or isn’t prosperity at the top of your list?

  11. Gravatar of ssumner ssumner
    30. September 2013 at 05:05

    libertaer, You need to focus on what markets think, not what market monetarists think. We take our marching orders from the markets. I’d guess the markets would react negatively to a default. Mostly because it would indicate a dysfunctional government. By analogy, the markets fell when the GOP failed to push Smoot Hawley through in October 1929—not because they liked Smoot Hawley, but rather because it showed the GOP had become dysfunctional.

    I also think that default is very unlikely to occur. What would the GOP gain from default?

  12. Gravatar of Benjamin Cole Benjamin Cole
    30. September 2013 at 05:28

    Amazing fact of the day:

    The PCE implicit price deflator rose from 1960 to 1969…are you ready for this? 21.56 percent. Less than 2 percent annually compounded.

    From FRED:

    http://research.stlouisfed.org/fred2/data/DPCERD3A086NBEA.txt

    Yet the 1960s—a decade in which real per capita incomes rose by more than 30 percent—remains one airily dismissed by modern economists, for having endured, or worse, introduced, “high inflation.”

    Th CPI ran higher. But on second reckoning, inflation was not the big issue that later economists have made of it. Ir reflects the unfortunate modern-day social norm of inflation hysteria.

    Give me 2 percent inflation, and real per capita real income growth of 30 percent every decade. I’ll take it from there….

  13. Gravatar of libertaer libertaer
    30. September 2013 at 06:45

    “I’d guess the markets would react negatively to a default. Mostly because it would indicate a dysfunctional government.”

    Okay, but Krugmans main fear is a sudden scarcity of collateral in the financial sector. Do you agree with that?

    I don’t see why -if central banks can keep NGDP on trend – this would be a reason for a recession.

  14. Gravatar of ssumner ssumner
    1. October 2013 at 04:30

    libertaer, Central banks cannot prevent a sudden shock from having a short term effect on the economy, at least not with their current operating procedures. They would do better with level targeting.

    I don’t know enough to comment on the collateral issue, although I doubt that a shortage of bonds is a significant problem, the supply of bonds has soared. The problem is monetary policy.

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