I have always been deeply skeptical of “imbalances” arguments.  Free Exchange recently linked to this discussion of the euro crisis by Guntram Wolff:

In the sixth year of the crisis of the euro area, it is time to review whether adjustment to external imbalances in the euro area is working. Current accounts have dramatically adjusted in a number of countries of the euro area as the graph below shows. The one country showing virtually no adjustment is Germany and I will revert below to it. Is the dramatic adjustment in current account deficits a sign of success of the export sector or merely a reflection of a dramatic collapse in domestic demand due to the private sector deleveraging and the start of fiscal consolidation?

The question should be:

“Is the dramatic adjustment in current account deficits a sign of success of the export sector or merely a reflection of a dramatic collapse in domestic demand due to tight money depressing eurozone NGDP?”

And the answer is pretty obvious.

Unfortunately I’m not fluent in “European,” but my eurozone commenters tell me that on the continent there is virtually no discussion of the role of monetary policy in the crisis.  I’m not saying that people should necessarily agree with my views, but wouldn’t you think that a historic collapse in NGDP growth would at least trigger a discussion of whether tight money might be to blame?

This is an addendum to my previous post.

I think some commenters are underestimating how different the intellectual climate would have been in 2009 absent ANY fiscal stimulus.  The Fed would have been seen as the only game in town.  Instead of the near total blackout of discussion of monetary policy, the pundits would have been talking about little else.  They would have immediately dug up Bernanke’s writings on Japan (instead of waiting months for Marcus Nunes to do so), and asked why the Fed couldn’t do the same in America.  Recall that we were in DEFLATION at the time, just like Japan.

My PLT hypothesis still embedded a 2% inflation target, albeit with level targeting.  Does anyone seriously believe that would have been viewed as too radical if our fiscal policymakers were doing nothing to prevent a depression?  If anything, I’d expect many economists would have been suggesting a 3% or 4% inflation target.  My counterfactual was fairly conservative.  And the Fed usually does roughly what a consensus of economists wants them to do.

And yet . . . as conservative as it sounds, it still would have led to considerably faster NGDP growth than we actually got.

BTW, anyone who thinks the Fed is aiming for some “catch-up” with the price level, needs to consider this excellent article by Matt O’Brien from a few weeks back.  He shows that since the recession got bad the Fed has never once forecast above 2% inflation, on any time horizon.  Even though we are well below the 2% trend line from late 2008.  Here’s the money shot:

Premature exit strategy.

PS.  In the comment section of the previous post Matt Rognlie pointed out that fiscal stimulus can increase output via supply-side effects.  So I was a bit sloppy there.  When I said the multiplier was zero under inflation targeting I was referring to demand-side effects.  Obviously if the multiplier is defined in terms of RGDP then it isn’t necessarily exactly zero, it might be positive or negative depending on supply-side effects.

The term ‘Keynesian economics’ means different things to different people.  But one thing almost everyone can agree on is that Keynesians believe that the 2009 fiscal stimulus boosted aggregate demand, at least compared to the no-stimulus alternative.  Alternatively, Keynesians believe the fiscal multiplier is positive.  In my view that’s a sort of sine qua non of modern Keynesianism.  Yes, it has many other things to say, but without the fiscal multiplier there’s nothing particularly “Keynesian” about the rest of the theoretical apparatus.

Even if you don’t agree with me, surely you’ve read dozens of pundits, reporters, economists and politicians make the argument for a positive multiplier, and call that argument “Keynesian.”  Indeed many go further and suggest that only unenlightened conservative ideologues could question something so obvious, so well established by both theory and empirical studies.

I’m here to tell you that it’s all a fraud.  There is no empirical study that shows the 2009 stimulus was effective.  It’s not even clear new Keynesian theory implies it was effective.  It might, but it also might not.  There is nothing scientific about “the multiplier.”  And many of the arguments made by pundits (with a few notable exceptions like Avent and Yglesias) are deeply misleading to readers.

Let’s start with the easy part.  New Keynesian theory predicts that the fiscal multiplier will be zero if the central bank is targeting inflation in a forward-looking fashion.  That is, increased deficit spending will not increase expected future growth in aggregate demand.  The smarter Keynesians know this, but the “smarter Keynesians” are a very, very small group.  If you polled PhD trained economists in America, I’d guess less that 10% know this, maybe less than 2%.

[Update:  The zero multiplier refers only to demand-side effects.  In the comment section it was noted that fiscal actions can also boost output by increasing labor supply, and this would not be offset by monetary policy.  This post addresses the demand-side effects of fiscal actions, which is also the focus of Keynesians.  I guess I’m not in the 2% either. :)]

Even worse, many of the Keynesians who do know this fail to mention it in most of their “pro-stimulus” screeds, thus giving average readers the impression that a positive multiplier is the default assumption, and that it’s up to those who disagree to explain why.  No, it’s up to those who believe fiscal stimulus would cause the Fed to stop targeting inflation (or stop Taylor Rule-type policies) to explain why they believe this.

Long time readers of this blog know that the monetary offset problem quickly degenerates into debate over whether the Fed would “sabotage” fiscal stimulus.  I don’t like that framing, because it implies monetary policy forces the Fed to “do something” to offset fiscal stimulus, or more precisely to “do something that looks like it’s doing something” to offset fiscal stimulus.

In a recent comment section, Statsguy asked if I thought the Fed would have offset a lack of fiscal stimulus in 2009.  I do think so, indeed I believe that the current unemployment rate would probably be lower than 7.7% if there had been no fiscal stimulus in 2009.  I will explain why, using what I hope everyone will see as eminently reasonable assumptions.  I’m not claiming that I know exactly what would have happened, but rather that quite plausible counterfactuals can leave us with a negative multiplier, contrary to the claims of Keynesians.  Here are my assumptions:

1.  In early 2009 there were fears of depression.  Stock prices had collapsed and unemployment was soaring.  People were frightened.

2.  If the fiscal policymakers provided no stimulus, Bernanke and the Fed would have felt an incredible burden to save the economy.

3.  However, I would not expect the Fed to do anything that looked radical or dangerous.

4.  I would have expected them to take off the shelf the most highly regarded models of how to save an economy with monetary policy when stuck at the zero bound.  That would be the Woodford model, which calls for level targeting of prices.

5.  I would have expected them to use at least some of the ideas that Bernanke suggested the BOJ employ.  One of those was level targeting of the price level.

6.  They would have been reluctant to abandon the 2% inflation target, with level targeting of the price level they would not have had to.

7.  Do you see where I’m going?  Level targeting of the price level along a 2% path is the overwhelmingly most likely “nuclear option” to be employed by the Fed if the economy is falling off the cliff and the fiscal policy makers are doing nothing.

8.  The level targeting theory suggests you want to make up ground lost in the crisis period where monetary stimulus is (supposedly) ineffective.  I think they would have started the trend line for the price level in September 2008, which is both the peak month for the price level (it started falling in October) and also the month the financial crisis blew up.

9.  The Fed uses the PCE price index, so we’ll assume they targeted that index (although the CPI or the core PCE would give you similar results.)  The PCE on September 2008 was 110.275.  That means the PCE for January 2013 should have been 120.165.

10.  The actual PCE in January 2013 was 116.342, well below the Fed’s likely target under PLT regime.  In other words, under the most likely alternative (no fiscal stimulus) policy, prices would have likely risen much faster than the actual path of prices, assuming the Fed was able to hit its target.

11.  Because both fiscal and monetary stimulus impact the demand-side of the economy, the depressed price level of January 2013 means, ipso facto, that AD and NGDP have also risen more slowly than under the no-fiscal stimulus PLT alternative.  We are worse off after having wasted hundreds of billions of dollars in fruitless deficit spending.

I can anticipate the objections:  “What makes you think the Fed would have hit its price level target?”  Initially I think they would have failed, but recall that even in the NK model a higher inflation target is far more effective than QE.  As prices fell in 2009, the expected inflation rate would tend to rise under PLT.  So even using the assumptions of the NK model, the Fed would have been doing a policy that is far more effective than the policy they actually conducted.  Surely that counts for something!  Indeed, with a higher inflation target you don’t even need to do as much QE, other things equal.  If you add in the lack of fiscal stimulus, then it’s unclear whether the PLT regime I propose would have required more or less QE than what we actually saw.

To be clear, I am not claiming that I “know” that this counterfactual would have occurred.  But I think any fair-minded person would admit that it’s a plausible counterfactual.  Here’s what I am claiming:

1.  My counterfactual is plausible.

2.  Almost all Keynesian discourse on fiscal stimulus, multipliers, neanderthal conservatives, etc, implicitly implies that my counterfactual is not plausible.

3.  Hence Keynesianism is nothing but a sandcastle built on a pile of flawed assumptions.

Maybe the 2009 fiscal stimulus helped a lot.  That’s possible.  But don’t pretend that your belief in the 2009 fiscal stimulus is any different from blind faith in some sort of religious dogma.  There’s no science to back it up, and none of the empirical studies I’ve seen have any bearing on the counterfactual I just presented.  None.

PS.  Remember those Keynesians telling us that higher payroll taxes would slow retail sales in Q1?  Looks like they might want to revise their models:

WASHINGTON (Reuters) – Retail sales expanded at their fastest clip in five months in February, the latest sign of momentum for an economy facing headwinds from higher taxes and pricier gasoline.

The solid sales last month comes on the heels of strong gains in employment and manufacturing. But the improvement in the economic picture is likely insufficient to shift the Federal Reserve from its very accommodative monetary policy stance.

“The economy in February is looking solid. None of this, however, is likely to cause the Fed to change tack in the near term,” said John Ryding, chief economist at RDQ Economics in New York.

Retail sales increased 1.1 percent, the largest rise since September, after a revised 0.2 percent gain in January. That was well above economists’ forecasts for a 0.5 percent advance.

So-called core sales, which strip out automobiles, gasoline and building materials and correspond most closely with the consumer spending component of gross domestic product, rose 0.4 percent after increasing 0.3 percent in January.

The upbeat report helped to lift to the dollar to a seven-month high against a basket of currencies. Prices for U.S. government debt fell and stocks on Wall Street slipped after a recent rally.

The healthy gains in retail sales came despite the end of a 2 percent payroll tax cut and an increase in tax rates for wealthy Americans on January 1.

Spending is being supported by the stock market rally, rising home prices and sustained job gains which are starting to push wages higher.

GROWTH FORECASTS RAISED

The gains in core sales in the first two months of the year offered hope that consumer spending, which accounts for about 70 percent of the U.S. economy, would probably not slow much this quarter after growing at a 2.1 percent annual rate in the fourth quarter.

A second report from the Commerce Department showed business inventories rose by the most in more than 1-1/2 years in January.

Retail inventories, excluding autos – which go into the calculation of gross domestic product – recorded their largest increase since August 1995.

That and the rise in core retail sales should help boost economic growth after output barely expanded in the last three months of 2012.

Economists raised their first-quarter growth estimates by as much as eight tenths of a percentage point after the reports.

Despite paying 35 cents more for gasoline at the pump, consumers also bought automobiles last month.

Receipts at auto dealerships rose 1.1 percent after falling 0.3 percent in January. Excluding autos, retail sales increased 1.0 percent, also the largest increase in five months. That followed a 0.4 percent advance in January.

Matt Yglesias makes an uncharacteristic error in mocking a restaurateur who claims that Obamacare will increase prices:

This is self-refuting nonsense. The only situation in which it would make sense for Ruffer to raise prices is if price increases will on net lead to higher revenue. And if price increases will lead to higher revenue (which they might) then it makes sense for Ruffer to raise prices no matter what happens with Obamacare. In fact, Ruffer himself articulates the truth later which is that Obamacare is going to reduce his profits by about one-eighth and he (and any investors in his business) will eat the loss.

The restaurant industry has relatively free entry and lots of firms (meaning it’s what economists call “competitive” or “monopolistically competitive.”)  Here are some facts about those industries:

1.  Higher variable costs raise prices in both the short and long run.

2.  Higher fixed costs raise prices in the long run.  (Which is just another way of saying that all prices are variable in the long run.)

So he’s wrong in the long run, and probably even a little bit wrong in the short run, as workers are usually considered variable factor.  However the short run impact will probably be pretty small–it will mostly come out of profits.  In the long run competitive and monopolistically competitive industries earn zero economic profit, and hence all cost increases are passed on to consumers.

It’s possible that costs would not rise at all, as the extra cost of health care might be offset by lower wages.  But it’s unlikely that workers value health-care benefits and wages equally, otherwise there would be no uninsured workers.

This doesn’t mean Obamacare is a bad idea, it’s appropriate that costs be passed on to consumers, and there are other arguments in favor.  I happen to oppose Obamacare, but not the principle that everyone should be forced to either self-insure, or buy some sort of coverage.

PS.  Matt’s argument does apply to monopolies, when the cost increase is a fixed cost.  My favorite example is big contracts for athletes.  Many sports fans blame high ticket prices on the big contracts, but the causation goes the other way.  Owners set prices at a level that maximizes revenue.  Then owners and athletes fight over the pie.  As TV money made the pie much bigger, athletes were able to grab much bigger salaries.  But if they didn’t get the money, it would go to owners.  BTW, I’m not saying teams are a pure monopoly, but rather that the entry into the industry is controlled.  The issue of free entry affects pricing far more than whether something is a monopoly or has numerous competitors.

PPS.  Speaking of restaurant jobs, I highly recommend Bryan Caplan’s post on the minimum wage.

I see that Paul Krugman is still insisting that Britain’s problems are due to fiscal “austerity,” which would only make sense if they were stuck in a liquidity trap and the BoE was no longer able to hit its nominal targets (whether inflation or NGDP.)

Even worse, he’s still using RGDP data even though NGDP is the appropriate way to ascertain the level of demand.  RGDP inappropriately mixes supply-side and demand-side issues. Employment in Britain is hitting record highs (unlike the US, where employment is mired far below the peak under Obama’s policies) suggesting that some of the low RGDP reflects supply-side problems.

Meanwhile, Mark Carney seems to have successfully talked the pound lower, and inflation expectations are soaring.

The U.K. 10-year break-even rate, a gauge of inflation expectations, climbed to the most since September 2008.

The rate, which measures the difference in yield between index-linked and nominal securities, rose six basis points to 3.35 percent at 12:43 p.m. London time.

For fiscal “austerity” to be a problem you’d somehow have to believe that it’s preventing the BoE from achieving even higher expected inflation rates.  How plausible does that sound?

PS.  Recall that famous example of liberal cluelessness at the New York Times?

Number in Prison Grows Despite Crime Reduction

The British newspaper The Guardian produced this gem:

Record jobs level with almost 30 million Britons in work

Unemployment down to 2.5 million by end of December but Labour says British workers paid price with wage cuts

In America employment is still more than 3 million below the pre-recession peak.  And we have a faster growing population than Britain.

PPS.  Nicolas Goetzmann sent me this FT article, which (implicitly) makes a strong case for the superiority of NGDPLT over inflation targeting, and then inexplicably ends as follows:

These considerations are highly relevant to the current discussion about the monetary policy framework that has been encouraged by Mark Carney, BoE governor-designate. To “tie the hands” of policy makers through a mechanism such as nominal GDP targeting could be unwise, as a shift in the relationship between inflation expectations and stock prices would require a change in policy.