But what type of fiscal stimulus?
This is a follow up to the earlier post on Ezra Klein. I think one issue that gets lost in the “does fiscal stimulus work” debate is the question of how the answer depends on the type of fiscal stimulus. It seems to me that the actual Obama fiscal stimulus was based on the Eggertsson/Krugman view that there is a paradox of toil. That supply-side initiatives to boost employment are self-defeating—they merely drive prices even lower, which negates the impact of lower costs on business. Hence we ended up cutting payroll taxes for employees.
This model might have been plausible in 2009, but has performed very poorly over the past few years. Inflation is higher than NK models predict, and doesn’t seem to be falling. In addition, after dropping the ball in 2009, the Fed seems committed to keeping inflation expectations from falling very far below 2%.
Under that sort of monetary policy the logic behind traditional fiscal stimulus disappears, and the argument for a new kind of fiscal stimulus becomes much stronger. What type of fiscal stimulus? Read Christy Romer to find out:
“We need to realize that there is still a lot of devastation out there,” Romer said, calling the 8.9% unemployment rate “an absolute crisis.”
“If I have a complaint about policy these days, it’s that we’re not doing enough,” she said. “That goes all the way up to the Federal Reserve, [which] could be taking more aggressive action. It goes to the Congress and the Administration – there are fiscal policy actions they could be taking.”
“And don’t tell me you can’t [take those actions] because of the deficit because I think there are fiscally responsible ways,” she said.
Romer suggested that extending the payroll tax break to the employer side of the payroll tax could spur the economy;
Ezra Klein argued that Romer was a supporter of fiscal stimulus, and that’s true. But ask yourself why a Keynesian like Romer would recommend that particular type of fiscal stimulus. After all, don’t we normally see Keynesians argue that the most effective tax cuts are those that boost spending, which means given money to lower income consumers who have a high propensity to spend? Why give money to big corporations? I can’t be certain, but it’s hard to imagine that Romer would have chosen the employer-side approach unless she had been thinking along the same lines as I am. That the Fed is targeting inflation, and hence will have to boost AD to the right to keep up with any increases in aggregate supply.
Please note that I am not arguing that “Romer agrees with me” in any broader sense than this narrow question. I don’t doubt that she is considerably more Keynesian than me, and also considerably more pro-fiscal stimulus. But at a minimum, her comments suggest that we need to carefully consider which types of fiscal stimulus are likely to be most effective in a world where the Fed is holding inflation expectations at 2% or slightly below. And once you start thinking about the issue that way, it’s not hard to imagine how someone could end up being even more skeptical of conventional fiscal stimulus than Romer ended up being. In other words, her policy conclusions obviously differ from mine, but her thought process is remarkably similar.
Tags:
14. March 2012 at 09:31
Prof. Sumner,
I’m nothing but an interested layman, so I won’t even try to engage you on professional terms. I’m curious, though – as I understand it, you favor some specific actions by The Fed. I find your arguments superficially convincing, but recognize that I certainly don’t have the economic expertise to adjudicate between you and the other professional economists who disagree with you.
Regardless, though, it seems very likely that The Fed is not going to follow your preferred policy any time soon. Given that reality, I was wondering if – short of dissolving The Fed – is there some policy that Congress could follow that would help things from your perspective? It seems that Congress could simply assume that The Fed is going to follow a 2% non-smoothing RGDP target. Certainly, it will be harder for them to go in one direction while Bernanke is rowing in another – but would it possible for them to simply overpower him using some fiscal policy?
The answer may well be “no”, but I’m curious if you’ve thought about whether or not there’s a clever solution to this that Congress (conceivably) could be convinced to try, since presumably we don’t really have any influence at all over Bernanke?
14. March 2012 at 10:16
Brett, Yes, a employer-side payroll tax cut would help a lot. I’ve consistently advocated that form of fiscal stimulus.
14. March 2012 at 11:27
Scott said:
“her policy conclusions obviously differ from mine, but her thought process is remarkably similar.”
Isn’t a simpler explanation, based on her own work, that she believes tax but multipliers to be much larger than spending multipliers?
14. March 2012 at 11:37
Perhaps Romer realized that an employer side payroll tax cut was the most politically palatable form of fiscal stimulus? Economists often publicly push for proposals that have some chance of passing. I obviously can’t speak for her, but is it possible that her rationale may have been more political than economic?
14. March 2012 at 11:50
Monetary policy works by propping up overpriced assets. That’s a fact, and it’s one that you might consider next time you make the argument: the Fed is all powerful and therefore fiscal policy is unattractive, QED. Another you might consider is the type of behavior that monetary policy invites and rewards.
Fiscal policy, by eye-watering contrast, can time positive NPV investment to smooth the business cycle and reduce the kinds of imbalances that lead to problems in the first place- like, I don’t know, one country absorbing 80% of global excess savings, just for example- hence an infrastructure bank, hence grants to states so that we can keep educating children during crises. Meanwhile, fiscal polciy doesn’t involve making whole heads-I-win-tails-you-lose speculators whose activitiy is so deleterious to our welfare.
You know, crazy stuff stuff like that.
I’m going to get back to you on empirical evidence when I get a free second. In the meantime, a moment of reflection could be called for.
14. March 2012 at 11:55
Unrelated: on Bernanke.
Does Bernanke really believe that central banks cannot increase inflation without losing control altogether?
14. March 2012 at 12:52
Aaron, But why employer-side?
Andrew, You said;
“Perhaps Romer realized that an employer side payroll tax cut was the most politically palatable form of fiscal stimulus?”
No, she has a reasonably good understanding of how politics works, she knows the employee-side cut is far more politically popular.
Majorajam, I hope you are joking.
David, No, but I can understand why he would not want to increase the inflation target.
14. March 2012 at 15:08
An illustrated argument for an employer-side payroll tax cut:
http://thefaintofheart.wordpress.com/2011/09/09/now-it%C2%B4s-up-to-bernanke-and-the-fomc/
14. March 2012 at 16:20
You bet Scott. Did you hear the one about the Greenspan/Bernanke Put? It’s a hoot.
But, but, but, price discovery and rational expectations!! Yes, rational expectations that the Fed will arbitrate price discovery when push comes to shove and the vain little men, who luxuriated in praise as they exalted the brave new world of modern finance, end up with egg strewn all over their red faces. Hey, but what good is evidence when there’s a compelling theory hanging in the balance?
No doubt but someone is in the humor business here.
14. March 2012 at 17:36
I’m sorry I’m not convinced that giving additional tax cuts to all businesses will lead them to spend more, invest more or hire more. If you’re sitting on a pile of money already, then why would some extra money induce you to spend? Why would you hire somebody for $30K if you could only save on $5-10K? You would have to make that tax cute humongous so that it would just be stupid not to hire people, but that would cost a fortune. I just don’t see the incentive.
I do see the incentive with start-ups however. If the government decided to reduce the payroll taxes or eliminate them for a few years in the beginning then that would help a lot of start-ups. It’s one thing to have a business running but it’s quite another to start one. In the beginning you have very little cash flow and any help would make it easier plus help would be more attractive to would-be entrepreneurs. I am talking about really small businesses, not start-ups with millions of dollars in investor money.
Lastly, I’m sad that we don’t have more tax credits to spur buying. The housing credit and the car credit were way to high but if you made a smaller one of each and spread it out, then more spending would have occurred, don’t you think?
14. March 2012 at 17:41
1 more thing, and this has nothing to do with your post.
How come you don’t read Dean Baker’s Beat The Press blog? I think you two should debate more often. I find him a lot more convincing and “economic” (does that make sense?) then Krugman. I’m just saying.
14. March 2012 at 21:04
@EricG
I sit on some corporate boards, and this may be anecdotal, but in my experience many, many companies are cash constrained. If there was more cash available either through more credit or lower taxes, investment (and jobs) would go up.
There are not that many companies around that are “sitting on a pile of money.”
15. March 2012 at 03:24
Perhaps economists are wrong, but we generally explain what firms do based upon the profits they expect to make. The effect of an employer side tax cut isn’t to give the employers more money so they can afford to hire more workers. It is rather to reduce the cost of hiring workers (which is mostly compensation for the worker but also includes the payroll taxes the employer must pay the government.) Given the revenue that that selling more output would generate, the lower cost of hiring the workers will make it profitable to hire more. Now, if it is necessary to lower prices (or raise them more slowly) to sell the extra output, this will tend to dampen this effect. However, with inflation targeting, prices will not need to fall (or rise more slowly.)
15. March 2012 at 05:47
Scott,
maybe the most interesting aspect of the fiscal policy debate is that apparently, governments believe that they have to do something to stimulate the economy AND do that by untried or discretited means. If that is true, than the only explanation is that politicians in power may use tools knowing that they have predictable costs but highly uncertain returns. What about the morality of that? What about standard collega economics that teaches something very different. What about an economics profession that subordinates it’s academic integrity to a magician’s/
15. March 2012 at 07:27
“the most effective tax cuts are those that boost spending, which means given money (sic) to lower income consumers who have a high propensity to spend”. This confused me, especially since I had just read your previous post. Are you saying that lower income consumers have a higher propensity to spend, or are you saying that keynesians say that? If it’s the latter, I imagine you’d also say that the keynesians are making a non-sensical statement?
15. March 2012 at 07:40
Thanks for the link Marcus.
Majorajam, That’s your “empirical evidence?”
Eric, You said;
“I’m sorry I’m not convinced that giving additional tax cuts to all businesses will lead them to spend more, invest more or hire more. If you’re sitting on a pile of money already, then why would some extra money induce you to spend? Why would you hire somebody for $30K if you could only save on $5-10K? You would have to make that tax cute humongous so that it would just be stupid not to hire people, but that would cost a fortune. I just don’t see the incentive.”
You don’t see the incentive because you are looking at the picture from the demand-side, and it’s a supply-side initiative. It makes no difference how much money they already have. It shifts SRAS to the right, doesn’t it?
I read Baker on occasion, and agree he’s smart. I just don’t have time for everything I’d like to read regularly. Maybe someday.
Bill, Exactly.
Rien, Good point, but never rule out stupidity.
15. March 2012 at 07:41
Frederico, I’m saying Keynesian believe that, I don’t.
15. March 2012 at 15:55
Scott, no actually, that’s an allusion to evidence, for those cognizant of what that type of thing looks like. Ehem. My mentioning it was really just a way to suggest you consider descending the stratosphere, setting aside the toy model frictionless surface and joining the real world. Really, it’s a great place full of mechanisms, institutional arrangements, parochial interests and unintended consequences. You should check it out some day.
But since you asked, I have to inquire, are you seriously asking me for evidence that the central bank governance (for lack of a better term) of the last three decades created a pervasive atmosphere of moral hazard, which led directly to the build up of leverage, frenzy of speculation and deterioration in underwriting standards that caused the calamitous financial crisis? In 2012? Really???
I wonder, how do you explain why and how broker dealers and money center banks were able to sustain 30% balance sheet growth for several years leading up to the crisis, all as the source of their gargantuan profits transitioned decisively from underwriting to far more risky proprietary trading? Who was financing all that raw speculation, and why didn’t they mind what was being done with their money?
And how you account for the tsunami of credit that was made available for hedge funds during the same time? Or for the overwhelming popularity of the carry trade, the high correlation of the dollar and risk markets, the massive international flows of speculative finance?
I wonder how you would explain why it is the Fed took all of, whatever it was, 24 hours?, to realize that- what do you know, Bear Stearns was systemically important after all!- having steadfastly refused to countenance, let alone raise, any concern over the activities of any such institutions for years of steadily more dodgy behavior (and balance sheet growth as noted). This is to name but a few direct falsifiable links between the financial crisis and Fed policy.
But you want evidence. Sorry, but I struggle to comprehend the, not so much indifference, but outright hostility some economists have to reality. As Jeremy Grantham pointed out, Greenspan’s very definition of the optimal approach to central banking- lack of intervention during booms, massive ‘clean-up’ operations thereafter- is actually a working definition of moral hazard.
But getting back to the fact that started it all, Ben Bernanke himself, in several speeches, as well as economists and academics in papers and comments too numerous to cite, have so much as said that monetary policy works by influencing asset prices, and through that channel, turning the credit taps. Your substitution of inane rhetorical requests for empirical evidence for engagement on this and other points speaks volumes.
16. March 2012 at 05:14
ssumner:
It seems to me that the actual Obama fiscal stimulus was based on the Eggertsson/Krugman view that there is a paradox of toil. That supply-side initiatives to boost employment are self-defeating””they merely drive prices even lower, which negates the impact of lower costs on business.
This is perhaps the core of the fallacious Keynesian view. They don’t understand that when wage rates fall, not only is it not true that total wage payments fall, it is also not true that prices and costs fall together one for one, thus allegedly nullifying the decline in costs.
The Keynesians believe that when wage rates fall, especially in a depression, total wage payments fall as well. But in reality total wage payments tend to up, since all the postponed investments that could not be made because of too high costs (from labor) can finally be made. As this happens, the decline in wage rates is certainly more than offset by a total rise in total wage payments.
The Keynesians also believe that if prices fall, it will “negate” the fall in business costs on account of lower wage rates. But this ignores the fact that alongside the rise in total wage payments that accompany a fall in wage rates and recovery out of depression, there is also tends to be a rise in net investment. Here is where the Keynesians turn economics completely upside down. They believe that a rise in net investment decreases profits, when in reality, a rise in net investment increases profits, because net investment is the difference between gross investment and depreciation costs, and gross investment is sales revenues for the sellers of capital goods. This means that an additional positive “revenues minus costs” is introduced into the economy, and that ADDS to profits. It does not decrease them.
What is also missed by the Keynesians is that as wage rates fall, that decreases the costs of not only labor, but also the prices and hence costs of capital goods, since labor goes into the production of capital goods as well. Lower wage rates result in lower capital goods prices. So not only are business costs reduced on account of labor, they are also reduced on account of the costs of capital goods.
With lower wage rates, higher total wage payments, and higher profitability, there is absolutely no reason for why employment should fall.
16. March 2012 at 11:15
Majorajam, You obviously don’t understand my views, as you attribute things to me that I’ve never said.
I don’t believe the Fed created most of the moral hazard, it was the Federal government. And yes, that did contribute to the housing boom and bust. But of course the housing boom and bust did not cause the recession. Most of the housing collpse occurred between January 2006 and April 2008. Over 70% of the decline, to be precise. And yet unemploymen rose from 4.7% to a grand total of 4.9%. So housing isn’t the culprit, it’s the plunging NGDP in the second half of 2008–and that’s on the Fed.
MF, You said;
“This is perhaps the core of the fallacious Keynesian view. They don’t understand that when wage rates fall, not only is it not true that total wage payments fall, it is also not true that prices and costs fall together one for one, thus allegedly nullifying the decline in costs.”
Finally a point of agreement. But I would say “not necessarily true.” Obviously one can find cases where both hourly wage costs and total incomes fell. But the two need not be linked.
16. March 2012 at 12:36
ssumner:
Finally a point of agreement. But I would say “not necessarily true.” Obviously one can find cases where both hourly wage costs and total incomes fell. But the two need not be linked.
Sure, if you mean empirically, then it’s better to say “not necessarily true”, because of course both could happen at the same time observationally, if other factors are present to make it so, but if we mean a causal link, then it’s better to say “not true.”
We agree on many things, it just appears as so much disagreement because you devote your blog primarily to the one thing we most disagree on, namely money.
Like I said before, whereas I recognize the same economic principles and laws in money as I do every other good, you deny this, you say money is somehow “different”, and that money is “too important” or whatever to be left to the market. I say money operates according to the same economic laws as every other commodity, and in addition, it is precisely because money is so important that it should be left to the market.
I don’t trust a government bureau to monopolize food, shelter, clothing, or medicine commodities, and I certainly don’t trust it to monopolize the most marketable commodity of them all, namely money. They are neither intellectually nor morally entitled to monopolize any of these goods.
I highly enjoy your demolitions of Keynesianism.
Your critique against gold was unfortunately a disaster, but that’s only because you have an intellectual bias against that which would spell doom for the majority of your academic legacy, and a bias in favor of that which protects it.
I hope you don’t end up like Keynes, who, ten days before he passed, confessed:
“I find myself more and more relying for a solution of our problems on the invisible hand which I tried to eject from economic thinking twenty years ago.”
16. March 2012 at 19:49
Scott, I’ve gotta ask, in the world you inhabit, do asset prices have any impact on loan performance? And in that place, which in all fairness, sounds rather serene, do bad loans play any role in the solvency of financial intermediaries? And, as long as we’re on a roll here, perhaps you can tell me whether things like cascading bank runs and systemic meltdown have any influence on NGDP there?
Because if so, you may want to investigate the relevance of those causalities to this whole ‘I’m smarter than the market’ contrarianism thing you’ve got going on here. This is not to mention the unsubtle pleading in arguments that go: the Fed controls NGDP, dips in the economy coincide with dips in NGDP -> any dip in an economy is the fault of the Fed. There is no evidence, as in none, that in a market economy the central bank controls NGDP. That’s because it does not- cannot, in fact, when you are cognizant of how and under what circumstances claims are created in the real world, as opposed to on a chalk board, something Keynes did understand.
If not, of course, well then we’re back to the prior stated need to push the stick forward and get that nose pointed back down in the direction of terra firma.
Btw, as the Fed has dominated the lender/reliquefier of last resort role since the Big One, I’d be really bemused… err… interested to hear you flesh out your novel thinking as to how the moral hazard that led directly to the crisis was the consequence of federal government policy (by which I assume you mean fiscal policy) rather than the Federal Reserve Governance. It seems strange to me that those who are so devoted to free markets are so quick to dismiss the judgement of the professionals whose consensus sets the prices in that market, but economists capacity for disjointed thinking doesn’t much surprise me anymore.
17. March 2012 at 06:04
Majorajam, You said;
“Scott, I’ve gotta ask, in the world you inhabit, do asset prices have any impact on loan performance? And in that place, which in all fairness, sounds rather serene, do bad loans play any role in the solvency of financial intermediaries? And, as long as we’re on a roll here, perhaps you can tell me whether things like cascading bank runs and systemic meltdown have any influence on NGDP there?”
I presume you are joking. I was one of the people who developed the theory that the financial crisis was caused by falling asset prices in late 2008, which reflected tight money.
And no, those factors don’t impact NGDP, monetary policy drives NGDP.
17. March 2012 at 13:33
ssumner:
I was one of the people who developed the theory that the financial crisis was caused by falling asset prices in late 2008, which reflected tight money.
That theory was already advanced literally decades ago by the Austrians.
They long ago discovered and explained how malinvestments (for example asset prices that are bid too high) are exposed after a previous boom generated by previous credit expansion and artificially low interest rates, and the crucial subsequent failure of the central bank to maintain a sufficient inflation to keep the boom going. You say it’s tight money, Austrians just say it’s a reflection of central banks avoiding runaway price inflation.
At any rate, this statement you made is very revealing. You are, intentionally or not, making a case that inflation and deflation of the money supply, or, if you will, a faster and slower rate of money production, do not affect all prices equally over time. This is huge because it connects back to the price system and economic coordination, i.e. the “recalculation” story.
If you recognize that a tightening of money production tends to lead to a fall in the prices of assets relative to final (consumer) goods prices, then you must also recognize the reverse, that a loosening of money production tends to lead to a rise in the prices of assets relative to final (consumer) goods prices.
If you recognize this, then you must admit that monetary policy distorts the relative price structure of the economy!
No more crude aggregate NGDP statistics. You’re now compelled to delve into RELATIVE price structure theory, and how central banks change the relative price structure of the economy, and hence bring about malinvestments.
19. March 2012 at 12:35
Scott, firstly, the idea that you discovered the link between falling asset prices and financial crises is not worthy of being taken seriously, save as comic relief. The idea that these falling prices were created by tight money policies is only yet more absurd.
In 2007, the average Broker Dealer leverage ratio was 30x. This while Wall Street cowboy finance was at its zenith, (or nadir, depending on one’s perspective), at least going by the Fed’s Z1 report. Leveraged loan growth, just to take one example, was running at 60%(!!!!) in the first half of 2007. Meanwhile, we were running unprecedented current account deficits at circa 7% of GDP to finance consumption- fully 80% of total global excess savings- most of which was being recycled back into our bond markets courtesy of Asian mercantilism and the lack of imaginativeness of the Petro states.
And you report that money was tight. Words fail.
The whole thing begs the question of how you actually think economic activity gets financed (and more to the point, got financed before the financial crisis). I mean, how do you account for sudden stops in positively massive sectors of the capital markets- many of which, e.g. ABCP, have since ceased to exist- after Lehman? And how would you counteract the wrenching effect this would have on NGDP, not least after having the chutzpa to blame the environment of moral hazard that created the fiasco on fiscal policy?
Sure central banks can control NGDP in a stick figure world where uncertainty is a caricature of what is actually unknowable, where information is a caricature of what is ever actually known of what is knowable, where agency issues don’t exist, where asset prices aren’t predicated on official guarantees, explicit and implicit, where bailouts and moral hazard don’t exist, where the credit worthiness of counterparties is transparent, where liquidity providers have access to credit and have incentives not to liquidate, etc. etc. etc. But to what end? A world of caricatures is nothing more than a caricature of the real world.
And the real world is what we’re really discussing, isn’t it Scott? So far as that goes, you have provided nothing of substance to indicate that the Fed would’ve been able to prevent the travesty of underwriting, nor its calamitous aftermath in a financial system with negative capital and fearful principals, nor the ultimate effect of retrenchment of intermediaries and the household sector on the economy. Your claim that the Fed could’ve managed all that and without creating moral hazard, is about as credible as a promise of a politician running for office. That you’ve provided nothing to substantiate any of this, indicates to me you have nothing.
For the record regarding the causes of the financial crisis- and this is only to state a position you presumably wouldn’t like to acknowledge the existence of- credit needs to grow at a continuously accelerating rate- inflate or bust- to sustain the resulting loan quality and asset prices indefinitely. That follows from the inability of Ponzi borrowers to make interest payments (if history has ever had a more obvious class of Ponzi borrowers than the vast swath of ‘teaser rate’, ‘liar loan’ and other negative am. mortgages that got underwritten during the boom, I am unaware of it).
But that has limits- for one, risk intermediation invariably becomes an issue regardless of the institutional landscape, as there’s only so far you can game a VAR downward, etc. When that limit arrives, you see decreasing loan quality, transactions and prices, and eventually what some have called a ‘Minsky moment’.
19. March 2012 at 12:38
I should add that the Fed of course could have prevented much of the calamity of underwriting by regulation, such as was the case study of many foreign nations (e.g. Canada). But what you were arguing, that the Fed could’ve prevented the financial crisis, ‘by not letting monetary policy get tight’, could serve as quality stand-up material, if nothing else.