Archive for the Category Fiscal policy


Zero fiscal multiplier, example #371


Fed Inclined to Lift Rates If New President Adds Budget Bump

The Federal Reserve is inclined to raise interest rates higher than otherwise if the next president pursues a more stimulative fiscal policy.

U.S. central bankers say they would welcome such a step as shifting some onus for supporting the economy away from the Fed. But they suggest they would offset the extra demand that a bigger budget deficit would spur by making monetary policy less stimulative.

Once again, market monetarists have known all along what the media is just beginning to discover—just as with negative interest rates.

And this made me shake my head:

It also could pose some political problems for the Fed if it was perceived by lawmakers as working at cross-purposes with their efforts to spur economic growth.

Congress has been whining about low rates for years.  And now were are told that if the Fed raises rates to 1% or 2%, Congress will start complaining about high interest rates?

BTW, the entire premise of the article is wrong.  Fiscal policy will not have much impact on interest rates, because rates mostly depend on NGDP growth, and the Fed isn’t going to let that rise above 3% on any sustained basis.

Hillary and Trump aren’t going to give us growth, they are going to deliver big government.

HT:  Michael Darda

PS.  Time for the daily Trump dump:

1.  Trump has threatened to sue people on at least 20 occasions since the campaign began.

2.  The ABA prepared a report on Trump’s excessive litigation, which called Trump a “libel bully“.  But the ABA refused to release the report .  .  . (and this is not a Onion joke) .  .  . for fear of being sued by Trump.

3.  Trump praised Hillary as a great senator and a great person.  Said Bill was a great president.  But don’t worry Harding, that was back in 2008, when he was not running for president and was free to speak his mind.  I’m sure his views since he had to begin kowtowing to the alt-right are much more representative of his actual beliefs.

4.  And talk about “first world problems“:

For all their sharp differences, supporters of Hillary Clinton and Donald Trump have one thing in common: election-related stress.

HT:  Tom Brown


Is Europe moving away from austerity? Will it matter?

Here’s a NYT headline:

Europe May Finally End Its Painful Embrace of Austerity

And here’s the claim:

As Europe has grappled with the trauma of a devastating financial and economic crisis, policy makers have consistently relied on one approach to managing the damage — budget austerity.

Shrink government spending by trimming pensions and cutting social programs, the logic runs, and the markets will gain confidence in the tough-minded people in charge. Confident markets make for happy markets. Money will pour in, and good times will roll.

Even as prosperity has remained painfully elusive across much of Europe, leaders have time and again renewed their faith in the virtues of this harsh medicine.

Until now.

Some policy makers are flashing tentative signs that they may be prepared to slacken their grip on public coffers to spur growth and improve the lot of ordinary people suffering joblessness and diminished wealth. In the clearest sign of this shift, the heavily indebted Italy is increasingly inclined to challenge Germany — the guardian of austerity — to loosen European purse strings.

Of course everything is relative, and European fiscal policy has not been particularly austere.  But even so, can we assume that a slackening of “austerity” will boost growth? Veronique de Rugy of the National Review reports:

The Congressional Budget Office recently released its Monthly Budget Review for September 2016. It includes a revised estimate of the deficit for 2016. It isn’t much different than the one projected in August. The document makes it hard to ignore that in 2016 the deficit grew by $149 billion, from $439 billion in 2015 to $588 billion at the end of FY2016. This explains why we haven’t heard president Obama brag about how the deficit is shrinking in a while.

Normally the deficit falls during expansions.  How did the economy respond to this loosening of “austerity”?  RGDP growth slowed to less than 1.3% during the past four quarters, as the Fed tightened policy.  As a result of our foolish fiscal policy, fiscal authorities will now have less room for “stimulus” during the next recession, as the deficit will be starting from a higher base.  Of course this will come as no surprise to readers of this blog.  The austerity of 2013 (when the deficit plunged from about $1,050 billion to about $550 billion between calendar year 2012 and 2013), coincided with an increase in GDP growth. But like Chicago Cubs fans, Keynesians never give up hope.

Now let’s look at the UK:

Before the June 23 vote for “Brexit,” the man in charge of the budget, the chancellor of the Exchequer, George Osborne, was publicly pursuing the aim of delivering a budget surplus by 2020. The target required cuts.

But as the political class absorbed the ballot result, interpreting it as a demand for redress from communities reeling from high unemployment and wage stagnation, Mr. Osborne acknowledged that his goal could no longer be achieved.

His successor, Philip Hammond, has raised the ante.

In a speech at an annual gathering of the governing Conservative Party on Monday, the new chancellor declared that the government would borrow more to finance new infrastructure projects — presumably creating construction and manufacturing jobs.

While reading this, I spied a link in the right column, to another NYT story, this one from May 25th:

‘Brexit’ Could Spell More Austerity for Britain, Study Warns

That’s pretty scary, but could the prediction be trusted?  The NYT says yes:

LONDON — Prime Minister David Cameron’s campaign to keep Britain in the European Union was bolstered on Wednesday by a report from one of the country’s most authoritative economic research bodies, which concluded that a withdrawal from the bloc would lead to up to two more years of public spending cuts or tax increases.

A frequent critic of government economic plans, the research body, theInstitute for Fiscal Studies, this time delivered some welcome news for Mr. Cameron.

Of course it could be trusted (the NYT signals), it came from “one of the country’s most authoritative economic research bodies”, which is also “A frequent critic of government economic plans”.  So we aren’t talking about one of those nutty right-wing outfits, like the Adam Smith Institute or the IEA.

NYT readers never need fear leaving their cosy intellectual cocoon, where fiscal stimulus produces growth miracles, and a continent where governments spend 50% of GDP is struggling because of “austerity.”  Yes, the Trumpistas are even worse (and also oppose austerity), but then I don’t expect much from the “stupid party”. I do expect more from the Times.

Why should we live in a low rate world?

The Economist can be very good on monetary policy.  For instance, they’ve endorsed NGDP targeting.  And then there are other times.  Check out the subtitle of their new cover story on living in a low rate world:

Central banks have been doing their best to pep up demand. Now they need help

Actually, they have not been doing their best, and it’s not even debatable:

1.   The Fed raised rates last December, and just a week ago indicated that it is likely to raise rates again later this year.  Is that doing your best to inflate?

2.  The ECB and the BOJ have mostly disappointed markets this year, offering up one announcement after another that was less expansionary than markets expected.

So no, they are not doing their best.  If at some point they do in fact do their best, and still come up short, then by all means given them help.

And what should that “help” look like?  Simple, give them more policy tools.  I.e. a higher target, or the right to buy more kinds of assets.  Whatever help they need.

And then there is this:

To live safely in a low-rate world, it is time to move beyond a reliance on central banks. Structural reforms to increase underlying growth rates have a vital role. But their effects materialise only slowly and economies need succour now. The most urgent priority is to enlist fiscal policy. The main tool for fighting recessions has to shift from central banks to governments.

Actually, the Japanese have already shown that enlisting fiscal policy does not help.  In fact, Japanese NGDP growth has picked up a bit since 2013, despite the fact that fiscal policy has become tighter.  Instead of resigning ourselves to a low rate world, why not have central banks create a higher rate world, by raising their NGDP/inflation target?  And tell the banks to actually hit their targets.  A low rate world is a choice, not some inevitable fate sent down to us by the gods.

To their credit, they realize that infrastructure spending cannot stabilize a modern economy:

But infrastructure spending is not the best way to prop up weak demand. Ambitious capital projects cannot be turned on and off to fine-tune the economy. They are a nightmare to plan, take ages to deliver and risk becoming bogged down in politics. To be effective as a countercyclical tool, fiscal policy must mimic the best features of modern-day monetary policy, whereby independent central banks can act immediately to loosen or tighten as circumstances require.

But then suggest something even less effective:

Politicians will not—and should not—hand over big budget decisions to technocrats. Yet there are ways to make fiscal policy less politicised and more responsive. Independent fiscal councils, like Britain’s Office for Budget Responsibility, can help depoliticise public-spending decisions, but they do nothing to speed up fiscal action. For that, more automaticity is needed, binding some spending to changes in the economic cycle. The duration and generosity of unemployment benefits could be linked to the overall joblessness rate in the economy, for example.

Actually, a number of studies show that extended unemployment benefits make unemployment even higher. When President Bush made unemployment benefits more generous during the 2008 recession, Brad DeLong correctly predicted that it would push unemployment 50 basis points higher by Election Day. Another example occurred in 2014, when we saw job creation accelerate by about 700,000 (from 2.3 million in 2013 to over 3 million in 2014), after the extended benefits were eliminated.  Exactly the opposite of what Keynesians like Paul Krugman expected.

I have a better idea; have the BoE adopt a more expansionary monetary policy.  Their governors will warn that this will push inflation above target. OK, but make up your mind—do you want more demand, or not?


Over at Econlog I did a post discussing the austerity of 1946.  The Federal deficit swung from over 20% of GDP during fiscal 1945 (mid-1944 to mid-1945) to an outright surplus in fiscal 1947.  Policy doesn’t get much more austere than that! Even worse, the austerity was a reduction in government output, which Keynesians view as the most potent part of the fiscal mix.  I pointed out that employment did fine, with the unemployment rate fluctuating between 3% and 5% during 1946, 1947 and 1948, even as Keynesian economists had predicted a rise in unemployment to 25% or even 35%—i.e. worse than the low point of the Great Depression.  That’s a pretty big miss in your forecast, and made me wonder about the validity of the model they used.

One commenter pointed out that RGDP fell by over 12% between 1945 and 1946, and that lots of women left the labor force after WWII.  So does a shrinking labor force explain the disconnect between unemployment and GDP?  As far as I can tell it does not, which surprised even me.  But the data is patchy, so please offer suggestions as to how I could do better.

Let’s start with hours worked per week, the data that is most supportive of the Keynesian view:


Weekly hours worked dropped about 5% between 1945 and 1946. Does that help explain the huge drop in GDP?  Not as much as you’d think. Here’s the civilian labor force:


So the labor force grew by close to 9%, indicating that the labor force in terms of numbers of worker hours probably grew.  Indeed if you add in the 3% jump in the unemployment rate, it appears as if the total number of hours worked was little changed between 1945 and 1946 (9% – 5% – 3%).  Which is really weird given that RGDP fell by 22% from the 1945Q1 peak to the 1947Q1 trough–a decline closer to the 36% decline during the Great Contraction, than the 3% fall during the Great Recession.

That’s all accounting, which is interesting, but it doesn’t really tell us what caused the employment miracle.  I’d like to point to NGDP, which did grow very rapidly between 1946 and 1948, but even that doesn’t quite help, as it fell by about 10% between early 1945 and early 1946.

Here’s why I think that the NGDP (musical chairs) model did not work this time. Let’s go back to the hours worked, and think about why they were roughly unchanged.  You had two big factors pushing hard, but in opposite directions. Hours worked were pushed up by 10 million soldiers suddenly entering the workforce.  In the offsetting direction were three factors.  A smaller number of (mostly women) workers leaving the workforce, unemployment rising from 1% to 4%, and average weekly hours falling by about 5%.  All that netted out to roughly zero change in hours worked.

So why did RGDP fall so sharply?  Keep in mind that while those soldiers were fighting WWII, their pay was a part of GDP. They helped make the “G” part of GDP rise to extraordinary levels in the early 1940s.  But when the war ended, that military pay stopped.  Many then got jobs in the civilian economy.  Now they were counted as part of hours worked. (Soldiers aren’t counted as workers.)  That artificially depressed productivity.

It’s also worth noting that real hourly wages fell by nearly 10% between February 1945 and November 1946:


This data only applies to manufacturing workers. But keep in mind that the 1940s was the peak period of unionism, so I’d guess service workers did even worse.  So my theory is that the sudden drop in NGDP in 1946 was an artifact of the end of massive military spending, and the strong growth in NGDP during 1946-48, which reflected high inflation, helped to stabilize the labor market.  When the inflation ended in 1949, real wages rose and we had a brief recession.  By 1950, the economy was recovering, even before the Korean War broke out in late June.

Obviously 1946 was an unusual year, and it’s hard to draw any policy lessons.  At Econlog, I pointed out that the high inflation occurred without any “concrete steppes” by the Fed; T-bill yields stayed at 0.38% during 1945-47 and the monetary base was pretty flat.  Some of the inflation represented the removal of price controls, but I suspect some of it was purely (demand-side) monetary—a rise in velocity as fears of a post-war recession faded.

This era shows that you can have a lot of “reallocation” and a lot of austerity, without necessarily seeing a big rise in unemployment.  And if you are going to make excuses for the Keynesian model, you also have to recognize that most Keynesians got it spectacularly wrong at the time.  Keynesians often make of big deal of Milton Friedman’s false prediction that inflation would rise sharply after 1982, but tend to ignore another monetarist (William Barnett, pp. 22-23) who correctly forecast that it would not rise.  OK, then the same standards should apply to the flawed Keynesian predictions of 1946.

Tyler Cowen used to argue that 2009 showed that we weren’t as rich as we thought we were.  I think 1946 and 2013 (another failed Keynesian prediction) show that we aren’t as smart as we thought we were.

Update:  David Henderson has some more observations on this period.


No free lunches, or free colleges

It’s silly to poll Americans on economic policy questions.  They do not understand enough economics to give an intelligent answer.  But people keep doing so.  A recent poll found that 62% of Americans favored making college free for everyone, and nearly 90% were in favor of making college free for students from lower income families, including a sizable number of Republicans:

Once an idealistic pipe dream of the far left, free higher education is now largely supported by a majority of Americans. Sixty-two percent say they support debt-free university tuition, according to a July survey of 1,000 American adults conducted by Princeton Survey Research Associates International for consumer financial company Bankrate Inc. Among those who are opposed to the initiative, 26 percent said they would support making college debt free for students coming from families that earn less than $50,000 annually. Another 5 percent are willing allow it for those whose families earn less than $85,000 a year.

This seems like a loony idea on both efficiency and equity grounds.  Imagine the tuition increases that will occur after college is made free.  I should not have retired from teaching. (Or perhaps the government will “regulate” college spending, what a wonderful idea!!)

The following helps to explain why Americans find the idea so attractive:

But when it comes to putting their money where their mouth is, Americans are more reluctant. Among those surveyed, 48 percent [said?] they would not be willing to pay more in federal taxes to fund free college.

I wonder if the near-zero interest rates make people even more prone to think in free lunch terms.  Over at Econlog I have a post discussing Trump’s proposed tax cuts, which would balloon the budget deficit.  Who will benefit from these tax cuts?  People who vacation here:
Screen Shot 2016-08-01 at 9.06.30 PM

I would benefit enormously if Trump’s plan were enacted.  My taxes would be cut sharply, and so I would join lots of other affluent boomers in being able to stay at 4-star hotels when I visit Bali during my retirement, instead of the lousy 3-star hotels I currently stay at.

So us top ten percenters will enjoy more consumption.  But will it come at anyone’s expense?  Let’s think in terms of the GDP equation:

Y = C + I + G

Trump plans to increase G, so it’s not coming out of that category.  He also plans to cut taxes for working class American, so it’s not coming out of the consumption of the bottom 90%.  I suppose you could argue that it will boost GDP, but I doubt it.  The Fed would offset any demand-side effects, and Trump’s program looked at in its entirety is anti-supply-side, especially regarding foreign trade and investment.

So that leaves crowding out of investment.  Less investment, and less future GDP growth.  And it makes no difference whether interest rates are 1% or 10%.

Right now Trump polls extremely well among the old.  Perhaps they know that Trump plans to shovel lots of money their way, and leave a poorer country for their children and grandchildren.

Selfish b******s.