Vaidas Urba and Mark Sadowski directed me to an Evan Soltas post, discussing recent research on fiscal multipliers:

I have been doing some reading for my undergraduate thesis, which looks at the role of credit-supply shocks in the Spain during its housing boom and bust, and I came across some interesting thoughts from Bob Hall. Commenting on research by Alan Auerbach and Yuriy Gorodnichenko, Hall makes some useful points that contradict a lot of the received wisdom about the efficacy of fiscal policy:

I conclude that the chapter uncovers a proposition of great importance in macroeconomics—that the response to government purchases is substantially greater in weak economies than in strong ones. The finding is a true challenge to current thinking. The first thing to clear away is that the finding has little to do with the current thought that the multiplier is much higher when the interest rate is at its lower bound of zero…Standard macro models have labor and product supply functions that are close to linear over the range of activity in the OECD post-1960 sample. The simple idea that output and employment are constrained at full employment is not reflected in any modern model that I know of. [Bolding is by me, not Hall.]

On the economics blogosphere, the “current thought” is also that, because monetary policy is in certain respects (that is, if only by social convention) constrained when the policy rate hits zero, fiscal policy becomes discontinuously powerful at the zero lower bound. Once the policy rate is a quarter of a percentage point, time to turn off fiscal policy, one might infer. Scott Sumner is one of the clearest and most persuasive exponents of this view—see here, for instance.

I thank Evan for calling me “persuasive”, but there are days when I feel like I’m not making any headway.  Just to reiterate, here are my basic views:

1.  There is no such thing as “the” multiplier, in the sense of it being a deep parameter.  It depends on how monetary policy responds.  It’s an empirical question, and “the” multiplier may be time-varying.

2. If monetary policy is optimal, there will be no demand-side multiplier effects, even at the zero bound.  (There may be supply-side effects.)  When Evan refers to “this view”, he means that I don’t favor fiscal stimulus at positive rates, not that I do favor it at zero rates.

3.  Previous studies suggesting a positive multiplier at the zero bound are marred by the inclusion of countries with and without monetary offset (with the eurozone being a particularly significant problem).

4.  There was no fiscal multiplier effect when the Federal government suddenly reduced the deficit from $1060 billion in calendar 2012 to $560 billion in 2013, despite predictions to the contrary by over 350 Keynesian economists.

I took a look at the Alan Auerbach and Yuriy Gorodnichenko paper, as well as Robert Hall’s comments.  I see two potential problems:

1.  The empirical results seem quite weak to me, unless I’m missing something.  Hall says:

Their point estimate is that one added dollar of government purchases results in about $3.50 of added GDP when the economy is weak, with a 90% confidence interval running from 0.6 to 6.3.

I’m very weak at econometrics, but this doesn’t seem at all persuasive to me.  I’ve always thought the standard 95% confidence interval is way too lenient, and helps explain all the bogus studies that cannot be reproduced.  It’s an invitation to data mining.  So why did they use the 90% confidence interval, instead of the already lenient 95%?  Perhaps because at 95% the interval would include zero.  In other words there would appear to be no statistically significant evidence of any multiplier effect.

2.  Let’s say I’m wrong about the econometrics (quite possible.)  My other concern is that I don’t see any evidence that they discriminated between countries with and without independent monetary policies (no list of countries was included).  In other words, they should have excluded countries under fixed exchange rate regimes, as well as those in a single currency like the eurozone.  Studies by people like Mark Sadowski, Kevin Erdmann, and also Benn Steil and Dinah Walker, suggest that when the data is limited to countries with an independent monetary policy, then the multiplier effect seems to nearly vanish, at least during the recent recession.

I don’t want to sound too dogmatic here.  I have no doubt that WWII military spending caused measured RGDP to rise (although consumption and living standards fell.)  So it’s possible that this paper did correctly find a positive multiplier. But I am not convinced that the Auerbach/Gorodnichenko paper has established a positive multiplier for countries with independent monetary policy regimes.

As they say, “more research is needed.”

Remember the Sports Illustrated jinx?  Athletes that appeared on the cover of Sports Illustrated often saw their performance drop off sharply.  I wonder if the same applies to Paul Krugman?  Here’s a Krugman post from 2013, trashing the Irish economic model:

The one sense in which Ireland has made some progress is that it has somewhat reassured bond investors that its population will continue to sullenly acquiesce in austerity; as a result, Irish 10-year rates, while still at a large premium, are now 60-80 basis points below those of Italy and Spain.

But the repeated invocation of Ireland as a role model has gotten to be a sick joke.

I’m not sure the Irish feel “sullen” about the 9.2% RGDP growth announced last week:

Notice that Ireland’s dramatic turnaround began almost immediately after Krugman’s August 2013 post.  The post was entitled:

Ireland Is The Success Story Of The Future, And Always Will Be

So what type of economic model does Krugman like?

Just to be clear, I think Brazil is going pretty well, and has had good leadership. But why exactly is Brazil an impressive “BRIC” while Argentina is always disparaged? Actually, we know why — but it doesn’t speak well for the state of economics reporting.

I first wrote this post on the day when Lula was indicted for corruption, and his successor is now threatened with impeachment for the same.  In fairness, I would not expect Krugman to be aware of the political intricacies of Brazil.  I’m more interested in his views of economic policy.  So how has Brazil’s economy done since the May 2012 post, under that “good leadership”?

Yikes, that’s almost the mirror image of Ireland.  While Ireland is already richer than Germany (In GDP/person, perhaps not GNP), and growing at a much faster rate, Brazil is now poorer than China, and declining as fast as China is growing.

Argentina also slowed sharply after Krugman’s post, indeed the slowdown was already underway in 2013, but he relied on the 2012 data, when growth was still strong.  Fortunately they have a new government, which is beginning to institute some reforms.

PS.  Another irony; didn’t the “country of the future” joke that Krugman applied to Ireland, originally apply to Brazil?

Christina and David Romer are both Keynesian economists with impeccable credentials.  Thus I thought you might be interested in their views on monetary offset:

Massive demand-side stimulus in an economy closing in on its productive capacity would have one of two effects. First—and most likely—it would lead the Federal Reserve to raise interest rates, offsetting as well as it could the expansionary effects of the stimulus. Output would rise little, and the main effects would be on interest rates and on the composition of output between the components stimulated by the fiscal expansion and the components restrained by higher interest rates. Second, if the Federal Reserve did not respond, the result would be inflation. And if the stimulus were large enough to try to push the economy 10%, 20%, or more above its productive capacity, the inflation would be substantial.

This is from a report criticizing the Sanders economic plan, which suggested that the US growth rate could be raised to 5.3%/year.  Since October 2009, growth has averaged a bit over 2%, as unemployment has fallen from 10% to 4.9%.  Even progressives like Matt Yglesias admit that Sanders proposals would reduce the labor force participation for many groups:

Friedman assumes there will be no growth-slowing supply-side impacts of any of Sanders’s policies initiatives. You don’t need to be hostile to Sanders’s goals or policies to see that this isn’t the case. For example, if you make Social Security more generous while also giving people free health care and raising taxes, some people are going to retire earlier. This is a feature of Sanders’ agenda (early retirement is nice), not a bug. But by reducing the number of people in the labor force, it will slow the rate of GDP growth.

Sanders’s plan to make college free has the same feature. Reducing the price will increase the number of young people who go to school and decrease the amount of part-time work that college students do.

As an aside, Yglesias is still a bit too soft on Sanders, and way too soft on Trump.

And Sanders also has some interesting views on monetary policy:

Mr Sanders has bold plans for monetary policy and banking, too. He supports a movement headed by Rand Paul, an erstwhile Republican runner, to get politicians more involved in decisions on interest rates, because he thinks Fed policy is too tight. To loosen it, he would bar the Fed from raising rates when unemployment is above 4%.

In other words, hyperinflation!!  Have I changed my mind that Trump is even worse?  No, but this should help you to better understand just how much I despise Trump.

HT:  SG

Got home at 3am, another Logan airport nightmare.  Lots of catching up to do.  Here are a few items of interest:

1.  Fiscal back-up?  David Beckworth had a piece in the Financial Times, Alphaville:

As noted above, a NGDP growth path target should create its own self-fulling expectations of stable demand growth. One way to reinforce this tendency and insure against central bank incompetence is to have the U.S. Treasury Department provide an automatic backstop for the spending target. This would make the system foolproof.

The way it would work is that once a year the Treasury Department would check to see if the Fed was keeping total dollar spending on target. If it fell below target, the Treasury Department would automatically deposit bonds at the Fed and send the new money created by those deposits directly to households. It would continue to do so until spending got back up to its targeted growth path.

If total dollar spending were above target, the Treasury Department would again deposit bonds at the Fed. But this time the Fed would be required sell the bonds to the public, which would take money out of circulation. The Treasury Department and the Fed would continue doing this until spending fell back down to its targeted growth path.

The Treasury backstop would further reinforce the public’s expectation that the NGDP target would be hit at all times. With this expectation, however, the Treasury Department would rarely if ever need to provide an actual backstop. The target, in other words, would become a self-fulling outcome where the public did the actual heavy lifting by adjusting their spending patterns.

The Treasury backstop would also provide a strong incentive for the Fed to do its job well. The public humiliation of having someone else doing their job would make Fed officials work very hard to stabilize spending the first place. This would reinforce the credibility of the target.

I’m generally skeptical of fiscal stimulus.  But I think this plan might work, with one modification.  If at any time the Treasury had to come in and rescue monetary policy, and the Fed was not 100% out of ammunition at the time, then the entire FOMC would be immediately fired, with no pension, and replaced with new people.  That’s the sort of compromise monetary/fiscal coordination I could support.

What would it mean to not be out of ammo?  In my view it should mean that interest rates on reserves are above negative 10%, and the Fed does not own some marketable investment grade bonds, somewhere in the world, that are being actively traded.  The Treasury may prefer a different set of criteria.  But wherever the Fed’s boundaries are, they need to be clearly spelled out.  Ambiguity hurts the effectiveness of monetary policy.

I agree with David that this plan (with the modification I suggest) would eliminate the need for the Treasury to intervene. The Chuck Norris effect would be enough.  David’s much wiser than me, realizing that self-indulgent tirades against the stupidity of helicopter drops are foolish, and that one can win more friends through policies that provide the reassurance of fiscal backup, without actually needing that backup in 99.999% of the cases.  That’s why he gets invited to write for the New York Times.

I’m very pleased to announce that David Beckworth will be joining the Program on Monetary Policy at Mercatus during the first half of this year.  He has lots of exciting plans, including podcasts involving interviews with monetary policy experts.

2.  Profiles in cowardice:  Chris Christie:

He said on “Morning Joe” afterward that Bush “had a chance to take on Donald Trump on Saturday night, and I don’t think really effectively delivered that punch.”

Could you? I asked Christie.

“Of course I could,” the New Jersey governor responded, mildly annoyed at even being asked about the limits of his sparring talents.

So why hadn’t he?

“I do so at a time and place of my choosing. There’s no need for me to do that now,” Christie said.

The next day, Christie dropped out. And the Republican Party said goodbye to the only presidential candidate with the combination of quick wit, charisma and gravitas necessary to stand up to Trump one on one.

Whenever I don’t know a person’s motives, I always like to assume the best.  Since I don’t know Christie’s motives for not going after Trump, I am going to assume the least bad interpretation, cowardice, and not something far worse, like hoping for a VP slot, or secret sympathy with his demagoguery.  If you think I’m being too kind to Christie, explain why.  If you think I’m being too mean, just go away.

3.  Banning bad commenters:  I’ve always had an uncanny ability to predict a person’s character just based on their name.  I know this seems hard to believe, but you’ll just have to take my word for it.  My “sixth sense” smelled a rat when a commenter named “Shmebulock, Crusher of Pussy” entered the scene a few days ago.  I’ve never banned a commenter in 7 years of blogging, and almost never banned a comment.  But there’s a first time for everything.  This cat smasher had an almost Trump-like mix of boring, juvenile and stupid, which led to him (I’m also pretty good at guessing gender) being awarded the first lifetime ban.  Congratulations to Crusher.  He wasn’t even able to mimic the humor of Ray’s inanities.  Of course there are many others that richly deserve banning, and would be banned in a classier venue than this one.  So consider the banning of Crusher to be a shot across the bow.  Once I’ve taste blood, it might become a habit.  Who knows how many people I’ll ban?

And to any potential commenter who says “You banned Crusher but not X, so you must find X’s racism, sexism, homophobia, etc., acceptable” my only response is . . . actually I can’t give you my response, it’s so rude I’d have to ban myself.

Over at Econlog I have a new post pointing out that central banks have never actually explored whether the zero rate bound limits monetary policy.  They don’t seem curious. I pointed out that, at a minimum, they’d first have to lower interest on reserves (IOR) so far that excess reserves fell close to zero.

Here I’d like to look at things from a different perspective—when is fiscal policy appropriate?

The place to begin is with the powers of the central bank—let’s use the Fed as an example.  What are their powers?  Who sets them?  Are they vague, or clearly spelled out?

Policy will be more effective if each branch of government clearly understands its role. Unfortunately, we don’t live in that world.  But even so, the Fed can certainly try to spell out its policy options, even if the set of options is rather complex.

As you know, I’d prefer a policy regime where fiscal stimulus was never needed, and instead the Fed bought up whatever was necessary to hit its target, even if it ended up owning the entire world.  Of course we don’t live in that world, so when should fiscal policy click in?

Like everything in economics, it’s all about costs and benefits.  Recall that in 2012 Fed chairman Ben Bernanke talked vaguely about various “costs and risks” of using unconventional monetary policy.  In his memoir, he gives the impression that this was more a concern of the committee, rather than him personally.  But nonetheless the perception of costs and risks is real, and influences policy.  So let’s assume these two costs:

The marginal cost of adding $1 to the Fed balance sheet is an increasing function of the size of the balance sheet.

The cost of a cut in the IOR is negatively related to the level of IOR.  The lower the interest rate, the higher the cost of an additional one basis point cut.

Fiscal policy also has costs and benefits, which increase with the size of the deficit.  In my view, the lowest cost fiscal stimulus, per job created, is a payroll tax cut.  This ignores possible supply-side effects of cuts in capital taxation, which is of course a highly contentious issue.  Or external benefits from more infrastructure, which is also controversial.

In other words, it’s always possible to point to fiscal changes that are desirable even if no fiscal stimulus were needed. (“Now more than ever, blah blah blah . . .) Conservatives want lower MTRs and liberals want more infrastructure or social programs.  But that’s sort of cheating, as those would presumably be done even if there were no need for fiscal stimulus.  And if they are not done, then policymakers clearly don’t agree that they are desirable.  Here I’m trying to approach the subject from a non-political angle, how to generate more AD.  (And yes I know, it’s hopeless—just trying to do thought experiments)

A cut in the payroll tax on employment seems like it would give the most bang for the buck, in terms of job creation.  An increase in the Earned Income Tax Credit is another possible policy aimed directly at more employment.

So let me summarize what I’ve got so far:

In an ideal world, the central bank does whatever it takes; no fiscal stimulus is called for.  The costs of more monetary stimulus are near zero, and certainly lower than the costs of fiscal stimulus.

In the second best world, Congress and Fed clearly describe the powers of the Fed, and the costs of things like a big balance sheet and/or lower IOR.  

In the third best world it’s all a big muddle.  Congress doesn’t even know what the Fed’s powers are, and indeed barely even understands what the term ‘monetary policy’ actually means.  (They probably think it means control of interest rates, not NGDP.) 

In that sort of world the Fed must decide what it thinks it is entitled to do, and the costs of more aggressive monetary stimulus (bigger balance sheet, more strongly negative IOR.)  Then it must weigh those costs against both the cost of high unemployment and also the cost of alternative fiscal stimulus, as well as the probability that this alternative fiscal stimulus will actually occur.

Here’s an example of the third best world (which is obviously the world we live in.)  In late 2012, the Fed saw that Congress was about to sharply reduce the budget deficit (which fell by $500 billion in calendar 2013).  Up until that point in time, the Fed had not done as much monetary stimulus as would normally be appropriate, because (according to Ben Bernanke) the FOMC was worried about the “costs and risks” of a larger balance sheet.  They had done QE up to the point where the perceived marginal cost of an additional dollar of QE was equal to the perceived benefit in terms of lower unemployment.  (I think they misjudged this, but let’s set that aside.)

Now with Congress about to do austerity, the perceived costs and risks changed.  Now the 2012 Fed policy stance would be associated with more unemployment than previously expected.  Still applying cost/benefit analysis, the Fed decided that more QE (and forward guidance) would be appropriate, as the risk in terms of lost employment of not acting was greater than in 2012, due to the fiscal austerity.  So they did act, and indeed overreacted if you buy my model.  That’s because growth actually accelerated, whereas my model predicts a tradeoff, with growth slowing, but not as much as it would have slowed with no action.

This post is rather messy because the real world is messy, so let’s conclude by trying to add some structure:

First, we need to think about what the Fed can and cannot do.  In my view we need clear instructions for the Fed, but I accept that this won’t happen.

Second, if we lack instructions, the Fed must decide on its own what it can and cannot do, and how much it is able to do things like QE and negative IOR.  In my view, it currently has enough power so that fiscal stimulus is not appropriate, if the powers are used wisely.

Third, the Fed doesn’t agree with me that it has enough power so that fiscal stimulus is never appropriate.  However the Fed has never clearly spelled out why it disagrees with my view.  For instance, Bernanke favored Bush’s spring 2008 fiscal stimulus, even though we were not at the zero bound.  But he doesn’t explain why.  What were the “costs and risks” of additional rate cuts, instead of fiscal stimulus?  Or was this about a split within the Fed, where Bernanke couldn’t get enough support for more stimulus, and hence he wanted Congress to do the Fed’s job?  Unfortunately, he doesn’t tell us, which is the weakest aspect of his recent memoir.

And finally, I understand that my view of the risks and costs of monetary stimulus is less important than the Fed’s view.  I do see that if the Fed views unconventional policies (and maybe even conventional?) as involving costs and risks, then they will sometimes fail to take adequate steps to maintain appropriate NGDP growth.  But it’s not really clear what this means.  It would be really easy if the Fed just sort of hit a wall, a legal limit on what they could buy, and then suddenly “ran out of ammo.”  In that sort of case the solution would be clear, let fiscal policy take over at that point, but not when the Fed can still cut rates.  But as we saw in late 2012, we don’t live in that world either; the Fed will do more costly and risky stuff when they see the need as being greater.

So in the end the problem is too complicated for any sort of “scientific” solution.  And thus we should not be surprised that people end up all over the map.  Monetarists like me want more monetary stimulus. Keynesians like Christy Romer want the same, but also employer-side payroll tax cuts.  Paul Krugman worries that employer-side tax cuts would be deflationary, and favors more spending on infrastructure or social programs.  Supply-siders favor cuts in MTRs to boost growth from a supply-side perspective.  The policy “game” being played here is far too complex for even our most advanced game theory models, and hence people will fall back on the solutions that they find the most appealing.

For me, I’m skeptical that Congress can ever do the “NGDP targeting” job adequately. In contrast, I saw signs in 1984 through 2007 that the Fed was reasonably good at the NGDP targeting, and I want to push hard for some additional modifications to overcome the zero bound problem, rather than throw up my hands and hope that Congress solves the problem next time.  I see the Fed’s ability to learn from past mistakes as being far superior to Congress’s ability, at least in the realm of macroeconomic stabilization.  So that’s why I focus like a laser on monetary reforms. It’s not that I don’t understand why others might find fiscal stimulus appealing—in a game this complex I can see how it might be an option.  I just don’t think it’s the best option.

We are about to exit zero rates. Now more than ever we need to fix monetary policy—before the next recession.  If we go into the next recession with the current monetary policy regime then the entire community of macroeconomics will have failed, and failed shamefully, to address the clear need for better options at the zero bound.  The Fed needs to act NOW.  I’m glad to see that the Bank of Canada understands the need for reform, and I hope the Fed also reaches this conclusion.

Most like we won’t solve the problem, and in the next recession a GOP government would do tax cuts and a Democratic government would boost spending.  That’s reality. But I do predict that we will make some progress, and not be as woefully unprepared as in 2008.