Fiscal policy isn’t about big government
But big government can be about fiscal policy. Let’s see why:
In 2001 President Bush said we needed to cut taxes to give the economy a boost. Paul Krugman opposed the tax cut. At the time I supported it for supply-side reasons, although in retrospect it was probably a mistake. What can we infer from all this?
1. Fiscal stimulus need not involve any increase in the size of government. Indeed it can lead to smaller government. In the long run if the government collects less revenue it will have to spend less (yes, “starve the beast” is true as a long run proposition.) From my perspective, what I now think made Bush’s tax cut a mistake was that it was a missed opportunity to do tax reform, and also he boosted spending sharply, running up substantial deficits during the boom years (when the government should run surpluses.)
2. But what about fiscal stimulus done in the form of more government spending, surely that means big government? Not at all. Suppose the government spends 4% more as a share of GDP during recessions than booms. Thus instead of spending 22% of GDP all the time, it spends 20% in booms and 24% in recessions, where the average is still 22%. A conservative Keynesian could easily argue for both small government, and also recommend that government projects like dams and highways should be built in recession periods, not boom periods. You’d move spending around, without changing the average.
3. Some might argue that there is an asymmetry, as monetary policy is enough when you need to restrain AD, but fiscal policy is needed when you need to boost AD. Doesn’t that bias you toward big government? No, for the reason I just mentioned. If government spending is countercyclical then it will be above average during recessions and below average during booms. Why? Because that’s what the word ‘average’ implies. It’s logically impossible to have a fiscal regime where spending is above average during recessions and average during booms. In any case, you can always cut taxes during recessions.
4. Despite all of the above, it’s certain possible that fiscal stimulus can be associated with big government. But that would not be fiscal policy causing big government, it would be the desire for big government leading to a particular type of fiscal policy. For instance, Larry Summers recently argued that the problem today is not the business cycle, but rather secular stagnation. He suggests that even if monetary policy could fix this problem, it would lead to such low real interest rates that the Fed would end up blowing up serial bubbles. And the resulting investment would be wasteful. So he wants more government investment, which he believes will be more efficient. He doesn’t want tax cuts, which would lead to (wasteful) in his view) private spending.
Summers can certainly make this argument, and perhaps it’s even true (although I doubt it.) But this is very far away from the textbook Keynesian fiscal stimulus with the various multipliers, nudging the economy toward the natural rate of output when actual output is too high or too low. That traditional sort of fiscal policy has no relationship to big government.
When people really want to do something, they can always find a justification. You’ve probably seen those famous phrases like “never let a crisis go to waste” and “now more than ever we need to invest more in . . .” For me it’s “now more than ever we need to legalize drugs and establish a NGDPLT regime and a progressive consumption tax.” And it doesn’t matter what happened, I’ll find some way to connect it up to my pet causes. For instance, the cover of this week’s Economist magazine complains that there are 2.3 million Americans in jail or prison. That makes me bring up drug legalization, even though “only” 400,000 are in there for drugs. Or if structural unemployment is discussed I’ll bring up occupational licensure, minimum wages, vouchers for education, or any other pet cause that is even tangentially related to structural unemployment.
To summarize, you can obviously find ways to do fiscal stimulus in a way that leads to bigger government. But I guarantee that if there was a Republican in the White House right now, and they were doing tax cuts to boost the economy, nobody would be equating fiscal policy and big government.
Some people wrongly think I believe fiscal policy is ineffective for ideological reasons. Sorry, but that doesn’t even pass the laugh test. Consider:
1. I recently provided some of Mark Sadowski’s graphs that show fiscal stimulus can work when countries lack their own central bank, as in the eurozone.
2. I’ve argued that fiscal stimulus can work if a central bank is not targeting inflation or NGDP.
3. I’ve argued that even under inflation targeting, VAT and employer-side payroll tax cuts work, by reducing prices and forcing the central bank to stimulate to hit their inflation target.
4. I’ve argued that massive government spending programs can work even under inflation targeting, by lowering private consumption and making people work harder (as in the early 1940s).
5. I’ve argued that cuts in MTRs can work for supply-side reasons.
6. I’ve argued that fiscal stimulus can work even under inflation targeting if the central bank in incompetent in a certain way (say frightened of a large balance sheet and also reluctant to do forward guidance.)
Six exceptions—does that sound like an ideologue that thinks fiscal stimulus can never work? I just think the world would be better off if we thought of monetary policy as the normal way to control AD, and I’m pushing to achieve that sort of world. Ironically we pretty much had that sort of world from 1984 to 2007. And double ironically Paul Krugman is also pushing to create that sort of world when he advocates a 4% inflation target.
People who think there’s some vast ideological different between me and Krugman on fiscal policy simply don’t know what they are talking about. We simply differ on whether the Fed could and/or would offset fiscal stimulus right now. That’s a small technical issue.
PS. I have a post responding to Krugman over at Econlog.
Update: Nothing in this post should imply I disagree with Russ Roberts’ claim that ideological bias can affect how some people feel about issues like fiscal stimulus. I think he’s right. I am just trying to point out that there are many aspects of the fiscal policy question that are highly technical, and that go far beyond ideology. There is no necessary logical connection, but many people certainly perceive a connection, as Russ indicates. For instance, I favor carbon taxes, but some other libertarians disagree with me on this issue. Ideology is not the only factor that goes into policy views.
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23. June 2015 at 17:10
If you use specifications that Wren-Lewis is using in the debate over 2013, where public spending has a “multiplier” of 2 and taxes and transfers have “multipliers” of 0, then it seems like you would want bigger government. Krugman’s reactions to various policies also seem to imply a set of “multipliers” that weights toward larger public spending and higher taxes.
So, it seems like the devil is in the details. Do different multipliers make different Keynesians or do different Keynesians make different multipliers? It’s turtles all the way down, isn’t it?
23. June 2015 at 17:19
Government budget deficits, encouraged and brought about by the Keynesians, increases the size of government relative to society as a whole because it redirects real resources away from private savings and investment, to current government activity.
Tax cuts I think are most appropriately labelled as a reduction in fiscal policy, not fiscal policy per se. If we call tax cuts fiscal policy, then that implies cutting taxes to zero, which would shrink the government down to whatever size it can get away with by inflation alone, a fiscal policy, despite the fact that it would have no fiscal activity to speak of, only monetary policy.
23. June 2015 at 17:52
Sumners thinks ‘starve the beast’ works but others at Cato, smarter, say it actually just makes government bigger as people forsake the pain of paying Big Government (i.e., ‘borrow and spend’), the point being as you ‘starve’ government of revenue without cutting government (waiting for it to starve) you are simply enjoying the benefits of Big Govt without paying for them, and the gov’t continues to borrow for a very long time. Even the architect of ‘starve the beast’, William Niskanen, later repudiated it (not unlike how Friedman repudiated his earlier monetarism views, but I digress) – RL
A dedicated libertarian, William Niskanen was also a dedicated pot-stirrer. … he later repudiated starve the beast -see http://www.weeklystandard.com/articles/gorging-beast_663547.html?page=2 “”””””. 2006. Limiting Government: The Failure of “Starve the Beast.” Cato Journal 26, no. 3 (fall): 553-58.
23. June 2015 at 18:11
@myself – I just noticed the point made by Andrew Ferguson at THE WEEKLY STANDARD re starve the beast is not the same argument made by Cato, which I summarized above. I adopt the Cato position, not the Ferguson position.
23. June 2015 at 20:09
Scott, although the FT is generally quite good, this article made me want to tear my hair out:
http://www.ft.com/intl/cms/s/2/4435a95e-18fc-11e5-8201-cbdb03d71480.html#axzz3dwuaf9Re
24. June 2015 at 04:39
Scott has often mentioned Australia’s ~5% inflation as being the main reason they have not had a recession in 20 years.
NGDPLT would be better than 5% inflation targetting. My wife and I graduated in 2011 and quite frankly, we’re kind of sick of living in a recession (EU…).
Just up that inflation, Mario!
24. June 2015 at 05:08
Kevin, Actually, even were that true (and Romer claims the opposite) it would not have any big government implications, for reason #3 above. Even if you rely 100% of changes in G, there are no big government implications, you just vary the timing of the spending.
Ray, Again you can’t read. I said “as a long run proposition.” The Cato study was looking at short run changes in taxes.
JL, Actually I’ve never mentioned that, as Australian inflation is not 5%, they have a 2.5% inflation target. As you say, NGDPLT is better, and Australia is one example. They don’t have particularly high inflation, but they do have high NGDP growth.
24. June 2015 at 05:09
Great post, but IMHO the disagreement between keynesians and monetarists remain the same: both schools identify AD shortfall as a problem, and both schools recommend some sort of intervention (e.g. wealth transfers to sustain AD): monetarists suggest monetary policy (with its associated Cantillon and “hot potatoes” effects) and keynesians recommend outright government spending to make up for AD shortfall (maybe associated with some sort of wealth taxation and negative taxes for the poor).
24. June 2015 at 05:16
Jose, Some monetarists and Keynesian may hold those views, but those are certainly not Keynesian economics. Keynesian economics suggests a bigger budget deficit during recessions, not wealth transfers and/or more government spending.
I do not favor intervention to address AD shortfalls, I favor a policy of pegging NGDP futures prices, which is exactly the same policy whether there is a shortfall or not.
24. June 2015 at 05:40
I feel like we should form a commission.
24. June 2015 at 06:15
@Prof. Sumner
Don’t you see increased deficits during recessions (and smaller deficits or even superavits) during growth years as an inter generational wealth transfer ?
24. June 2015 at 06:42
Excellent blogging. Like I always say, cut FICA taxes, go to QE hard and heavy, stuff the Treasury bonds into the Social Security trust funds, and rock and roll baby, that is how to do it.
24. June 2015 at 07:44
Is the easiest historical argument about Supply Side Keynesism the Reagan administration? (Admittingly, I don’t think he planned to be a Supply Side Keynesian but on paper he looked like one.) However, he left Bush the limits of supply side Keynesian and the S&L crash.
I am amazed that low tax Republicans have not come up:
1) We can lower the corporate tax rate to 10% with no deductions with cuts to the military. I have jokingly stated that I trust Bernie Sanders with the US economy the most, because he is the most likely to avoid a wasteful Middle East war.
2) Is the problem with low tax Republicans Governors (WI, KS, LA, & NJ) that they giving all the breaks to the top 10% which does nothing to increase labor supply? If they lowered taxes for the bottom 50% would that bring more workers and businesses would follow? I am thinking that WI is not taking MN businesses because the skilled labor won’t move to WI. So if the skilled labor had more incentives to move to WI then businesses could move.
24. June 2015 at 08:15
“In 2001 President Bush said we needed to cut taxes to give the economy a boost. Paul Krugman opposed the tax cut. At the time I supported it for supply-side reasons, although in retrospect it was probably a mistake. What can we infer from all this?”
“Fiscal stimulus need not involve any increase in the size of government. Indeed it can lead to smaller government. In the long run if the government collects less revenue it will have to spend less (yes, “starve the beast” is true as a long run proposition.) From my perspective, what I now think made Bush’s tax cut a mistake was that it was a missed opportunity to do tax reform, and also he boosted spending sharply, running up substantial deficits during the boom years (when the government should run surpluses.)”
I think this is a very good point. Bush did use Keynesian reasoning to argue for his tax cuts yet most liberal/Keynesian types like me didn’t support it.
However, it’s important to say that Bush didn’t sit down and say, ‘You know, I’d like to increase govt spending.’
Rather he was determined to invade Iraq.
Which shows that conservatives aren’t always against big government-in fact on foreign policy they support it while liberals are more likely to oppose it.
Maybe libertarians are different than conservatives here.
24. June 2015 at 08:29
“I’ve argued that cuts in MTRs can work for supply-side reasons.”
But that isn’t stimulus-by definition doesn’t ‘stimulus’ need to be demand side?
Supply side would be more associated with the ‘Long Run’ wouldn’t it?
24. June 2015 at 08:40
@ssumner “Ray, Again you can’t read. I said “as a long run proposition.” The Cato study was looking at short run changes in taxes.” – wrong again. The long run is a series of short runs (did Keynes teach you nothing?) and the Cato study aptly underscores how ‘starve the beast’ simply makes government bigger, since people are not paying for services. From the Cato paper (available online, if you cared to actually read it):
“It is most implausible that reducing the current tax burden of federal spending would reduce the amount of federal services that voters demand. Orthodox price theory, of which Friedman and Becker are among the leading exponents, is unambiguous in concluding that reducing the price of a good or service increases the amount demanded. Reducing the current tax burden of federal spending has much the same effect as a price control, increasing the amount demanded relative to that supplied from current revenues, an effect that Friedman and Becker have consistently and correctly opposed in private markets. ”
Once again, Sumner shoots from the hip and asks questions later.
24. June 2015 at 09:17
Scott, I believe that he’s saying you could have deficit neutral stimulus. 1 trillion in public spending and a 1 trillion tax hike will give you 2 trillion in economic activity. And that is specifically consumption and investment – not transfers. So I presume that some of that is real. He’s got a kind of economic perpetual motion machine there. If public spending and marginal tax collection are 50%, it seems like a trillion in spending would end up taking in a trillion in taxes after the 2 trillion in new economic activity happened. Why would you ever pull back on that?
24. June 2015 at 10:11
I have to agree with Ray in the debate about “starve the beast.” The Cato Journal article did not highlight a distinction between short term vs. long term effects of a starve the beast approach(see http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2009/11/cj29n3-7.pdf).
And, I’m not sure I understand Russ Roberts’ definition of ideological bias. I think he means everyone is on the lookout for what he fears more: ochlocracy or plutocracy. What if you believe that one leads to the other? What then is your bias?
24. June 2015 at 10:19
This below really needs to be said and often:
2. But what about fiscal stimulus done in the form of more government spending, surely that means big government? Not at all. Suppose the government spends 4% more as a share of GDP during recessions than booms. Thus instead of spending 22% of GDP all the time, it spends 20% in booms and 24% in recessions, where the average is still 22%. A conservative Keynesian could easily argue for both small government, and also recommend that government projects like dams and highways should be built in recession periods, not boom periods. You’d move spending around, without changing the average.
Stimulus and big Government are 2 completely separate issues. One can be for Stimulus and for very small government. Also it makes sense for Government to build capital (roads, bridges etc.) ahead when labor demand and interest rates are low.
24. June 2015 at 11:18
IMHO The problem with the “starve the beast” is that it leads to hidden taxes. The consumption that comes from Government spending has to come from a reduction in consumption somewhere.
24. June 2015 at 11:56
Floccina,
Agreed. We need to stop thinking about taxes as the price of government, just as we need to stop thinking about interest rates as the price of money. The price of government is what it spends.
24. June 2015 at 12:11
Sumner on fiscal stimulus vs. government spending
http://diaryofarepublicanhater.blogspot.com/2015/06/sumner-hasnt-changed-his-mind-but-has.html
24. June 2015 at 13:00
I think that generally speaking Keynesians don’t like sales taxes. And it’s easy to call the sales tax a failure as it lead to a recession.
Unemployment may be low but isn’t’ that due supposedly to the the fact that Japan allegedly engages in ‘crony capitalism’ that is in need of reform?
Japan unemployment is always low, the problem is no growth not employment. After all Japan is said to have had 20 years of stagnation. During the entire period there UR was low.
24. June 2015 at 13:22
Sumner said: “Thus instead of spending 22% of GDP all the time, it spends 20% in booms and 24% in recessions, where the average is still 22%.”
Floccina said: “Stimulus and big Government are 2 completely separate issues.“.
Yeah, I’m not so sure, though. The problem is whether it is politically realistic to cut spending during booms. In Sumner’s hypothetical, the nation used to spend 22% of GDP every year. He’s proposing a fiscal policy of spending the same average, but 24% in recessions, and 20% in booms.
But you start this plan during a recession, and move spending up to 24%. And the the economy recovers, and has a boom. What if it’s just not politically feasible to drop spending down to 20%? Then, instead, you’ve raised the average from the old 22% to a new baseline of 24%. That’s not necessarily an improvement, under any macro model
I think that’s where the big/small government impacts the debate over fiscal stimulus. Neither side actually expects a growth in the size of government, to be countercyclical. So, if you want big government, you’re in favor of fiscal stimulus (during a recession), because you expect (probably correctly) that the larger government will stay around after the recession is over. And if you want small government, then you resist fiscal stimulus during a recession, because again you (correctly) fear that the spending programs will remain long after the short-term recession is over.
Yes, in theory, the two topics could be separated. But in a world of practical politics, I’m not so sure that they can be.
24. June 2015 at 14:23
We need to stop thinking about taxes as the price of government, just as we need to stop thinking about interest rates as the price of money. The price of government is what it spends.
Well, OK, but as Friedman pointed out taxes = spending. Because the discounted-to-current-value tax cost of deficit spending (the tax cost of servicing the incurred debt including interest on it) exactly equals the amount of the spending. Thus, e.g., with a 5% interest rate $1 of current spending = $1 of taxes now, or 5 cents of taxes annually forever, or 60 cents of taxes now and 2 cents of taxes annually forever…
What we have to stop thinking is that deficit spending lets us avoid the full tax cost of spending.
If I believed taxes didn’t fully = spending I’d be saying “spend away, we’ll never pay for it”, just as so many who do believe it really do.
(Also, the interest rate is of course not the price of money but the price of renting money.)
24. June 2015 at 14:42
As to “Starve the Beast” there’s plenty of evidence that it works fine in the long run on the macro, points-of-GDP scale. For instance…
1) What happened when Social Security ran out of money in 1983? Congress enacted a financing fix into the future that was 50% benefit cuts. Ever seen Congress cut entitlement benefits any other time, when it hadn’t run out of money to pay for them?
2) History. Here’s former CBO head Rudy Penner explaining to Brad DeLong how spending was restrained during the 1990s, *until* the surplus arrived. (This was on the blog of the younger, polite, 2002 DeLong who was still lamented and worried about the ‘big’ deficits of that era — in fact, actually criticizing the budget cost of the 2002 stimulus bill for the 2001 recession)…
If that wasn’t the Beast being starved, lack of revenue restraining spending and “stopping entitlement policy from increasing the deficit” — until and *only* until the unexpected surplus revenue arrived — then what the heck was it?
3) Logic. If you really believe that revenue level doesn’t affect spending level — that Starve the Beast doesn’t work — then you have no reason to fear that politicians would spend new revenue wastefully rather than save it to reduce the debt. You are saying Friedman was wrong when he gave this reasoning…
“Over a long period of time, government will spend whatever the tax system raises, plus as much more as they can get away with. That’s why you have had universal deficits.”
… as his rationale behind his “StB” advice. Well, if he was wrong then where are all the surpluses being run up around the world by all the govts that have taken their tax takes up to ~ 50% of GDP?
4) Logic II. You’ll also have no concern about the inverse “Feed the
Beast, er,Beauty” strategy taken up by the left, such as…I’d submit the correction: “Americans will, over time, come to realize that the government *we* want is actually worth *them* paying for” — but heck, if you don’t believe spending and revenue levels affect each other, what’s to worry?
Bonus) Krugman damned Starve the Beast and specifically the Bush tax rate cuts as a StB “poison pill” that effectively prevented Obama and the good people of the left from raising revenue by enough to enact all the good social programs they aspired to. By your enemy’s reaction to a policy you shall know it? Odd juxtaposition — who do we want to believe, Cato that StB doesn’t work or Krugman that it does?
(Admittedly, this was the older-version Krugman who dreaded the danger of growing debt and said federal taxes should be increased by 65%(!) to 28% of GDP (from 17%) *before* any Obama spending increases. Of course, that PK has sent himself completely down the memory hole — but it is fun to recall him now and again.)
24. June 2015 at 15:29
Jim Glass
Looking at these graphs I don’t see drops in receipts leading to drops in expenditures:
http://origin.factcheck.org/Images/image/2011/Articles/Tax%20or%20Spend/Outlays%20vs%20Revenues%20Since%201930(1).png
and
http://static2.businessinsider.com/image/4e1b069c49e2ae172a000000/us-federal-receipts-and-expenditures-2000-2011.png
24. June 2015 at 16:32
I cleaned up the URLs:
http://preview.tinyurl.com/pd39o3h
and
http://preview.tinyurl.com/obld2bc
24. June 2015 at 18:32
Jim Glass
Looking at these graphs I don’t see drops in receipts leading to drops in expenditures
Well, why would you expect to?
None of my five points referred to “drops in receipts” at all, much less as leading to anything. This is missing the issue entirely.
Look at the Friedman quote on the thinking behind StB, there’s nothing about “drops in receipts” in it — exactly the opposite!
In 1983 SS benefits that had grown faster than SS revenue had grown caused to program to become insolvent – directly leading to cuts in future benefits amounting to trillions of dollars at current value, as part of a political deal that was at current value 50% revenue increase to cover the cost of nearer-term benefits and 50% benefit cuts backloaded into the future to eliminate the need for more tax increases later.
So, OK, when you look at these charts just how do you expect them to show (1) the insolvency, & (2) the current receipts increase from the deal, & (3) the benefit cuts gradually getting larger as they stretch decades into the future, all as some sort of current “drop in receipts” causing a drop in current expenditures?
(Especially on the chart covering all the way from 2000 to 2011, missing the entire story!)
Look again at what Penner said happened while he was the head of CBO — that the deficits of the 1990s politically drove the Budget Enforcement Act and its PAYGO rules to effectively restrain spending growth. If that isn’t limited revenue restraining spending growth, what is? He didn’t say there was any “drop in receipts” behind the BEA. So why are you looking for one on your graphs?
24. June 2015 at 19:04
Jose, Bigger deficits overall could be, but I don’t see how making deficits more countercyclical would have intergenerational effects. Generations span many business cycles.
Mike, You said:
“However, it’s important to say that Bush didn’t sit down and say, ‘You know, I’d like to increase govt spending.'”
Yes he did. On education, on drugs for the elderly, on homeland defense, on the space program, and on lots of other programs.
Ray, Let’s try some accounting. The present value of all future spending must equal the present value of all future revenues. Agree?
Kevin, Krugman’s a smart guy, he understands the natural rate hypothesis. There are no magical ways of keeping the economy permanently above average. But see my answer to Don, because maybe I am missing your point.
Carl, You’ll have to ask Russ, and see my response to Ray.
Don, You asked:
“The problem is whether it is politically realistic to cut spending during booms.”
If you don’t do that then you’ll quickly run out of ammo, as G will rise to 100% of GDP. Fiscal policy is symmetrical. If it isn’t, it won’t do any good in the Keynesian model. I know this seems weird, but Keynesians claim a budget deficit of even $9 trillion, 50% of GDP, is not expansionary if done year after year at the same level. It must rise and fall, otherwise it’s not Keynesian economics.
I’m not saying you are wrong in the politics of what would happen, but let’s be clear that if you are right then the left has completely abandoned Keynesian economics.
24. June 2015 at 21:56
Sumner: “Ray, Let’s try some accounting. The present value of all future spending must equal the present value of all future revenues. Agree?”
I think you’re parroting Samuelson’s inter-generational transfer or some such nonsense you picked up in Chicago.
In theory this may be true, but in practice you get things like modern Greece, Argentina, USSR/Russia, ancient vs modern Italy, Greece, China. Keep in mind matching assets to liabilities is very tricky, as LTCM (Long-Term Capital Management) found (I think it was discovered that had LTCM held onto their positions, without having to surrender them due to their fatal liquidity event, they would have done OK), as well as numerous S&L banks in the 1980s. Another factor: as is well known, you can sell assets to ‘balance the books’ but if the USA were to sell Mt. Rushmore, or Greece the Acropolis, there would be too much hue and cry. It’s much easier politically to default (same for Japan and the Emperor’s Palace).
Long term, Gambler’s Ruin and the laws of entropy ensure that nothing will last, but as Keynes said in the long run we are all dead.
24. June 2015 at 21:57
Jim Glass:
Starving the beast means cutting government receipts to force the cutting of government expenditures. We should be able to see that by looking at times when receipts dropped to see if they led to reduced expenditures. You points to a one time reform of social security to avoid insolvency, but Medicare and social Security are currently insolvent yet we continue to run deficits and grow the size of government.
24. June 2015 at 22:47
Scott,
I’m referring to Wren-Lewis. He had a post last weekend basically calling you a liar. I don’t want to just engage in back and forth name calling. But, the more I’ve thought about W-Ls specifications, the more I’ve wanted to spout the old cliché of “how can they call this a science if an economist can get away with saying this?” I’d like to know if I’m missing something. Basically, by using a multiplier of 2 for spending and 0 for taxes and transfers, W-L has created a no-lose specification for larger government. So, while the reasonable fiscal policy you describe here may not lead to larger government, W-L has basically created the fiscal equivalent of your monetary offset.
Choose G: How about $10 trillion. You get a $20 trillion economy. You tax it for $10 trillion, with no effect on production, throw in whatever other taxes and transfers tickle your fancy, and voila, you have a $20 trillion economy that has G pegged at 50% of GDP, no matter what you do. By his model, you can’t get G to 100% of GDP, because G is so powerful, increasing it just increases the private economy by just as much, and you balance the budget at no cost to total production.
The ramifications are that the W-L economy grows as fast as the obstructionists will let you grow G, and tax and transfer questions become purely normative questions.
So, a reasonable fiscal policy may not be related to larger government. But W-L has specifically created a model that produces that outcome. I don’t know if Krugman has been as explicit about his specifications, but he’s leaning in that direction. The specifications make reasonable fiscal policy = bigger government. W-L’s (2,0) multiplier pair has taken it to a level of metaphysical purity. With the model he applied to the 2013 debate, there is no economic justification for ever reducing G or for foregoing any tax or transfer.
Actually, you reach a sort of GDP singularity if G reaches 50% of GDP, because a 1% increase in G leads to a 2% increase in GDP, which puts G back at 50%, and you just tax it to a balanced budget.
The sad thing is, even though the combination of multipliers W-L uses creates this purity of argument, I suspect that each one falls within the range of the findings of respectable research. Which leads me back to the cliché.
Is there something I’m missing here?
25. June 2015 at 05:44
Ray, How can something be true in theory but not practice? I thought that was impossible?
Kevin, You might be right about SWL, I can’t say. But Krugman’s much too smart to believe that nonsense. I’ve read a lot of his stuff, and he’s a fairly conventional Keynesian. There are clear rules and limits to these policies, you can’t just wave magic wands. For instance, in the Keynesian model fiscal stimulus has only a short run effect on output, in the long run you go back to the natural rate.
25. June 2015 at 06:11
Sumner: “Ray, Let’s try some accounting. The present value of all future spending must equal the present value of all future revenues. Agree?”
I don’t: sustainable government spending can be higher than revenues in the future if one assumes growing economy.
26. June 2015 at 14:03
Jussi, If you make plausible assumptions about the endgame, the two must equal. In any case, it’s a reasonable assumption for real world fiscal analysis. No economy grows forever.
26. June 2015 at 14:26
sustainable government spending can be higher than revenues in the future if one assumes growing economy.
Not after counting debt service on the spending.
When $1 of program spending is financed by borrowing, creating debt that will be rolled over forever, the future interest cost on the borrowing that must be financed by taxes or other revenue discounts to a present value of $1. As $1 = $1 spending equals revenue.
Deficit spending ain’t financed for free. As I noted above:
“If I believed taxes didn’t fully = spending I’d be saying ‘spend away, we’ll never pay for it’, just as so many who do believe it really do.
Well, here we are.
26. June 2015 at 21:46
“If you make plausible assumptions about the endgame, the two must equal. In any case, …”
What end game? The one after we are all dead? I’m okay with leaving some debt lying around after that. Assuming growth is totally plausible, so is to keep the debt share constant (i.e. no ponzi scheme).
“it’s a reasonable assumption for real world fiscal analysis. No economy grows forever.”
Here we disagree. I’m happy to stick with growing economy.
28. June 2015 at 06:43
Jussi, Have you looked at the Japanese population projections?
29. June 2015 at 05:05
Scott, not really but I have an idea. But Japanese still alive aren’t exactly hurrying to pay it all back, are they? And back to growth – which OECD baselines to be double by 2060 (http://stats.oecd.org/Index.aspx?DataSetCode=EO95_LTB#)
By the way, how do you reconcile zero growth assumption and positive growth target for NGDP (which might be a good idea)?