Paging Brad DeLong
In a recent post I argued that the expectations trap idea applied even more strongly to fiscal policy that monetary policy. The argument for the expectations trap is that future monetary policymakers might sabotage the attempt of current monetary policymakers by adopting a policy that is too tight to hit the inflation target. Expectations of that happening would depress current AD. I argued that it is even more likely that they would try to sabotage current fiscal policymakers, as you’d expect them to have a closer affinity for their own predecessors. And in my typical long-winded way, I made the argument not one but four times. (Feel free to skim, if you already read it.) Here they are:
1.
For some reason people don’t worry about this problem with fiscal policy; and the reason is very odd. Perhaps without knowing it, people tend to assume that future monetary policymakers would be expected to sabotage current monetary policymakers, but would not be expected to sabotage current fiscal policymakers. This is a rather odd assumption, as you’d expect that future monetary policymakers have more respect for current monetary policymakers than they do for the bozos in Congress.
2.
After all, given the very long terms served by Greenspan (and now apparently Bernanke) the future and current monetary policymakers are often the very same person. Is future Mr. Bernanke expected to differ from current Mr. Bernanke, by more than future Mr. Bernanke differs from the current Congress?
3.
Here’s one way to think about this issue. The future Fed is considered the last mover in this game. The current Fed can do QE, and the future Fed can undo QE. Or the future Fed can raise rates sooner than expected, or by more than expected. But that’s also true of fiscal policy. The Congress can pass a bill to spend more money, and the Fed can raise rates right afterward if they think inflation is going to exceed their target. I’m not saying that’s likely, but I also don’t think it’s likely that the future Mr. Bernanke would try to sabotage the current Mr. Bernanke if the current Bernanke publicly announced “We need to get core inflation back up to the trend line of 2% extending out from September 2008, and will do whatever it takes.” Why would the future Mr. Bernanke try to sabotage the current Mr. Bernanke, if he made that promise publicly and explicitly? After all, if he did so he would make both Bernankes look like fools in the history books.
4.
So please don’t take this post the wrong way. When I say that the expectations trap is equally applicable to fiscal policy, I’m not saying that I think the Fed is likely to go out of its way to sabotage fiscal policy. But it is even less likely to sabotage monetary policy, indeed the latter hypothesis seems much more far-fetched to me.
Now a commenter named Q2 suggests that Krugman (and Thoma) did not read my post carefully:
I believe both Thoma and Krugman did not read your entire post, or at least not carefully, as they seemed to miss the point that the Fed can counteract any attempt to raise AD through fiscal policy. As I read it, they think you’re arguing that in order for fiscal policy to work, the *legislator* needs to be credible, which is why they emphasize that all the legislator needs to do is spend the money; they don’t need to set expectations.
I hope not, as I never mentioned this idea. I believe Q2 is referring to the following passage in Krugman’s post, which I didn’t read closely enough the first time (there seems to be a lot of that going around.)
And the Tinkerbell principle NEVER applies to fiscal policy. If the government goes out and hires a million people to dig ditches, the direct effect is that a million people have been put to work digging ditches. It doesn’t matter whether people believe it will work. Some of the effect might be partially offset if people believe the government will have to raise taxes later (though not completely offset- we’ve had that discussion). The point, however, is that expectations effects if anything diminish the effectiveness of fiscal policy, which actually works best if expectations don’t change at all.
I’d hate to think that when I finally got a Nobel Prize winner to pay attention to my clever new idea, he actually thought I was simply making a tired old argument and claiming it was my clever idea. But I always get in trouble when I try to interpret Mr. Krugman, so I’ll let you commenters weigh in. What do you think? Did he “misunderestimate” me?
Even better, maybe Brad DeLong would weigh in. A few weeks ago he did a post entitled “Can Scott Sumner read? The empirical evidence suggests not” It’s good to have someone scolding bloggers who don’t do their due diligence, as long as they aren’t swayed by ideological bias. So what do you think Brad DeLong?
PS. If Brad DeLong does agree with me, I do hope he comes up with an equally clever post title using Paul Krugman’s name. If not . . . well, nevermind.
PPS. I couldn’t find a similar quotation from Mark Thoma, so I’ll give him the benefit of the doubt. But I would like to respond to this quotation in Thoma’s post:
More generally, if people want to go back and use older or different models to make their arguments, that is fine, but it doesn’t have a lot to do with the argument I was making. Perhaps they believe these models are superior to the models that Woodford and Eggertsson are using, that’s certainly their prerogative, but which model provides better answers to the questions we are asking is a completely different argument. For the most part, the issues being raised about credibility have been considered and addressed within the New Keynesian framework.
My model isn’t older than Eggertsson and Woodford’s model, because it was only developed yesterday (At least I think it was; keep in mind that whenever I think I have a new idea, I always find out someone else got their first.) BTW, several years ago Gauti Eggertsson and I had a fairly extensive email discussion. I am familiar with his work, and respect it. But I don’t always agree with him on the policy implications of this way of thinking about macro.
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4. June 2010 at 16:09
I don’t find your arguments too persuasive. Future monetary policymakers will have more information and act on that basis. They owe no allegiance to their former selves with less information. On the other hand, countering fiscal policymakers risks their independence, even if they are only trying to establish that independence. They could well expect not to be there in the future in that case. Nor do I see monetary policymakers holding a constant as the standard, but a range. They will act when that range has been exceeded in either direction, but will remain pat as long as it remains in range. This leaves fiscal policymakers room to work within that range. Again, should it not result in exceeding that range even if they expected it would, they would not act until it was established in the data to exempt themselves from political risk. Nor would they consider changing their minds based on evidence in anyway sabotage, but doing their job.
4. June 2010 at 17:06
Thanks for the shout-out. By the way, I usually post in the blogosphere under “q”, but I noticed on your blog there is already a commenter named “q.”
When I said Thoma, I was really referring to the Eggertson quote he cites approvingly:
“This credibility problem is what Eggertsson (2006) calls the “deflation bias” of discretionary monetary policy at zero interest rates. Government spending does not have this problem. … The intuition is that fiscal policy not only requires promises about what the government will do in the future, but also involves direct actions today. And those actions are fully consistent with those the government promises in the future (namely, increasing government spending throughout the recession period). …”
I’m not sure if I understand this entirely, but Eggertson seems to be saying once interest rates hit zero, the Fed is going to be very wary of letting inflation get too high, hence the “deflation bias” that is intrinsic with any action by the Fed to inflate today. But the legislator doesn’t have a similar problem, because their decision to spend today are consistent with their promises to spend throughout the recessionary period. So it sounds like to me, a comparison is being made between what the Fed can do today and how that affects its actions tomorrow, and what Congress can do today and how that affects its actions tomorrow. This is consistent with Krugman’s slight caveat that Congress may face a similar “deficit-reduction bias” by raising taxes, but of course he emphasizes it will not completely counteract the effect of increased spending. And in both Thoma and Krugman’s post, they completely ignore the Fed’s role in counteracting Congressional fiscal policy.
At least that’s my interpretation. Because I don’t otherwise see where Thoma and Krugman actually reject your argument that the Fed has the power to deflate if fiscal policy overshoots its inflation targets.
4. June 2010 at 17:19
As for why I think there’s a lot of confusion going on, I believe it comes from this paragraph in your original post:
“But here’s the bigger flaw with the whole expectations trap argument. People think it applies to monetary policy, but they forget it applies equally to fiscal policy. (Indeed I never realized this until today.) Here’s why. Krugman’s model relies on rational expectations, indeed you can’t get the expectations trap without ratex. But if you have ratex in your model, then no policy can work unless it is expected to work. That’s why ratex should actually be called “consistent expectations.” What you are really assuming is not that that people are “rational” (which is pretty much a meaningless term anyway), but rather that their expectations are consistent with the predictions of the model. So if monetary policy is aimed at boosting nominal spending by 10%; it will only “work” in a ratex model if it is expected to boost nominal spending by 10%. But that’s equally true of a fiscal policy aimed at boosting nominal spending by 10%. It won’t work unless it is expected to work.”
If someone neglected to read further, they might interpret your statement that fiscal policy won’t work unless it’s expected to work to be transferring the Fed credibility issue onto Congress, i.e. an expectation that fiscal policy works means *Congress* needs the credibility of sticking with that fiscal policy. Hence Krugman’s argument that Congress does not need any credibility, because spending will already have the desired affect on AD.
4. June 2010 at 17:58
I won’t hold my breath, but I think you and Paul Krugman really need to do a bloggingheads.tv together or something.
I think in five minutes you could communicate more information than you have in an entire year blogging back and forth.
4. June 2010 at 18:12
I’m not sure I follow the logic in you bringing DeLong into this. He criticized you a few weeks ago, therefore when you get something right he has to pat you on the head and give you a bonio?
4. June 2010 at 18:55
No, it’s more like he wants DeLong to criticize Krugman for getting something wrong. Of course Sumner is being facetious as everyone knows DeLong likes to play the partisan hack.
4. June 2010 at 19:13
He can’t criticize Krugman on this without backing Sumner up. Two sides of the same coin.
It still doesn’t answer my question of why DeLong needs to be brought into this at all.
If we criticize Scott Sumner, do we get put on the naughty list, and be subjected to repeated “Will you condemn…?”-a-thons for years afterwards?
4. June 2010 at 20:54
Alex, you’re taking things way too seriously. DeLong insulted Sumner by saying he can’t read; Sumner is now saying DeLong is a hack. Yet, I doubt either is that offended by the other; catty quips are DeLong’s MO and Sumner is just playing along.
5. June 2010 at 00:50
I’m pretty sure Scott’s just kidding around, Alex. I ditto Cameron re bloggingheads — that sounds like it would be pretty useful and effective.
5. June 2010 at 07:38
I can’t stand de Long and wish that people would start ignoring him to bring his petty ego down to earth.
5. June 2010 at 08:09
Lord, You said;
“I don’t find your arguments too persuasive. Future monetary policymakers will have more information and act on that basis. They owe no allegiance to their former selves with less information.”
This ignores the “time inconsistency problem.” If future policymakers don’t adopt a “timeless perspective” we will get continually suboptimal policy. That is now a widely accepted view among monetary economists, it’s not just my view.
But even if you are right, it doesn’t undercut my argument that expectations traps are an even bigger problem for fiscal policy. The same is true of policy “ranges”, that affects fiscal and monetary policy equally.
Q2, I think you are right that Eggertsson would disagree with my view of the situation. He tends to think of monetary policy in terms of interest rates and inflation, whereas I think of it in terms of price level or NGDP targets. When you take a level targeting approach to the subject, things look very different. I don’t doubt that under his assumptions a fiscal expectations trap is less likely than a monetary trap. But I don’t accept those assumptions. I am assuming the Fed sets an explicit target trajectory for prices and or NGDP. A future central bank must explicitly repudiate that target if they want to neutralize current policy. Conversely if the fiscal authority doesn’t like that trajectory, and tries to move us to a higher trajectory, they will get a lot of pushback from the Fed. As far as I know, Eggertsson doesn’t approach the two party game that way.
The pushback I’ll get is that the Fed doesn’t currently behave the way I suggest. Yes, but that’s because THEY CURRENTLY DON’T WANT MORE INFLATION, not because they are stuck in an expectations trap.
Q2#2, You said:
“If someone neglected to read further, . . . ”
Yes, I agree.
Cameron, I doubt that would be possible, but I’d love to do one. He probably sees me as a mosquito not worth his time.
Alex, That was a joke. If I didn’t think DeLong was joking, I would have thought him a complete moron. I mean does anyone seriously think I don’t know how to read?
I didn’t know what ‘bonio’ meant until I looked it up, however, so maybe I don’t know how to read. 🙂
Q2, Exactly.
Alex, When Krugman and I were disputing an issue last month, why did “DeLong need to be brought into this” by DeLong himself?
Believe me, DeLong won’t take the bait. He won’t ridicule Krugman. It was merely humor intended for my own readers. If you didn’t find it funny, move on to the next unfunny post. I don’t claim to be a great humorist.
Johnleemk. That would be nice.
7. June 2010 at 17:43
I find this interesting, but I am not convinced. Arguments like “if future monetary policymakers have an incentive to frustrate current ones, fiscal policymakers should, too” are arguments from similarity. That’s okay as far as it goes but I think you need to go further. A stronger argument would look into the dynamics of decision-making and the institutional arrangements that are said to exist with respect to monetary policy and examine whether or not they exist in the case of fiscal policy.
If I recall correctly, this problem with with monetary policy is essentially game-theoretic. The argument is that, at least in game with only two rounds, the rational thing for policymakers to do is to trick the other economic actors into expecting a contractionary monetary policy so that they set prices low in the first round of the game. So come second round of the game, they can use an expansive monetary policy, which will somehow let them boost employment without increasing prices- shift onto a different and better Phillips curve, I guess. If I am totally wrong in my characterization of this problem, sorry, please ignore my whole post. I only dabble in economics.
For my money… it does seem that fiscal policymakers can try to set expectations of fiscal austerity in order to combat inflation, and then later try to exploit that by engaging in periods of unexpected fiscal expansion. That might even be a decent characterization of pre-Friedman fiscal policy. But it seems to me that the game would be more difficult to play using fiscal policy as opposed to monetary policy, because of the large outside time lags associated with fiscal policy (the time taken to implement the new expenditure and revenue arrangements, and then the time for them to soak through into the economy).
That being said, I don’t find that version of the problem (stated for monetary policy) convincing at all, mainly because real situations, at least in developed countries, aren’t a two round game. They are a repeated game, with learning. I think that monetary policymakers have learned the enormous value of credibility, and that generally speaking it is not worth throwing that away for one episode of unexpected monetary expansion.
8. June 2010 at 14:19
marcusW, You said;
“I find this interesting, but I am not convinced. Arguments like “if future monetary policymakers have an incentive to frustrate current ones, fiscal policymakers should, too” are arguments from similarity. That’s okay as far as it goes but I think you need to go further. A stronger argument would look into the dynamics of decision-making and the institutional arrangements that are said to exist with respect to monetary policy and examine whether or not they exist in the case of fiscal policy.”
I never said what you quote, nor do I believe it. I said future MONETARY policymakers might sabotage current fiscal policymakers. That is very different.
I agree with the last part of your comment, I don’t find these game theory arguments at all convincing. Especially for monetary policy.
8. June 2010 at 17:22
Dear Scott, Sorry, somehow I got the wrong impression reading your post. It seems that what you are actually saying would be glossed better as “if dynamic inconsistency is going to pop up anywhere it’s going to be in fiscal policy (although probably neither are likely)”. The arguments you offer do have some force.
I’m glad I came across your blog. I’ll be visiting regularly.
8. June 2010 at 17:29
Argh! That’s not the best gloss. It would be “If future monetary policymakers are going to sabotage any present policymakers at all, it would be more likely that they would sabotage fiscal policymakers (although it is not that likely that they would sabotage anyone).” I am being especially thick headed today (and yesterday).
9. June 2010 at 04:38
mercusW, Yes, lots of people misunderstood, so I should have worded it differently.
9. June 2010 at 04:38
Sorry, That’s marcus.