Rogoff on monetary stimulus

Ken Rogoff and Carmen Reinhart have an excellent new column in the FT:

The recent debate about the global economy has taken a distressingly simplistic turn.

Actually, it’s been simplistic from the beginning.  The real problem in the developed world is tight money.   Or should I say the nominal problem. Here’s more:

One of us [Rogoff] attracted considerable fire for suggesting moderately elevated  inflation (say, 4-6 per cent for a few years) at the outset of the crisis.  However, a once-in-75-year crisis is precisely the time when central banks  should expend some credibility to take the edge off public and private debts,  and to accelerate the process bringing down the real price of housing and real  estate.

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very  promising ideas for simplifying the tax codes.

A few comments:

Rogoff is right that higher inflation would have been desirable back in 2008-09.  But today wage growth has fallen so low that even 2% inflation would promote a robust recovery.  We don’t need to clobber savers with high inflation.  And we won’t.

Over the past year NGDP growth has been running around 3.5%; 2% real and 1.5% inflation.  Given the slack in the economy, if the Fed bumped that up to 5.5% NGDP growth for 2 years, we’d get around 2% inflation and 3.5% RGDP growth.  At worst it would be 2.5% inflation and 3% RGDP growth.  In either case the unemployment rate would quickly fall back to the natural rate (whatever it is.)

Unfortunately there is very little chance that the Fed will achieve 5.5% NGDP growth.  Some have argued that fiscal austerity is slowing the recovery.  Indeed the Fed has argued that fiscal austerity is slowing the recovery.  And that’s because fiscal austerity is slowing the recovery.  RGDP growth in Q2 will likely be lower than if the sequester had not taken effect.  So why do I keep prattling on about  “zero fiscal multiplier?”

This is a hard concept to explain, so let me use the analogy of Lucas’s critique of discretionary monetary stimulus.  Lucas argued that discretionary monetary policy was undesirable.  He argued that monetary stimulus was ineffective if anticipated, as it would already be factored into wages and prices.  Then people would ask Lucas why unanticipated stimulus would not work.  He replied that one had to think in terms of systematic policy rules that one could write down on a piece of paper, otherwise there was little hope of producing a welfare-enhancing monetary regime.  Suppose you wrote down “Every time unemployment rises above 7% we’ll do an unexpected monetary stimulus.”   Then it would no longer be unexpected!  In other words, the monetary authority could only surprise the public by doing “wild and crazy” things which people had no reason to expect.  How likely is that to work?

I think wages and prices are stickier than Lucas believes, so I think even systematic monetary policies will have some real effects.  But the logic of his argument applies pretty well to the monetary offset issue.  The claim today seems to be “fiscal stimulus can work if it catches the Fed off guard, as with the April 2013 sequester.” Yes, but now think about this game from a “timeless perspective,” (not a 2013:2 perspective) where you don’t know the starting point.  Over time, there will be equal number of cases where fiscal stimulus is greater than expected, and less than expected.  Thus on average fiscal stimulus will have no effect.  Since 2009 there have certainly been some quarters of greater than expected stimulus and some quarters where it was less than the Fed expected. But it’s absurd to think we can have long run success from fiscal stimulus via a policy of Congress continually fooling the Fed.  It’s hard to imagine a less nimble organization than Congress.

I’ve emphasized that estimates of fiscal multipliers are nothing more than estimates of central bank incompetence.  When the Fed took some aggressive steps late last year, they said that one purpose was to offset fiscal austerity.  They said their actions, combined with the expected results of the fiscal cliff, would lead to 3% to 3.5% RGDP growth.  They will probably fall short, but why?

1.  Faulty model; over-estimating expansionary effect of the Evan Rule, or the very low rates, or QE?

2.  A worsening global environment?

3.  More fiscal austerity than expected?

4.  All three?

Who knows? But I’m still not seeing any evidence that RGDP growth will slow by 1.5% as compared to recent years, as the anti-austerians predict.  However I do see evidence of central bank incompetence.  So I’ll re-iterate that the zero multiplier is a baseline for starting to think about the problem, or as the average effect over long periods of time, not a precise estimate of the effect of fiscal stimulus in each and every case.

Here’s the question that should be of interest to serious macroeconomists (as opposed to ideologues.)  If the fiscal contraction of 2013 had not been expected, what would the Fed have done in late 2012?  And what would their forecast for RGDP growth have been?  I’m not certain exactly what the Fed would have done, but I’m pretty sure their forecast for 2013 growth would have been around 3% to 3.5%.  Maybe a tad higher than otherwise, but nothing close to the 1.5% extra RGDP growth predicted by the anti-austerians.

HT:  Nicolas Goetzmann


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43 Responses to “Rogoff on monetary stimulus”

  1. Gravatar of Morgan Warstler Morgan Warstler
    2. May 2013 at 06:24

    The economic news continues to be a mixed bag. The stock market however is SURE that if things slowdown, the Fed will do QEforever.

    Fiscal Stimulus: The GOP ought to be screaming that the Fed has just endorsed tax cuts (employer side).

    Let’s and gentlemen, Scott has FINALLY given up / stopped asking for make up, we’re down to 5.5% vs. 5% vs. 4.5%.

    Frankly, that’s a much easier ask – I think at 4.5% for sure you get Kudlow screaming about it.

    Finally,

    It’s time to start HIGHLIGHTING that NGDPLT makes MOAR SEQUESTER! possible.

    We’re got a party that desperately needs a economic plan that:

    1. argues more productive govt. justifies cuts to taxes
    2. argues more productive govt. will not cause economic slow down.

    NGDPLT is the GOP silver bullet. We should sell it that way.

  2. Gravatar of Laurent Laurent
    2. May 2013 at 06:27

    On a similar issue:
    http://www.bloomberg.com/news/2013-05-02/ecb-cuts-key-interest-rate-to-record-low-as-recession-lingers.html

    I almost cried when I read this:

    “””
    Asmussen said last week that the effect of any further rate reductions may only be “limited” because they are not being passed on in the economies that need them most. He also said that the ECB can’t emulate the policies of the Bank of England, the Bank of Japan and the Fed.

    “Large-scale asset purchase programs targeted at capital markets would not be very helpful in the euro area” and policies like forward guidance or quantitative easing “are not easily applicable here,” he said in a speech in London on April 25. One day later, he told a Frankfurt audience that higher inflation or targeting the rate of unemployment “are ideas that we simply cannot entertain.”
    “””
    These are the people running the ECB.

  3. Gravatar of StatsGuy StatsGuy
    2. May 2013 at 06:38

    All in all, I’ve been wondering if the current status quo equilibrium is turning out favorable. I would describe it as:

    Run a large, but not too-large, fiscal deficit

    Finance it through QE (which, effectively, we are)

    The larger the portion of the total debt that is owned by the Fed (note that interest on debt is kicked back to the treasury, AND that treasury is further benefiting from lower real rates than might otherwise be available), the more the budget is effectively being financed by seignorage. In other words, the current status quo is shifting from a tax on income to a (small) tax on currency-denominated wealth, and that tax is actually contributing to efficiency (at the moment at least). Given the increasing importance of wealth vs. labor income in the world (due to automation and other trends), one has to wonder if this is just the way the world is going to work in the future.

    While we’re at it, I’ve always disagreed with you on the notion that taxing interest/capital gains income is double taxation and both unfair/inefficient.

    Allow me to explain why: labor, like capital, suffers depreciation (Call it aging) and maintenance costs. It incurs replacement costs, and the costs of labor investment are more than mere skills (though that is considerable). As such, ALL childcare, child feeding, child housing, child medical bills, parental medical bills, food (to sustain health), and everything except pure discretionary items, are really costs of production (of human capital), even the cost of basic housing (for a given city/geography), etc. And should not be taxed.

    Fun stuff going on in EU right now – negative IOR on the table!

  4. Gravatar of marcus nunes marcus nunes
    2. May 2013 at 06:40

    R&R will keep ‘defending’ themselves till the end of time. And it´s easily seen that DEBT was the consequence of monetary failure:
    http://thefaintofheart.wordpress.com/2013/05/01/rr-defend-themselves-again/

  5. Gravatar of Michael Michael
    2. May 2013 at 06:51

    At the end of the day, are we getting exactly the recovery that the Fed *wants*?

    Your argument on fiscal policy could be applied to other factors such as supply shocks, right? A positve supply shock should be expected to increase NGDP growth (including both real growth and inflation) but not if they lead to Fed tightening?

  6. Gravatar of TravisV TravisV
    2. May 2013 at 07:00

    Dear Market Monetarists,

    Do y’all have a standard response to this point by Nouriel Roubini about the dangers of the gigantic monetary base we have now?

    http://www.project-syndicate.org/commentary/the-federal-reserve-s-policy-dilemma-by-nouriel-roubini

    “The exit from the Fed’s QE and zero-interest-rate policies will be treacherous: Exiting too fast will crash the real economy, while exiting too slowly will first create a huge bubble and then crash the financial system.”

  7. Gravatar of Doug M Doug M
    2. May 2013 at 07:36

    “Given the slack in the economy, if the Fed bumped that up to 5.5% NGDP growth for 2 years, we’d get around 2% inflation and 3.5% RGDP growth. At worst it would be 2.5% inflation and 3% RGDP growth.”

    No, in the worst case, a perception that the Fed was incompetent would cause a flood of dollars out of the United States. Real interest rates rise much faster than inflation. Inflation rises approaching double digit rates and real GDP delcining.

    On the Lucas critique, if monetary policy is only effective if it is unanticipated, then the Fed should do away with transparency. Go back to the pre-Greenspan Fed, where we would have to look at the actual flow of OMO to determine a change in stance.

  8. Gravatar of TallDave TallDave
    2. May 2013 at 07:36

    Excellent article, thanks for sharing.

    “Some now argue that just because one cannot definitely prove very high debt is bad for growth (though the weight of the results still say it is), then high debt is not a problem. Looking beyond the recent public debate about the literature on debt – we have already discussed our results on debt and growth in that context – the debate needs to be reconnected to the facts.”

    Thank you! The amount of short-term debt the US is carrying will be catastrophic if we see a change in real rates. The Plank curve is very steep and gives little warning.

  9. Gravatar of Geoff Geoff
    2. May 2013 at 07:39

    This post is very weak. The same old fallacies creeping up again and again, like they were never refuted a million times already.

    “The real problem in the developed world is tight money. Or should I say the nominal problem.”

    Nominal problems can be caused by real problems, and real problems can be caused by nominal problems. It is wrong to separate these and ignore one while universalizing the other, as a causal explanation.

    “But today wage growth has fallen so low that even 2% inflation would promote a robust recovery.”

    Philips curve fallacy.

    “Demand for commodities is not demand for labor.” – John Stuart Mill.

    In other words, wages are not financed out of final spending on goods and services. Final spending on goods and services is financed (in part) out of prior wage payments.

    But, but, ‘but businesses pay more current wages when they expect more future revenues! Expectations expectations expectations!’ Oh really? With what current money? Expectations alone cannot make new money magically appear. It doesn’t matter if a business expects higher prices. It has to have more money to pay higher prices.

    Thus, it follows that unemployment is solved on the side of falling prices. That means allowing wages to be more flexible, which will, eventually, eliminate unemployment. This means no welfare, no minimum wage laws, no inflation threats, no government intervention.

    “And that’s because fiscal austerity is slowing the recovery.

    True austerity, namely lower taxes, lower deficits (and spending), and lower regulations, NEVER slow economic recovery. Ever. Recovery includes reallocating capital and labor to their most highly valued uses. That of course means (temporary) unemployment and idle resources.

    It is not a recovery for the government to prevent this recovery process by flooding the economy with non-market money and spending, so that various arbitrary aggregated statistics are prevented from falling at all times, as if the production of more weapons and fewer civilian goods, that results in a greater “net output” is superior to all energy and resources being put to civilian use which may or may not result in a greater “net output.”

    MM theory is clearly intellectually bankrupt, for it is leading to the false conclusion that austerity hampers economic recovery, or, in other words, it leads the false conclusion that governmental coercion against peaceful market activity is beneficial to its victims.

    “I think wages and prices are stickier than Lucas believes, so I think even systematic monetary policies will have some real effects.”

    And once again, no mention whatsoever of the effects of inflation itself on wage “stickiness.” Chasing one’s own tail continues to abound.

    “Yes, but now think about this game from a “timeless perspective,” (not a 2013:2 perspective) where you don’t know the starting point. Over time, there will be equal number of cases where fiscal stimulus is greater than expected, and less than expected.”

    That does not follow. From a rational expectations framework, for fiscal stimulus to “work”, i.e. prop up bad investments, prevent necessary labor reallocations, etc, it would have to continue to be unexpected over time, or else there would be no fiscal stimulus to speak of. The number of unexpected fiscal activities would thus appear as historically outnumbering the number of expected fiscal activities.

    Finally, relating to the Lucas Critique, which Dr. Sumner continues to deny applies to NGDPLT (which is in itself tragic): NGDPLT is very much subject to the Lucas Critique. Actually, both the Lucas Critique and Goodhart’s Law apply.

    1. Lucas warned against trying to predict the effects of a change in policy based on historical data, especially highly aggregated data. And what are MMs doing? That very activity. They are trying to predict the effects of a change in policy (monetary policy) based on historical data (total employment, total wages, total output, NGDP), especially highly aggregated data (total employment, total wages, total output, NGDP!).

    Employment and output are not policy invariant. If the policy is changed, so will employment and output change. Thus, policy conclusions (NGDPLT) based on those parameters would be misleading.

    2. Goodhart argued that when a measure becomes a target, it ceases to be a good measure. MMs want NGDP to become the target. Thus, NGDP would cease to be a good measure of whether or not monetary policy is too expansionary or too contractionary. It could be too expansionary (in the sense of distorting price signals that brings about unsustainable capital and labor allocations, and NOT necessarily in price inflation indexes which is what MMs superficially look at when considering whether or not money is too loose or too tight, just like most macroeconomists did throughout the 1920s, with catastrophic consequences). Or, it could be too contractionary (in the sense of bringing about credit deflation due to prior fractional reserve lending).

    Sometimes when I read the posts on this blog, I’m reminded of mantras chanted in the face of overwhelming evidence and reason that would make the content of such mantras incorrect, but doing so purposefully, with contempt for evidence and reason, as some sort of ideological litmus test to prove one’s devotion to a particular religion, worshiping a singularity called the NGDP God, under which man is to prostrate himself to prove one is not an “ideologue”, i.e. anti-NGDP God.

    Serious macroeconomists? I’d like to find one who isn’t an ideologue. MM is chock full of ideology, couched in “pragmatic” rhetoric. Amusingly, pragmatism itself is an ideology. But it’s an OK ideology, so it’s not an ideology, and its adherents are not ideologues.

  10. Gravatar of J J
    2. May 2013 at 07:54

    Professor Sumner,

    The Fed has continued to overestimate growth quarter after quarter. I suppose Krugman’s argument is that there is a correlation between this overestimation and fiscal policy. I suppose it’s hard to know without an understanding of why the Fed continues to overestimate growth. Are they just incompetent? Are they afraid to expand their balance sheet too quickly because of political pressure? If the latter is true, then there is an argument that more expansionary fiscal policy would not be offset by less expansionary monetary policy.

    Maybe the Fed wants to do more, and so uses big news items such as the fiscal cliff to justify more expansionary monetary policy. It doesn’t follow that expansionary fiscal policy will be met symmetrically by less expansionary monetary policy.

  11. Gravatar of Ashok Rao Ashok Rao
    2. May 2013 at 08:09

    Prof. you said “But it’s absurd to think we can have long run success from fiscal stimulus via a policy of Congress continually fooling the Fed. It’s hard to imagine a less nimble organization than Congress.”

    Isn’t this precisely *why* fiscal stimulus *can* be effective? Because Congress is dumb and politicians have very difficult to predict vested interests (and primaries etc.) we know that they are not acting in purely selfish interest of the American economy.

    We are surprised every time Congress does something, from letting the sequester pass to letting our old friend GW go to war on lies. Basically, it’s an entirely irrational and skittish organization. So to analyze its behavior from rational expectations seems a stretch.

    Take it another way. Let’s say the effectiveness of a policy P is proportional to the new information it provides. If Congress does not pass a law at all at some time T, then no new information is generated. And nothing out of the ordinary happens.

    Now lets say America is attacked by a foreign country, and P is “engage in war”. The real economic information derives from the hugely unexpected attack, not P. We know that any Congress would react. So I’d buy my Lockheed Martin stocks after the attack, not after Congress announces war.

    But, lets say a not TBTF but still very big and important bank failed. I have NO clue what P might be. I know there are many in Congress – on both sides of the aisle – that are deeply averse to bank bailouts. But I don’t know what to do. Suddenly, P conveys a huge amount of information.

    Boltzmann (actually Gibbs Entropy) helps us calculate the “amount” of information. The outcome of a fair dice carries far more “surprise” than that of a highly biased one. Therefore the fair die is far more “informative” than the one-sided one.

    Applying this to Congress, considering the very complex political tensions therein and stupidity of many members, it’s fair to say on important things the information is high. And precisely because it is high, it can be useful.

  12. Gravatar of ssumner ssumner
    2. May 2013 at 08:41

    Morgan, Larry’s already moving our direction.

    Laurent, What’s most sad about that statement is that the ECB’s mandate calls for higher inflation. They are breaking the law by not producing higher inflation.

    Statsguy, That’s incorrect, the Fed is not monetizing the debt, they are issuing interest-bearing reserves.

    Michael, No, the monetary offset only applies to demand shocks, not supply shocks.

    J, You said;

    “I suppose Krugman’s argument is that there is a correlation between this overestimation and fiscal policy.”

    That argument makes no sense. Surely the Fed knows what’s going on with fiscal policy, at least over longer periods of time, and we know they think fiscal policy has an effect on growth.

    Ashok, I think you are missing the point of the Lucas argument. If institutions have an “effect” because they are crazy and irrational, then you don’t want to use that institution to try to stabilize the economy. It’s not about whether fiscal policy can or cannot have an effect right now, (it can) it’s about whether fiscal policy should be used at all. Lucas is making a very subtle point, and even today I think most people miss the point.

    An irrational fiscal policy REGIME will make things worse, even if right this minute they might make things temporarily better, by dumb luck.

  13. Gravatar of Blissful Ignorance, George Carlin, and the Damned Multiplier | This is Ashok. Blissful Ignorance, George Carlin, and the Damned Multiplier | This is Ashok.
    2. May 2013 at 09:42

    […] I think his argument today is […]

  14. Gravatar of Ashok Rao Ashok Rao
    2. May 2013 at 09:45

    Typed up my comment in the process of a post on this subject. The first part is a more detailed explanation of my above thoughts, but then I consider your point about the Lucas Critique in context of a Krugman Rule (“Fiscal policy only at the zero bound”).

    I’m inclined to think you’ll disagree with me, but I’d be really excited to hear your remarks and answer to my thought experiment in the end (you only have to read the second part): http://ashokarao.com/2013/05/02/blissful-ignorance-george-carlin-and-the-damned-multiplier/

  15. Gravatar of Don Geddis Don Geddis
    2. May 2013 at 09:51

    @J: “Are they just incompetent? Are they afraid to expand their balance sheet too quickly because of political pressure?

    Is there a difference?

    there is an argument that more expansionary fiscal policy would not be offset by less expansionary monetary policy.

    This seems consistent with Sumner’s long-time claim, not that the fiscal multiplier is always zero, but instead that the fiscal multiplier is an estimate of the central bank’s incompetence.

  16. Gravatar of Don Geddis Don Geddis
    2. May 2013 at 10:01

    @Geoff: “The same old fallacies creeping up again and again, like they were never refuted a million times already.

    Pot, kettle. I’m impressed that you can write those words, seemingly without irony.

    Recovery includes reallocating capital and labor to their most highly valued uses. That of course means (temporary) unemployment and idle resources.

    If your theory were true, then the past few years should have seen industries (the “most highly valued”) with high growth, while unemployment was concentrated in the “low value” industries. Unfortunately for your theories, the US economy showed widespread unemployment in every industry, across the board. Hence it’s obvious this is not a “reallocation” recession.

    So it’s clear that you have no idea what has been going on in the macro economy, as your theory makes predictions which have already been falsified by real-world data.

  17. Gravatar of Ashok Rao Ashok Rao
    2. May 2013 at 10:25

    @Don, to be fair, Geoff’s point can be interpreted in the relative reallocation into productive industries (computer science, healthcare come to mind).

    BTW, Tyler Cowen’s new post seems relevant: http://marginalrevolution.com/marginalrevolution/2013/05/we-are-not-as-wealthy-as-we-thought-we-were-and-its-consequences.html

  18. Gravatar of Mike Sax Mike Sax
    2. May 2013 at 10:28

    “Some have argued that fiscal austerity is slowing the recovery. Indeed the Fed has argued that fiscal austerity is slowing the recovery. And that’s because fiscal austerity is slowing the recovery. RGDP growth in Q2 will likely be lower than if the sequester had not taken effect. So why do I keep prattling on about “zero fiscal multiplier?”

    Until now I was never sure if you believed the sequester was slowing the recovery. As you do, why do you seem so critical of those who criticize the sequester?

  19. Gravatar of Grim23 Grim23
    2. May 2013 at 10:31

    Scott
    It’s because of good posts like this that my favourites folder called “money” is over full.
    Also, in regards to your reply to michael, under NGDPLT, rather than inflation targeting, wouldn’t the monetary offset also apply to supply shocks?

  20. Gravatar of mpowell mpowell
    2. May 2013 at 10:37

    This post was unexpected. It’s always really irritated me when people argue that fiscal stimulus won’t work because the monetary authority moves last, or whatever. And then you get Bernanke inviting more fiscal stimulus. We can have an argument about which way works better in the long run, but does this mean we can retire arguments about whether fiscal stimulus can work when the fed prefers fiscal stimulus to additional monetary action? You can even call it central bank incompetence if you want.

  21. Gravatar of Doug M Doug M
    2. May 2013 at 11:09

    Taking the Lucas critique to its logical end.

    If policy is predictable the market will anticipate policy, and the implementation of policy will have no effect.

    If policy makers are able to influence the economy it must be because their action was unanticipated.

    “Random” shocks to the economy are nearly always negative.

    Institutions should strive to be as predictable as possible.

    Wouldn’t it be reasonable then to say that ANY policy rule will suffice, and all would be equally effective. Fix the supply of money, or fixing the price of money to a hard asset, or even abolish the Fed.

  22. Gravatar of Don Don
    2. May 2013 at 11:10

    What does this:

    “We don’t need to clobber savers with high inflation. And we won’t.”

    mean? Are you implying that some inflation is a little bad for savors? Cuz I thought that more inflation in current conditions means more real growth and more real growth means higher real returns to savors. I see low inflation as robbing savors.

  23. Gravatar of Morgan Warstler Morgan Warstler
    2. May 2013 at 11:29

    Sax,

    You can cutting govt. spending AND cut taxes:

    get no larger deficit. (moar sequester) say $500B in spending cuts

    get more private sector growth. (payroll tax cut bigger than size of fed cuts) say $501B in tax cuts.

    and economists all still call it (successful) Fiscal Stimulus.

    —–

    This drives me crazy too, bc folks on left equate fiscal stimulus with dems spending more money and thats not what economists mean.

    it confuses peeps.

  24. Gravatar of J J
    2. May 2013 at 11:30

    Don Geddis,

    I believe there is a difference. If the Fed is simply incompetent, then we can’t know whether they will overestimate or underestimate the effects of fiscal policy. Maybe they would respond too strongly to expansionary fiscal policy and we would end up with lower NGDP.

    Yet, if the Fed is simply afraid to act too aggressively — not to let NGDP rise too quickly or to let inflation get too high, but to be the sole factor behind this rise — then expansionary fiscal policy will boost NGDP. It can be argued that Bernanke is stating that he won’t get too aggressive, but if fiscal policy gets more aggressive he won’t stand in its way.

  25. Gravatar of J J
    2. May 2013 at 11:43

    Doug M,

    If unexpected shocks from the Fed can have real effects, then so can unexpected nominal shocks not from the Fed. If prices and wages are sticky, then unexpected nominal changes will have real effects and the Fed should combat them.

    For example, a sudden increase in the reserve-deposit ratio (banks get nervous) will decrease M2. This will have a real effect because it was unexpected. The Fed can, expectedly, respond with an increase in high-powered money to keep M2 stable. This will prevent the initial unexpected fall in M2 from having a real effect. Some other policy regime that called for a further fall in M2 would only worsen the problem.

    Another way to think about it is that a nominal change being expected only matters if it is expected sufficiently far in advance. If there is an unexpected shock to M2 and the Fed responds (expectedly), then the Fed’s action is also unexpected — we only expected it a day in advance after the first unexpected shock occurred. Such a situation is no different from one in which the Fed makes its response move (unexpectedly) the day BEFORE the (then expected) exogenous shock to M2.

  26. Gravatar of Don Geddis Don Geddis
    2. May 2013 at 13:14

    @mpowell: “fiscal stimulus can work when the fed prefers fiscal stimulus to additional monetary action? You can even call it central bank incompetence if you want.

    Sure, we can all agree that fiscal stimulus can “work” when the central bank is incompetent. One can accept that, while still being a strong opponent of fiscal stimulus. (Since, of course, we should be advocating for a competent central bank, instead of for fiscal stimulus.)

  27. Gravatar of Philo Philo
    2. May 2013 at 13:46

    “It’s hard to imagine a less nimble organization than Congress.” Yes, surely the Fed is much nimbler. But the Fed should not really worry about keeping one step ahead of Congress. The Sumnerized Fed is concerned only with stabilizing *market expectations* for NGDP (one or two years into the future); it is not concerned with Congressional actions, even if these turn out to affect actual NGDP in surprising ways. The goal is *steady market expectations*, not *steady (actual) NGDP*. The Sumnerized Fed need only monitor some accurate gauge of market expectations, letting the market do the work of monitoring and evaluating Congress’s actions (as well as all the other relevant economic factors).

  28. Gravatar of ssumner ssumner
    2. May 2013 at 15:50

    Ashok, I’m very short of time, so I’d appreciate a summary of your main point in this comment section.

    Mike Sax, I explain why in this post. Take another look.

    Grim23, No, I think monetary offset only applies to demand shocks, unless I’m missing something.

    mpowell, I still don’t think fiscal stimulus “works” if by works you mean improve things. I think it can affect the economy if the central bank is incompetent, in much the same way as a raging bull affects a china shop.

    Doug, Yes, any systematic monetary policy would work if Lucas is right about wage and price stickiness. But I don’t think he’s right.

    Don, Good point, but I was trying to reassure those who are worried about inflation, and may be holding hoards of cash.

    Philo, Yes, that’s a good way of looking at the picture.

  29. Gravatar of Tom Brown Tom Brown
    2. May 2013 at 16:05

    Excellent article, thanks for sharing.

    “To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched”

    “A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.”

  30. Gravatar of Tom Brown Tom Brown
    2. May 2013 at 16:19

    More excellent quotes:

    “First and foremost, governments must be prepared to write down debts rather than continuing to absorb them. This principle applies to the senior debt of insolvent financial institutions, to peripheral eurozone debt and to mortgage debt in the US. For Europe, in particular, any reasonable endgame will require a large transfer from Germany to the periphery. The sooner this implicit transfer becomes explicit, the sooner Europe will be able to find its way towards a stable growth path.”

    Exactly! Well said about mortgage debt! Ireland should have protected deposit holders, but let their hopeless banks go under too. I especially like the part about immediate transfers from Germany to the periphery!! If they’re going to have a United States of Europe, with a common currency, then these transfers are a necessity. Much like producer states like New Jersey make net transfers to taker states like Mississippi here. What they’ve got now is no monetary sovereignty and no political unity. One or the other please!

  31. Gravatar of Ashok Rao Ashok Rao
    2. May 2013 at 16:22

    Sure. Here’s a cut down version. TLDR below:

    “There’s another really important point here. Congress isn’t going to get smart in the future. So by your own logic, they’ll screw up the economy with bad fiscal policy eventually. But if you cede that there’s some “minute” benefit today ignoring it would just yield a negative rather than zero effect.

    Let’s say Congress implicitly adopts a so-called Krugman Rule (KR) “Fiscal policy only at the zero-lower bound”. (where you accept “minute” benefits). Note, this is a reverse implication not a biconditional for that would remove all uncertainty and has no chance of capturing reality for reasons mentioned above. How would this be statistically represented? We could imagine Congress passing fiscal policy is log-normally distributed with mean m and standard deviation s. This is probably too simplistic, but better than a normal because there’s a definite right-skew. Adoption of KR, today at the ZLB, would increase m and decrease s. That is, there is a greater chance that Congress passes a higher stimulus with a tighter bound.

    But there’s still uncertainty. Because the conditionality of KR runs only one way, the market and FOMC cannot anticipate and hence render useless fiscal policy. But KR also means that bad precedents wouldn’t be set because the Fed can anticipate no fiscal policy unless interest rates hit zero. (In fact it can rationally expect no extraordinary action until this point).

    Of course, there’s an uncertainty to KR itself. But, the general culture of debt aversion (except during unexpected events like invading Iraq) will probably render fiscal policy in times of expansion, beyond expected automatic stabilizers, unlikely. So an “irrational policy regime” couldn’t make things worse.

    And uncertainty is sometimes better. Big bankers have far more political information then me, and know that Congress will save them if they fail. That kind of certainty corrodes systems and breeds corruption. Imagine if Congressmen were so random that even bankers didn’t know what would happen. Well, they wouldn’t have made stupidly risky bets or leveraged themselves to the heavens.

    But we don’t want Congress to be a coin. That would be disastrous. The real policy debate should be on the parts of Congressional activity that remain uncertain, and the parts that don’t. Taking this to the logical conclusion, we know certain rights – enshrined the Constitution – will be guaranteed. While there are certain threats to the Bill of Rights, these are generally checked by a independent judiciary.

    Here’s a parting thought experiment. You might think my assumption of a Krugman Rule is too strong (because maybe Congress will be pressured to act in a non-ZLB recession, or rents, or whatever). What if this was enshrined in the Constitution with the Chicago IGM as Supreme Court. Would you, then, support fiscal policy today?”

    TLDR:
    0. I disagree with your belief that any fiscal multiplier is only a measure of central bank incompetence, to the extent inability to predict clowns is not “incompetence”.
    1. If fiscal policy can have long-term benefits in stabilizing AD today, so long as we know it will exist in the future it’s better to do it than not. (You accept that it can have such benefits).
    2. Congress can implicitly adopt a rule that fiscal policy will never be applied out of the ZLB. This says nothing about whether it will be applied in the ZLB. This removes uncertainty that fiscal policy might be used for the wrong reasons, but still makes it sufficiently uncertain that Fed cannot predict. Value of stimulus can be log-normally distributed, this would increase the mean and decrease variance. So a little less unexpected, and hence by the entropy argument developed above a little less valuable, but still better than hoping for a full monetary offset, because the Fed can’t predict idiots.
    3. Parting thought experiment. If the rule that extra fiscal policy ONLY at the ZLB were enforceable, would you support it today? (This removes problem of bad precedents etc.)
    4. There is always uncertainty, mitigated mostly by culture and the Constitution. The ultimate debate on policy has to regard what we make uncertain and what we don’t. We don’t put our civil rights up for grabs. Economically speaking, we should make bank bailouts completely unanticipated. Otherwise government speak to the contrary is not subgame perfect.

  32. Gravatar of Ashok Rao Ashok Rao
    2. May 2013 at 16:27

    For what its worth, I really don’t like the Rogoff reason for inflation. Inflation is a means to an end, never an end in and of itself. But when you say things like “However, a once-in-75-year crisis is precisely the time when central banks should expend some credibility to take the edge off public and private debts” we’re talking basically about a partial default.

    Remember, we own most of our debt. If inflation is needed to fix sticky wages, or even get people to spend more, whatever then great. But inflation for the purpose of making debt more tolerable is a bad precedent.

  33. Gravatar of Geoff Geoff
    2. May 2013 at 16:37

    Don Geddis:

    @Geoff: “The same old fallacies creeping up again and again, like they were never refuted a million times already.”

    “Pot, kettle. I’m impressed that you can write those words, seemingly without irony.”

    What irony? You mean your failed attempts to show the alleged fallacies in what I have written?

    Oh do tell.

    “Recovery includes reallocating capital and labor to their most highly valued uses. That of course means (temporary) unemployment and idle resources.”

    “If your theory were true, then the past few years should have seen industries (the “most highly valued”) with high growth, while unemployment was concentrated in the “low value” industries.”

    Not if the Fed reinflates, again, and brings about the same category of malinvestments, again.

    Then it’s just another unsustainable boom, of capital and labor being allocated to the wrong lines once again.

    “Unfortunately for your theories, the US economy showed widespread unemployment in every industry, across the board.”

    My theory does not predict or imply unchanged aggregate employment.

    Yes, there was unemployment in every industry, but if you paid attention to unemployment per industrial sector, then you will see that not every industry suffered equally.

    This chart shows how some industries (relatively more sensitive to interest rates industries) suffered more than other industries (relatively less sensitive to interest rates industries). This is a reflection of the fact that capital was misallocated to the wrong sectors.

    If it was an “aggregate demand” story, this should not have happened.

    “Hence it’s obvious this is not a “reallocation” recession.”

    Totally false. Your “test” suggests a deep rooted misunderstanding of economic theory. Reallocation occurs when the market is allowed to function. I will only ask you “What market?” The Fed has not let the market fully correct. It has blown up an even greater bubble.

    “So it’s clear that you have no idea what has been going on in the macro economy, as your theory makes predictions which have already been falsified by real-world data.”

    No, it’s clear you have no idea what has been going on in the economy. I didn’t make the prediction that resources and labor will be sustainably allocated in an economy with Fed intervention. Your post is all wrong, as usual.

  34. Gravatar of TheMoneyIllusion » Monetary offset refutation, or CYA? TheMoneyIllusion » Monetary offset refutation, or CYA?
    2. May 2013 at 17:35

    […] will likely fall a bit below “Sumner Critique” predictions.  I address that issue in this recent post, which some commenters seemed to misinterpret as support for fiscal […]

  35. Gravatar of ssumner ssumner
    3. May 2013 at 06:01

    Tom, Agree on the Irish banking comments, disagree about Germany. It’s a mistake to move to a federal fiscal structure in Europe. It won’t work, as Germany is not as rich as most people think. NGDPLT is far superior.

    Ashok, You said;

    “Let’s say Congress implicitly adopts a so-called Krugman Rule (KR) “Fiscal policy only at the zero-lower bound”. (where you accept “minute” benefits).”

    No I don’t accept the benefits at the zero bound. Any “rule” will be offset by monetary policy. I’m not sure I follow the rest of your argument.

  36. Gravatar of Mike Sax Mike Sax
    3. May 2013 at 07:20

    “You can cutting govt. spending AND cut taxes:”

    Morgan this isn’t a state secret-just give the Repubs what they want right? Why do you think we want to do that? Yeah lets just cut teh taxes on the rich and cut the poor’s social services. They lost the election and yet the Rs are so arrogant they think they’ll get what they want anyway. WE;’ll see. It’s a long game. I for one have the staying power.

  37. Gravatar of Tom Brown Tom Brown
    3. May 2013 at 07:36

    This quote though:

    “No one fully understands why rates have fallen so far so fast, and therefore no one can be sure for how long their current low level will be sustained.”

    I have a problem with, in regards to the US anyway.

  38. Gravatar of Ashok Rao Ashok Rao
    3. May 2013 at 09:17

    “No I don’t accept the benefits at the zero bound. Any “rule” will be offset by monetary policy. I’m not sure I follow the rest of your argument.”

    We agree that there can be benefits if the change is a “surprise” or completely unanticipated by the FOMC, right? Like the Sequester. This is an extension of that argument in ZLB times.

  39. Gravatar of mpowell mpowell
    3. May 2013 at 09:28

    I don’t think a payroll tax cut is going to act like a raging bull in a china shop on the economy, and I don’t really understand, based on your views as I understand them, why you would even draw that analogy. There are reasonably safe options for fiscal stimulus where even if you prefer monetary easing, fiscal stimulus is not a bad 2nd option. Maybe you can clarify why you feel this way.

    The position of an internet commenter is an odd one. I can argue, “Congress should extend the payroll tax cut”. Then someone says, “No the fed should ease more”. And I say, “Well that would be fine, but Bernanke is complaining about fiscal tightening and since I think the fed is relunctant to ease further but we need more easing, Congress should be willing to act”. And the response is the same. Here is the thing: my commentary is no more likely to influence Bernanke than Congress. But if I were somehow able to influence Congress only, then my advice would make sense. And that’s how I’m speaking, but yeah, it’s basically arbitrary, but that’s where the disagreement lies (well, sometimes at least). Perhaps Sumner’s is slightly more likely to influence one of those parties so it’s really quite important how he approaches it, but I feel like we could be a little more honest or explicit about the source of disagreement at times.

  40. Gravatar of Tom Brown Tom Brown
    3. May 2013 at 11:29

    I thought this was a good comment on the FT R&R piece:

    “So what Reinhart and Rogoff are arguing is that we should not lock ourselves into long-term debt at very low real interest rates now, because real interest rates might go back up. Suffice it to say that if your financial adviser told you not to take out a long-term fixed rate mortgage now, because interest rates might go up next year, you might reasonably doubt her competence.”

    http://notthetreasuryview.blogspot.com/2013/05/comment-on-reinhart-and-rogoffs-ft.html

    The response to the bit about Keynes worrying about how to pay for the war was good too.

  41. Gravatar of ssumner ssumner
    3. May 2013 at 18:29

    Ashok, In theory a surprise can be beneficial, but in a recent post I argued that most Congressional surprises will be destructive, hence Congress should not use (demand side) fiscal policy to stabilize the economy. Supply-side is fine, but Obama opposes it.

    mpowell, As soon as you write down a sensible policy for fiscal stimulus, it will stop working as the Fed will offset it. It’s like the EMH and technical analysis. If you find something that works the market will find out, and it will stop working. In this case it’s the Fed, not the market, that offsets it.

  42. Gravatar of Dow Crosses 15000 For First Time With Today’s Strong Job Numbers; Sumner Takes Victory Lap Dow Crosses 15000 For First Time With Today’s Strong Job Numbers; Sumner Takes Victory Lap
    2. February 2017 at 08:36

    […] do I keep prattling on about  ”zero fiscal multiplier?”       https://www.themoneyillusion.com/?p=20971      He manages to actually admit that the sequester will lower RGDP-and also to […]

  43. Gravatar of Scott Sumner Asks the Right Question | Last Men and OverMen Scott Sumner Asks the Right Question | Last Men and OverMen
    21. February 2017 at 05:16

    […] why do I keep prattling on about  ”zero fiscal multiplier?”        https://www.themoneyillusion.com/?p=20971       I don’t know. That’s something that I- and many others no […]

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