Two years is not the “very short term”

Matt Yglesias has a post up where he points out that Bernanke’s recent statement on fiscal policy is somewhat at odds with my views of the situation:

I was pondering Scott Sumner’s argument yesterday that a true inflation-targeting regime from the Federal Reserve would imply extremely small fiscal multipliers. But it’s difficult to get around the fact that this cuts against the stated views of the Fed’s top official as well as all the staff economists I’ve ever heard from:

That’s true, but Yglesias hints that it is also somewhat at odds with Bernanke’s own stated views on inflation targeting:

There are a lot of ways you can reconcile Bernanke’s view with Sumner’s, including by just saying that the Fed isn’t doing inflation targeting. But it sure would be nice to know what the Fed’s own theory is.

If the Fed is inflation targeting, then simple logic suggests the multiplier is zero.   Matt is obviously uncomfortable with this implication, and suggests that perhaps the Fed is not doing inflation targeting.  OK, but if they are doing flexible inflation targeting (Taylor Rule), or NGDP targeting, the multiplier is also zero.  Perhaps Fed policy is just a big incoherent mess.  In that case it’s possible Matt’s right.  Here he quotes Bernanke:

“I only ask … as Congress looks at the timing and composition of its changes to the budget, that it does take into account that in the very near term the recovery is still rather fragile, and that sharp and excessive cuts in the very short term would be potentially damaging to that recovery,” Bernanke told members of the Senate Banking Committee.

I’ve never argued that the fiscal multiplier is precisely zero at each and every moment.  If the federal government suddenly cut spending sharply, it’s unlikely that the effects would be immediately offset by the Fed.  But I have argued that there is no evidence that unemployment would be higher than 9.2% in mid-2011 if the government had not passed the $787 billion stimulus bill in early 2009.  The Fed would have been more expansionary in that case.  Look at Bernanke’s wording; the phrase “very short term” is suggestively precise.  Usually people just lazily say “short term.”  I think Bernanke is signaling that you can make all the cuts you want in the “not very short term,” and they’ll offset them with easier money.  He’s also signaling that over periods longer than the very short run, it’s the Fed who steers the economy.  And two years is definitely not the very short term.  It’s not even the short term–it’s medium term.  Unfortunately, we’re currently about where the Fed wants us to be (in NGDP terms.)

Now for a bit of fun.  Go back to the end of the first quotation, where he notes that Scott Sumner of Bentley (where’s that?) has views that are contested by all the experts in the Federal Reserve System.  OK, but here’s one question:  In late 2008 and early 2009 whose views on the adequacy of Fed stimulus, as well as the implications of interest on reserves, proved to be more accurate?  Who argued in mid-2009 that the Swedish approach of Lars Svensson was far superior?  Who pointed out that the Fed was not out of ammunition, and inflation expectations would rise with unconventional stimulus like QE2?  Who said the markets were telling us fiscal stimulus would do little?  So yeah, all the Fed guys think I’m nuts.  But what does Yglesias think; who’s been more on target?

PS.  I’ve consistently supported a payroll tax cut for employers, recently endorsed by Christina Romer.

PPS.  I do think Bernanke himself would prefer slightly higher NGDP, but I believe “the Fed” is slightly more hawkish than Bernanke.  He’s cautious and consensus-driven, and doesn’t want a big split at the Fed.



17 Responses to “Two years is not the “very short term””

  1. Gravatar of Daniel Molling Daniel Molling
    14. July 2011 at 18:44

    You nailed it, great post to cap off the past few weeks with. I think you’re bringing Mr. Yglesias around.

  2. Gravatar of Morgan Warstler Morgan Warstler
    14. July 2011 at 21:22

    I urge everyone to re-read this post and say mentally, “Matty” instead of Matt.

    SECOND, with this:

    “I think Bernanke is signaling that you can make all the cuts you want in the “not very short term,” and they’ll offset them with easier money.”

    Scott is NOW FINALLY 100% UNCONDITIONALLY repeating my oft-made claim: if you buy that Ben will always QE to avert deflation, then LOGICALLY the best economic strategy is deflationary pressure brought about by long term cuts in Federal Spending.

    To all you hopeful weak liberals hanging out around here parts, monetary stimulus is the the way exasperated conservatives RUIN free-spending economists like DeKrugman.

    Monetary stimulus admits government is the bitch of the banks.

  3. Gravatar of W. Peden W. Peden
    15. July 2011 at 00:55

    Prof. Sumner,

    Great post. It grieves me, therefore, to point out that the possessive form of ‘who’ is ‘whose’, not ‘who’s’.

    That’s how little I have to argue with the substance of this post! One of the attractive things about a good monetary policy regime is that fiscal stimulus can be put to bed, forever.

  4. Gravatar of Bill Woolsey Bill Woolsey
    15. July 2011 at 02:36

    The Fed (and most central banks) may target inflation during some run or other, but it seems very important to them that they implement this target by slow steady adjustments in short term interest rates. Each month, change the federal funds rate a few basis points.

    Just think of how terrible it would be if the Fed made sudden and large changes in the Fed funds rate? Or worse, just let the Fed funds rate float _out of control_ and used some other means to reach its inflation target!!!!!!

    Surely, it would be better for fiscal policy to cause a change in money expenditures on output and so inflation at a _given_ level of interest rate, or even a given trajectory of slow, steady changes in the federal funds rate, than making the federal fund rate uncontrolled.

    In fact, if we think of the Fed as really trying to stablize interest rates, subject to an inflation rate constraint, (damn, we have got to let interest rates rise, because otherwise the economy will cause high inflation or we must let interest rates fall, because otherwise the economy will screw up and cause deflation) then the scales will fall from your eyes.

  5. Gravatar of Indy Indy
    15. July 2011 at 05:25

    Actually, this argument plus “The Central Bank Always Moves Last” – in a world where the Fed is targeting anything at all and has the legal authority to do QE of arbitrary size, velocity, and duration (so, unlimited ammunition) – is a strong case that the fiscal multiplier need never (and perhaps cannot) be anything but zero.

    To get it to be other than zero, you have to concoct a just-so Byzantine model of the nebulous “political and ideological” constraints on Fed activity that lead people to expect that it will be somehow prevented from doing what is within its power to achieve its economic targets for an extended period of time – and even after that, won’t “make up for lost time”. I think Krugman’s arguments about Fed Behavior at the liquidity trap zero-bound often allude to something of this nature.

    At any rate, even if you have such a model of the extra-legal constraints on the Fed’s freedom of action – then that’s not an argument for fiscal stimulus – it’s an argument to reform the Fed and give it the ability to resist these mysterious, indeterminate political pressures and use its existing authorities to accomplish its mission.

    And even if you don’t believe in the optimality of NGDP-expectations level-targeting, any kind of requirement to hit any objective target should do the trick.

  6. Gravatar of Scott Sumner Scott Sumner
    15. July 2011 at 05:27

    Thanks Daniel,

    Thanks Morgan.

    W. Peden. Ouch, my brain isn’t wired for grammar. I often write things like “it’s” for a possessive. I know better, but for some reason it’s not instinctual, I need to think it through. When I go fast I make lots of errors–fortunately many are picked up by spell-check.

    I fixed it.

    Bill, Yeah fluctuating short term rates would be really terrible, especially if NGDP was growing right on target. 🙂

  7. Gravatar of Scott Sumner Scott Sumner
    15. July 2011 at 05:29

    Indy, Well put. Somehow I’m viewed as an extremist on this issue, but I’m really just doing mainstream macro–I’m a moderate.

  8. Gravatar of John Thacker John Thacker
    15. July 2011 at 05:33

    This is part of why the criticism of how slow fiscal stimulus is, and how, as the President himself now admits, there’s no such thing as truly “shovel-ready” projects, is so important. On the time frames that the stimulus actually could take effect, the Fed could obviously keep pace.

    I think that Krugman originally realized this when he commented that the aid to state and local governments was the most effective type of stimulus, because it really could be “spent immediately,” since it was just avoiding immediate cuts. He backed away from that later because he needed to argue that the stimulus wasn’t really a stimulus.

  9. Gravatar of ssumner ssumner
    15. July 2011 at 10:05

    John, That’s a very astute observation about Krugman.

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. July 2011 at 10:09

    Andrew Biggs says somethings that are at least tangentially related to this post, so:

    The academic debate over fiscal consolidations and economic growth concerns whether the positive “expectational effects” of fiscal consolidations””that is, the increased consumer and investor confidence generated by the belief that adverse fiscal outcomes have been avoided down the road””outweigh the short-term negative Keynesian effects of reduced government spending. Entitlement reform, however, would generate new confidence in the near term while the contractionary reductions to actual spending would not occur for years to come. For instance, many Social Security reform plans raise the retirement age, but all do so over the space of many years, and the effects are gradual. This combination is ideal in our current times of high unemployment and low growth.

    This fact is particularly salient given that the Democratic congressional leadership””in particular, House minority leader Nancy Pelosi””has argued for no cuts to Social Security or Medicare. This implies that the long-term fiscal gap would be filled almost entirely by new revenues or draconian cuts to the military and discretionary spending. The academic literature suggests that a consolidation based on raising tax rates or cutting government investment would be practically doomed to failure.

    Rather than focus on any given number””be it 85 percent, or 100 percent, or something else””policy makers should heed the broad lessons of the fiscal consolidation literature: that spending cuts, not tax increases, are more likely to succeed in reducing deficits and debt and are more friendly to economic growth; that the larger the debt we need to reduce, the larger the role for spending cuts; and that the most effective spending cuts are in transfer payments, such as entitlement programs, not in areas such as government investment.

  11. Gravatar of onliberty onliberty
    15. July 2011 at 10:46

    I will never understand why the heavyweights of economics even pay any attention to Yglesias. This guy is a nobody talking head with no background in economics. I’m really baffled by this.

  12. Gravatar of Morgan Warstler Morgan Warstler
    15. July 2011 at 16:47


    Scott’s getting it. He’s come back FAR MORE clear minded on the enemy of the left.

    Ultimately, Matty’s logic all runs into its own buzzsaw: he wants “fiscal stimulus” but he doesn’t want “tax cuts” to boost AD.

    And we all know, tax cuts = increased AD

    Progressives don’t want AD, they just want government spending EVEN IF the multiplier is zero.

    That is not economics. That is not science.

    That is just the rational policy choice for community activists who want the credit for giving free shit to poor people.

  13. Gravatar of Doc Merlin Doc Merlin
    16. July 2011 at 02:35

    Food for thought:
    Now if they are /bad/ at inflation targeting and tend to think that fiscal policy will still have an effect even if they are inflation targeting and adjust for that fiscal policy…. then would that make the multiplier /negative/?

  14. Gravatar of W. Peden W. Peden
    16. July 2011 at 02:54

    Doc Merlin,

    Seems like it would to me. Unaccomodative/more tight than unaccomodative monetary policy does all kinds of weird things to fiscal attempts at stimulus e.g. all the old crowding-out arguments apply if monetary policy offsets increased government spending in a recession.

  15. Gravatar of Scott Sumner Scott Sumner
    16. July 2011 at 09:41

    Patrick, I agree it can work, but I don’t think the GOP is focusing on the right issues. Given where the Fed is now, we need more AS. I heard the GOP was skeptical of payroll tax cuts for business.

    onliberty, I think Yglesias is one of the smartest people on the internet, and knows more economics than most economists.

    Doc Merlin and W. Peden, It’s possible.

  16. Gravatar of onliberty onliberty
    16. July 2011 at 21:04

    Thanks, Scott.

    In rereading my post it came off way more negative than was warranted. I was more thinking that there are thousands of bloggers out there that talk economics. I was just curious how this non-economist got a seat at the proverbial table. Now I know.

    No need to respond, I just wanted to clarify my position. Thanks.

  17. Gravatar of Scott Sumner Scott Sumner
    17. July 2011 at 16:39

    onliberty, No problem.

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