Arnold Kling  


Andrew Lo, JP Morgan, and PBR ... 1>0, and Other Thoughts on App...

Simon Wren-Lewis writes,

I do not think targeting nominal GDP means that the monetary authorities can achieve that target at all points in time. The main way I think it overcomes the zero lower bound (ZLB) for nominal interest rates is by promising to create higher inflation in the future, which is itself a cost. The more austerity reduces current demand, the more inflation we will have in the future to counteract it.

So the argument for using deficit spending rather than monetary policy to raise aggregate demand is that deficit spending will produce a significantly lower path of inflation in the future.


I am sure that somebody can come up with a model under which this is true. But how many macroeconomists would sign on to such a model? Back when I was doing macro, nobody would have done so. AD is AD, whether it comes from monetary policy or fiscal policy.

I'll admit that I am probably not the one to be carrying this particular fight. I think that all of macro is likely to be mistaken (see PSST).

Pointer from Mark Thoma.

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CATEGORIES: Macroeconomics

COMMENTS (10 to date)
rob writes:

"AD is AD, whether it comes from monetary policy or fiscal policy."


I would think the psychological perceptions of economic actors would have an influence over the form of AD and its affect on prices and employment.

Nick Rowe writes:

What Simon says makes sense, given his (implicit) underlying model.

Suppose the central bank were targeting (say) 2% inflation (or 5% NGDP growth when the natural rate of output growth is 3%), and there was a negative shock to the IS curve that pushed the natural rate of interest down to (say) negative 3%. The ZLB prevents you cutting the nominal rate to minus 1%. So: either you accept inflation temporarily above 3%; or else you use fiscal policy to shift the IS curve up and increase the natural rate of interest above minus 2%; or you have a recession, because the market rate of interest is above the natural rate.

In Simon's (implicit) model, AD is AD, but fiscal policy increases the natural rate of interest and monetary policy doesn't. (Monetary policy works by reducing the market rate).

In (say) Scott 's (implicit) model, monetary policy can also shift up the short run IS curve, and can also increase the (short run) natural rate of interest.

johnleemk writes:

Nick, I agree that makes sense -- but I think it's difficult to reconcile this with the standard AS-AD framework unless one accepts without question that interest rates are the only mechanism through which monetary policy can work.

Arnold Kling writes:

I need more of an explanation.

Take the AS curve as fixed. That means that if we get to any given Y, call it Y*, there is a P* that will be associated with it. That would seem to be true regardless of how you get to Y*. So, regardless of whether you use fiscal policy or monetary policy, if you follow the same path of Y then you must follow the same path of P. That's the implicit model that I am using, and I can't get it to yield a different inflation rate for fiscal policy vs. monetary policy.

Lord writes:

It seems reasonable as government spending differs from individual spending but I wouldn't say it is an argument for waste. If it doesn't make sense, it doesn't make sense, but lower costs mean more marginal public investments make sense. The argument is that under the condition private investment is not responsive, public investment can be. How responsive private investment is empirical, but those fearing inflation are assuming it is not.

Nick Rowe writes:

johnleemk: "...unless one accepts without question that interest rates are the only mechanism through which monetary policy can work."

OK, but simple models of AD sometimes do say that (real) interest rates are the only mechanism through which monetary policy works. Or, more generally, some economists might argue that any other channels of the monetary transmission mechanism are weak enough that they can be ignored, to a first approximation.

I'm not saying I agree with Simon, but I reckon he's a very good economist, and open-minded, so I really do want to try to make clear where the underlying differences are. (The better to convert him ;-) )

Arnold: OK. I (now) see where you are coming from. I was interpreting Simon as talking about the AD side, where fiscal policy can (in standard models) shift the AD curve for a given nominal interest rate and given *expected future* inflation rate. And you are talking about the AS side, where fiscal policy does not (in standard models) shift the SRAS curve (or short run Phillips Curve).

But I think my interpretation of Simon is correct. He is talking about "promising to create higher inflation *in the future*", which would increase AD, for a given nominal interest rate today. Your point, as I understand it, is that if AD did increase, whether via fiscal or monetary policy, and moved us up along the SRAS curve, there would be an equal increase in inflation (or the price level) *today*, regardless of whether fiscal or monetary policy were used to get that increased AD.

Suppose, just suppose, that the SRAS curve (or SR Phillips Curve) were nearly flat. Then an increase in AD (whether due to fiscal or monetary) would cause only a very small increase in *current* inflation (or the current price level). But (given Simon's implicit model) monetary policy would require an increase in *expected future* inflation to increase AD, and fiscal policy wouldn't.

Is that clearer? (It's now clearer to me, which means this is a good discussion, from my POV!)

Justin Irving writes:

AD is not AD.

AD from the government creates jobs, makes the dumb smart and cures cancer. AD from the fed causes inflation, wealth inequality, gentrification and asset bubbles. This is what the downturn has taught us. Duh!

Arnold Kling writes:

You wrote:

monetary policy would require an increase in *expected future* inflation to increase AD, and fiscal policy wouldn't.

That is clarifying. I still think it's BS. Part of it is that I am not a rational-expectations kind of guy. But even if I were, I think I would lean toward the Sargent-Wallace analysis (unpleasant monetarist arithmetic) which says the opposite about the ultimate source of inflation.

You were right that my original remark was probably only obvious to myself. I've tried to be clearer in this subsequent post:

Thanks for making me explain myself (I hope!)

Kevin Driscoll writes:

Arnold, given that you're not a rational-expectations kind of guy, I would expect something like this to possibly resonate with you. Obviously you think that this particular idea is BS, but if we're being less-than-rational and we think about a host of psychological factors and (possibly mistaken) expectations, then we might expect AD (or the corresponding function that acts as an 'effective' AD in this theory) to no longer be a state function, ie it might depend not only on the present variables but on what path we used to get there.

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