Scott Sumner  

Simon Wren-Lewis on expansionary austerity

John Lee on Krugman and Cowen ... How the Web Has Changed Journa...

Everyone from market monetarists to Jeffrey Sachs have recently been pointing out that the Keynesian predictions about austerity have been shown to be incorrect. Now Simon Wren-Lewis has a post that tries to salvage the Keynesian model. Unfortunately he fails to do so. Here he tries to defend Paul Krugman:

Of course the proper way to tackle this is as Paul Krugman does. As he says other stuff happens (like a large fall in the US savings ratio in 2013), so you need to go beyond a single country and look at lots of data.
First of all, it was Paul Krugman who suggested that 2013 would be a test of the market monetarist claim that monetary stimulus offsets the effects of fiscal austerity, not me. After the test strongly supported the claim that fiscal austerity does not slow growth, he changed his mind. Suddenly it was not a good test.

But what about the reverse case? Suppose the Cameron government does fiscal austerity in late 2010 and 2011 and growth slows. Correct me if I am wrong, but didn't Keynesians like Paul Krugman and Simon Wren-Lewis say that the British case refutes claims of expansionary austerity? So how is it that a single data point can be important when it supports your argument, but not when it refutes it?

Yes, it would be useful to do a more systematic study of fiscal austerity, but the Keynesians don't seem to know how to do so. All I see are cross sectional studies that mix together countries with an independent monetary policy, with those that lack an independent monetary policy (like the eurozone members.) Mark Sadowski did a regression with only those countries having an independent monetary policy, and found the effect went away. No correlation between austerity and growth. This objection to Krugman's graphs has been made over and over again, but he never responds.

Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that's annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.

Wren-Lewis says "other stuff happens." Yes, but the "other stuff" that happened in 2013 is exactly what you might expect with aggressive monetary stimulus, whereas the other stuff that happened when Britain saw a couple years of low RGDP growth, was not at all what the Keynesian model predicts. The British growth slowdown was a productivity story (their job creation is more impressive than the US), and productivity slowdowns suggest supply-side factors (declining North Sea oil output, a structural shift from high compensation City jobs to low compensation service sector jobs, etc.)

Over at TheMoneyIllusion I point out that Krugman's 2014 experiment turned out just as poorly as his 2013 experiment.

HT: Bob Murphy

Comments and Sharing

CATEGORIES: Fiscal Policy

COMMENTS (10 to date)
wufwugy writes:

[Comment removed pending confirmation of email address. Email the to request restoring this comment. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

ThomasH writes:

"Keynesians" claimed that the sequester in the US and "fiscal austerity" in general would, ceteris paribus, slow growth relative to what it would have been without the "austerity." Since the prediction was not accompanied by a statement of the monetary policy that was part of the ceteris paribus, the prediction was un-testable. If the monetary authority was already reducing long term rates as much as was politically feasible (my view of Fed thinking) in order to encourage investment, it may well be that it did not and could not offset the additional contraction arising from the "austere" fiscal policy. But without a complete model, it's hard to say. It's not obvious that austerity did not slow growth but it cannot be shown decisively that it did, either.

I understand the "Keynesian" position on contractionary fiscal policy in a recession to be that monetary policy will not offset fiscal contraction, because monetary policy is already everything it can (politically) do. It would help if they were more explicit.

MFFA writes:

Sorry to ask this stupid question, but what makes QoQ a better indicator than YoY to discuss 2013 austerity? If YoY compares GDP on December 31st 2011 with GDP on December 31st 2012 to get the 2012 growth figure, then shouldn't it be the same as Q4oQ4, if the later takes end of Q4 2011 and end of Q4 2012? I guess it's not, but then what makes it better in this case? If you want to measure the effect of something that started on January 1st over the period of 1 year, then YoY (as I defined it, could be wrong) looks like the most suited. What do I miss?

Johannes Fritz writes:


YoY is calculated using average 2013 GDP over average 2012 GDP See this timely blog post from the FRBNY:

Ray Lopez writes:

Both fiscal policy and monetary policy are joined at the hip; Keynes and Friedman are flip sides of the same coin. Both depend on short term effects from manipulating short term AD/AS using sticky wages/prices and money illusion (to the extent they exist). So when Sumner criticizes Keynesianism, I hope it's understood that monetary policy is equally impotent.

Rajat writes:

Wren-Lewis has responded:

Most of it seems besides the point. I'm not sure what levels of government consumption and investment imply about 'austerity', which presumably also captures cuts to transfer payments and tax increases. And the papers he cites seem to suffer from the flaw you mentioned - including countries/states without an independent monetary policy.

Scott Sumner writes:

Thomas, That may be the view of some Keynesians, but certainly not Krugman. In any case, it doesn't really relate to the claims made in the post. I was showing inconsistencies in how Keynesians evaluate evidence.

MFFA, See Johannes's comment.

Ray, You said:

"So when Sumner criticizes Keynesianism, I hope it's understood that monetary policy is equally impotent."

That's not what this post is discussing. There are two types of policy impotence, inability to boost AD, and inability of more AD to boost RGDP.

Thanks Rajat.

Levi Russell writes:

I suppose this isn't 100% relevant, but since you mentioned monetary offset, I'll ask.

What is, in your opinion, the ideal monetary institutional arrangement? I know you talk a lot about NGDP targeting, but you've said before that you only advocate it in a world with a central bank (can't find a cite for that, so I may be mis-stating it somewhat). So is central banking the optimal institutional arrangement in your view or is it "free banking" or 100% reserve? Something else?

ThomasH writes:


Unless you know what a claimant is assuming is ceteris paribus, you just don't have a prediction. I suppose. because I think he is an intelligent guy, that Krugman was thinking that monetary policy was already doing everything it could and so could not do more to offset the effects of the sequester, but maybe not.

At any rate, I continue to be surprised at which fights you pick. If you think that getting the Fed and even more the ECB to use the right monetary target (and I agree), people that argue for fiscal policy (meaning more than just investing in projects whose net present values have become positive at low borrowing rates), Krugman for the sake of argument although I don;t know if he actually thinks that[see], are just irrelevant. They never argue against more aggressive monetary policy they just don't argue very often or very hard for it. Our real opponents are not Krugman and Simon Wren-Lewis, but people who think the Fed's balance sheet will lead to hyperinflation, or who think that governments should reduce deficits during recessions, or who worry about "asset bubbles" and "financial instability." It wold be great if we had Krugman beating the drums for NGDPLT, but until we do, the enemy of my enemy is my friend.

mike ryan writes:

[Comment removed pending confirmation of email address and for rudeness. Email the to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

Comments for this entry have been closed
Return to top