Scott Sumner  

Tyler Cowen on fiscal stimulus

The Silent Suffering of the No... Breaking Conformity Equilibria...

Here's Tyler Cowen in Bloomberg:

In Keynesian theory, fiscal policy only works well if you use it in down times and pay off the bill during a boom. Trump seems ready to do the opposite by upping spending as the economy approaches full employment. After that? Recent history suggests that many countries switch back to austerity precisely when they shouldn't. That is a reality proponents of "spend more now" have to reckon with, and it means stimulus can bring a bigger contraction in the future than the boost it gives today.

For years, I have been reading about evidence that the 2009 fiscal stimulus promoted by the administration of President Barack Obama was good for the American economy. Study after study shows that it boosted GDP across a two- to three-year time horizon, as indeed it did. Furthermore, some parts of the stimulus truly were beneficial, for instance the aid to state and local governments that limited the need for temporary layoffs. But a serious evaluation of the Obama stimulus, and its longer-term consequences, remains to be done.

Tyler's right that if the Keynesian model is true, then fiscal stimulus right now would make the economy less stable (as I pointed out in my previous post.) But I don't think the Keynesian model is true, and hence I'm not particularly concerned about that issue. (Instead, I'm concerned that fiscal stimulus will worsen the public debt problem in future decades--the deficit numbers being bandied about are frightening.)

Tyler links to nine studies that supposedly show the 2009 stimulus package was successful in boosting RGDP over a period of several years. But are those studies reliable? The ones that I have read don't even come close to showing what they claim to show. Let's review the evidence:

1. The recovery from the 2009 recession was weaker than the Obama administration forecast, indeed weaker than the forecast path if there were no fiscal stimulus.

2. In theory, fiscal stimulus should have no effect if the central bank is targeting inflation at 2%. The central bank is targeting inflation at 2%. Any empirical or theoretical study that does not account for monetary offset is useless. Some of those studies use cross sectional data, which tells us nothing about aggregate effects, for standard fallacy of composition reasons.

3. Keynesians said the 2013 austerity (when the deficit suddenly fell from about $1050 billion to roughly $550 billion) was a test of the proposition that monetary policy could offset fiscal austerity. Monetary policy passes the test with flying colors--as growth sped up in 2013, as compared to 2012 (Q4 over Q4). So when the stimulus models Tyler alludes to were actually tested in the real world, they failed.

4. Ben Bernanke headed the Fed in 2009. He was a student of history, and his primary desire was to avoid repeating the mistakes of the Great Depression. Recall that he believes that Fed passivity caused the Depression. Avoiding that outcome was his overriding goal. Do you really think he would have just passively sat back if there had been no fiscal stimulus, and not have done any monetary offset?

If someone wants to show me studies that do account for monetary offset, I'd be glad to look at them. Until then, I will continue to assume that there are not any reliable studies showing that the 2009 stimulus was effective.

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COMMENTS (8 to date)
Mr. Econotarian writes:

"Recall that he believes that Fed passivity caused the Depression."

The Fed was not passive. Motivated by a concern about speculation in the stock market, between January and July 1928 the Fed raised the discount rate from 3.5% to 5%. At the same time, the Fed engaged in extensive open market operations to drain reserves from the banking system. It sold more than three-quarters of its total stock of government securities. In August 1929, the Fed raised the discount rate by another percentage point to 6%.

Throughout 1930, monetary policy remained contractionary; the monetary aggregates fell by 2% to 4%, and long-term real interest rates increased.

The Fed actively tried to pop an asset bubble. They succeeded wildly! Perhaps central banks should worry about inflation instead of other items in the economy such as asset bubbles and employment.

Peter H writes:
The recovery from the 2009 recession was weaker than the Obama administration forecast, indeed weaker than the forecast path if there were no fiscal stimulus.

This criticism doesn't hold up in my view.

The criticism is (I believe) based on the projections in the Jan 9, 2009 Romer and Bernstein report, available here.

The report was based on then-current BLS data, which as it turned out was way behind the curve in terms of how bad the jobs situation was. The December 2008 jobs report for instance reported a loss of -524,000 jobs, which would be a terrible report normally. But BLS had to apply downward revision to -681,000 jobs. And every other month in the 2008-2009 recession also saw large downward revisions as BLS did their usual following up.

The stimulus bill was signed into law on Feb 17 2009. By that date, U3 unemployment was somewhere between 8.3% (Feb '09 BLS as revised) and 8.7% (Mar '09 BLS as revised).

It would have been literally impossible for the stimulus package to keep unemployment below 8%, since it was already above 8% by the time it was passed into law, and very nearly in excess of the 9% assumed without the bill (which would be reached the next month).

In summary, it's not fair to say that the recovery was weaker than forecast without acknowledging that the recession was much deeper than thought at the time the forecast was made. I do not fault the BLS or Romer and Bernstein for the error, since knowing exactly where you're at in a financial and economic crisis is incredibly difficult.

It may be fair to fault the then-incoming Obama administration for falling prey to the fallacy of precision in economics, but that's a different critique from the one you've made.

Cmot writes:

Obviously Tyler's buying into the Keynesian model and you are not. Ideological Turing test time: why do think that he thinks you're wrong?

Mark Bahner writes:
The Fed was not passive.

I still remember, I think from my Money and Banking course (back when punch cards were the big computer input method), the story of the reserve requirements ratio increases circa 1937:

Probably not a good idea

So it wasn't just at the beginning of the Depression that the Fed was implementing policies that were contractionary.

Thaomas writes:

Comments on points

I do not think we should worry about increased debt to finance investment. Chosen well investment projects increase income more than the debt to finance them. Debt to finance large tax reductions on high consumption taxpayers however would be bad.

2. But the Fed has not targeted inflation; it has had an inflation ceiling. With less political pressure from inflation hawks, it might change course and start targeting inflation which would imply a period of catch up for missing the target since 2010.

4. Bernanke was the Fed chairman but it seems clear to me that he felt constrained in the amount of QE he could do. A larger investment when so many resources were unemployed especially in the first 3-4 years after the crisis would have loosened the de facto constraints on the amounts of QE the Fed permitted itself to do.

Lewis writes:

" Chosen well investment projects increase income more than the debt to finance them."
This is true, but I want to point out that nothing about the current system of project selection is geared toward GDP growth. Note this does not mean the current system has no cost-benefit analysis, only that it does not have a real GDP growth analysis. For example, in highway projects, projects will often be selected for lowering travel times or accessibility. These are benefits, and lowering travel times can translate into GDP growth, but it is not the same as selecting projects for GDP growth. The benefits in the benefit-cost analysis are usually immaterial, non-market things, like time savings, pollution savings, etc. These are then translated into market terms. But while that might be good for improving people's quality of life and raising aggregate utility, that doesn't mean they will raise the volume of money transactions, which means they won't necessarily pay for themselves with GDP growth.

As an example, contrast two highway projects. One is a beltway around a medium-sized city that will enable considerable sprawl. People will move into the city from smaller towns, develop property and earn city wages instead of small-town wages. So GDP will grow. The other project is a highway widening in a major city that is growth constrained by zoning and geography, like most of our big cities are. It will save commuters lots of travel time. But it will not enable more people to move into the city and earn better wages, nor allow unused land to move into high-value housing production.
When you do a cost-benefit, the travel time savings of hte latter project might make it a winner, especially because the people in the big city have a high value of time. But it will cause less GDP growth than the first project.

Roger McKinney writes:

Monetary offset is important. Also, the economy has always had a natural ability to recover from recessions. After all, it recovered from many before the Fed and state decided to rescue the economy in the 1930s. Low prices, savings, entrepreneurial spirit and other things cause it. Yet those are never in the models, so fiscal and monetary stimuli get all of the credit. In statistics they call it confounded effects. I would guess that if modelers could include the natural recovery factors then fiscal and monetary policies would lose most of their effect.

Scott Sumner writes:

Mr. Econotarian, Yes, I agree with that. I was referring to a lack of effort to boost the economy, once the Depression had begun.

Peter, I accept that, but in a way it supports my point. The Obama administration was completely unable to make unconditional forecasts of the near term trajectory of the economy. But in that case, how could they possibly make (much tougher) conditional forecasts on the path of the economy with and without fiscal stimulus? Here's how---plug numbers into models that simply assume that fiscal policy works.

Cmot, Not sure, maybe he hasn't spent as much time thinking about it as I do. My interests are narrow, his are very broad. Most people (including me) accept the consensus view in areas where they are not specialists. Thus I believe in evolution, global warming, etc, partly because the experts believe in those things.

On the other hand, I do recall Tyler doing posts that are critical of simple Keynesian multiplier models.

Thaomas, Those are all complex issues, which I've addressed in detail in earlier posts on the subject.

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