The current question being debated by the “Economics by Invitation” panel is:
Are current deficit reduction plans likely to boost growth?
Perhaps unsurprisingly, I was not invited to this panel. But I want to share a comment anyway.
Pursuant to Brad Delong’s post here, in which he answers the question: “David Altig of the Federal Reserve Bank of Atlanta has just convinced me that the answer to this question is ‘yes’.”. I believe that this question is highly incomplete. Let us ask a similar question…if the Federal Government were to pull the plug on Fannie and Freddie, would it cause a severe enough nominal shock to pull us into a deep recession again?
That question is similarly incomplete. The operative question is what reaction the central bank will have to the developments on the fiscal side of government. If, indeed as Scott Sumner has theorized, there was a very large risk of (actual) deep deflation resulting from larger shocks (nominal or real), I believe that the Fed would be moved to act in a way to accommodate the demand for money. Further, I believe that this would force the hand of central banks around the world to become more accommodative in their policy. Bafflingly, Alerto Alesina believes that since European monetary policy is “easy” currently, that liberalizing supply-side burdens along with austerity in automatic spending programs will produce growth. I don’t happen to think that monetary policy is “easy” in Europe, nor do I believe that reducing automatic spending programs will work to alleviate the demand for the medium of exchange in Europe — which seems to be quite high in countries wrecked by fiscal problems.
The failure of Lehman Brothers forced the hand of the Federal Reserve, but the damage of tight money had already been done, and the Fed failed to accommodate a large increase in the demand to hold the medium of exchange. Instead, the Fed focused on propping up “credit channels” (unsurprisingly, as much of Bernanke’s academic scholarship has to do with credit and lending), and in doing so, seemed to confuse credit and money. So the proper question to ask in this instance is:
“Is it likely that current decifit reduction plans will cause central banks to ease monetary policy in a way that satiates the demand for the medium of exchange?”
If your answer to that question is ‘yes’, then austerity will, indeed, have “boosted” growth. If your answer is no, then it won’t. Indeed, causality may be attributed to the austerity measures either way, but the real proximate cause is the central bank’s reaction function.
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Tuesday ~ August 3rd, 2010 at 4:11 pm
jazzbumpa
Woah! Hold it right there. You are on a wrong track right from the beginning.
Delong’s answer that you quote is to a completely different question, regarding structural employment. Follow your link. It is very hard for me to imagine Delong answering the question you cited with the answer he gave.
What are you doing?
By the way, my answer to the last question is no. In fact, at the 0 bound liquidity trap, easing monetary policy is pretty anemic.
Cheers!
JzB
Tuesday ~ August 3rd, 2010 at 4:35 pm
Niklas Blanchard
Thanks for letting me know, the DeLong quote has been edited out.
And I suppose that we will have to agree to disagree on the last point. I don’t think the zero bound is a problem at all, and any models that incorporate (all) monetary policy becoming ineffective at the zero bound to be erroneous to the point of uselessness…and probably even dangerous to the prospects of recovery from deep recessions.
Tuesday ~ August 3rd, 2010 at 8:20 pm
jazzbumpa
Well, I didn’t say ineffective, I said anemic – which means less effective than you would like it to be.
And there’s a problem with models. They are not accurate representations of reality – which is what they would need to be if they were to have any value relative to policy recommendations.
In an earlier post, I think you recommended the Fed purchase some $ value of gov’t bonds. So far so good – but the gov’t then needs to do something constructive with the money it has borrowed – and that means a real stimulus program, proportional to the size of the output gap, and based on spending, not ineffective tax cuts.
If there is something purely monetary that would increase GDP and decrease unemployment, I’d love to know about it.
Cheers!
JzB
Wednesday ~ August 4th, 2010 at 4:23 am
Niklas Blanchard
@jazzbumpa:
I agree with you about models. A big portion of what I’m interested in revolves around agent-based simulations, which I’m finding vastly superior to equilibrium models. Furthermore, all of the “modern macro” models that you hear about are generally 1970′s vintage, and maybe even older…
There are a lot of people that will claim that your model didn’t predict this, or that…but I never, ever make that claim as it is sloppy, and unwarranted. And I’m hoping that you don’t either…but that doesn’t exonerate macro models as they stand.
I’m of the persuasion that a central bank can always “hit” a nominal target, no matter what it is. And by “hit it”, I mean that in the same way that an oscilloscope can hit a wavelength. The variance is rather unimportant, however. I posit that if the Fed was determined to create 10, 20, or 500% inflation, it could do so with reasonable accuracy. In some sense, they may need a willing Treasury…but maybe not.
In the past, I have advocated that the Fed buy bonds off of the balance sheets of the public, and pay any coupon necessary to separate the people from their paper.
So, if the Fed has some sort of control over NGDP, then it can always boost it. The composition of NGDP depends on the slope of the SRAS. At this point in the business cycle, I claim that a sharp increase in NGDP would cause a considerable increase in real growth and a negligible increase in CPI inflation — which has to translate into decreased unemployment.
In this post, I was making the claim that austerity only matters to the extent that it causes a monetary reaction. I think that is borne out by historical events of the Great Depression, and Lost Decade.
Wednesday ~ August 4th, 2010 at 3:33 pm
jazzbumpa
So, if the Fed has some sort of control over NGDP, then it can always boost it.
This sounds like an absolutist fallacy. It assumes control is effective in all conditions and environments. Is there a historical precedent, or sound theoretical blueprint for effective Fed action (contrast (BoJ) in a 0-bound liquidity trap?
Paying a high coupon is, de facto, setting interest rates up. If this is not an argument for austerity in disguise, then I guess I am totally missing your point. (Which is real possibility.)
Cheers!
JzB