“Advocate Fiscal Policy, not Fiscal Stimulus”

Just like Schrödinger’s cat, I find myself suspended between two physical states. I’m stuck in a metaphysical state between agreement and disagreement. The catalyst of this sorry state of affairs is the now-infamous Jeff Sachs op-ed, which was followed by an exposition of his points in the Huffington Post. I agree with the overall premise of the article, while disagreeing with most of the specific points.

Mark Thoma has the most thorough take down from the Keynesian perspective. Ashok Rao also has some thoughtful comments . Tyler Cowen is in agreement by “at least two-thirds”.

I think both pieces are train wrecks, but there is an overall theme to them that is undeniably true, and thus I find myself in agreement with. That theme is captured in the title of this post, which may be meandering and hard to follow, but bear with me!

I had commented to Ashok that I liked Sachs’ paragraph on monetary policy. However, it seems that was due to a misreading (was reading the piece while distracted by other things), so I’m walking back my support for it. In fact, it is pretty confused:

One of the Obama arguments at the time was that the rush in the stimulus program was needed to avoid a Great Depression. This was and is highly doubtful (though, yes, it is widely accepted). The US economic emergency in late 2008 and early 2009 wasn’t really an aggregate demand crisis but a financial crisis. The chaotic failure of Lehman Brothers had led to an intense panic and credit squeeze. The Fed therefore needed to flood the markets with liquidity, which it rightly did, in order to unwind the panic. The Fed’s action was the real difference with 1933 (when the Fed allowed the banks to fail). It was the Fed, not the fiscal stimulus, which prevented a fall into depression.

The only saving grace in the paragraph above is that Sachs recognizes that it was monetary policy, not fiscal policy, that pulled us back from the brink of depression in 2008/09. I had originally, in my mind, swapped “financial crisis” and “AD crisis”. In fact, what most people recognize as “the financial crisis” was almost surely caused by the slow erosion of AD, which was itself caused by the Fed passively tightening monetary policy in response to rising energy prices. The chaotic failure of Lehman Brothers is merely a fixed point, attracting our attention. While it is true that the Fed rode to the rescue following Lehman with ample liquidity, it did so in a way that any monetary expansion was sure not to effect AD (by paying interest on excess reserves). Indeed, this was the stated policy of the Fed.

I also have a similar opinion of Sachs’ list of the elements of “crude Keynesianism”:

There are four elements of crude Keynesianism and, indeed, of Krugman’s position:

(1) The belief that multipliers on tax cuts and transfers are stable, predictable and large;
(2) The belief that America’s employment and growth problems are overwhelmingly cyclical, not structural, and therefore remediable by short-term aggregate demand management;
(3) The belief that a growing debt burden is a minor nuisance as long as the economy is in recession;
(4) The belief that for practical purposes, the most urgent need is to raise aggregate demand rather than to focus on the quality and type of public spending.

One is an extremely good point. The idea that ever single budget cut, and every single extra dollar spent has a multiplier of, say, 1.6 is clearly nonsense. Infrastructure investment — of which in the ARRA there was plenty — is particularly poorly targeted “stimulus” for search theoretic reasons. Cash transfers and tax cuts are hoarded due to increased demand for money or used to pay debt (not finance new spending). Investment in health care IT — also a part of the ARRA — mainly supports a sector of the economy which was strong the entire recession anyway. The truth of the matter is that multiplier estimates are simply estimates of central bank incompetence, the heart of the “Sumner critique“.

Just look at the title of the stimulus bill, “American Recovery and Reinvestment Act“. Sachs’ ideas of long-term investment are there!

This is not to say that fiscal policy has no role to play! On the contrary, I’m on record around the internet agreeing that fiscal policy certainly helps people bridge the gap over troubled waters — and that is a legitimate public policy undertaking. My main complaint is cheapening that legitimate role for fiscal policy by assuming that the actual role is “stimulus”. The ARRA did precisely approximately zero stimulating.

I don’t believe that Paul Krugman’s Keynesianism is ‘crude’ in any way. I think he’s wrong to highlight the primacy of fiscal policy at the zero lower bound, but there is nothing crude about doing so…regardless of whether that is the base position of a simple old Keynesian analysis. Krugman is also not wrong to emphasize that budget deficits aren’t a major problem right now…but again, that doesn’t legitimize unlimited debt-financed fiscal stimulus. It is likely that our future is one of repeated bumps against the zero lower bound. Even in the event that Keynesian counter-cyclical policy is the correct cure for a “liquidity trap”, they were supposed to be a rare aberration*, not something that happens every ten years or so. So in this world, it is likely that deficits and debt levels matter more than Krugman leads on, but certainly less that Sachs fears.

Keynesians sometimes do lose sight of the supply side (hence support for raising minimum wage and infinitely extending unemployment insurance), but that is no excuse to dive in 100% on the supply side, as Sachs does. To tie everything together, Sachs uses a public choice argument:

This approach is disastrous both politically and economically. Progressives like myself believe strongly in the potential role of public investments to address society’s needs – whether for job skills, infrastructure, climate change, or other needs. Yet to mobilize the public’s tax dollars for these purposes, it is vital for government to be a good steward of those tax dollars. To proclaim that spending is spending, waste notwithstanding, is remarkably destructive of the public’s trust. It suggests that governments are indeed profligate stewards of the public’s funds.

This is where the problem lies. I agree that fiscal policy should be fiscal policy, and never fiscal stimulus…however, saying this isn’t an argument against Krugman’s position, it’s just a banal point.

*Indeed they are the rarest of aberrations, having never existed.

Update:Ryan Avent adds:

17) It is very difficult to say with any certainty whether a particular level of debt-to-GDP is bad or should be lower. Whether or not debt levels above certain thresholds constrain growth, there is a risk that high levels of debt may limit the responsiveness of both fiscal and monetary policy to future crises. In general, widespread hand-wringing about the level of debt is a decent indicator that debt is approaching levels at which the ability to respond to future crises faces political constraints. Subject to all the factors discussed above, then, stabilising and reducing the debt-to-GDP level is a legitimate policy goal at such times.