In recent years, I get the impression that Keynesians are being more and more aggressive in their arguments for fiscal stimulus. I see economists arguing for stimulus when we are in a deep slump (2009), a sluggish recovery (2011-14) and even full employment (now.) Here’s an example from Brad DeLong:
When should you use fiscal policy to expand demand even if the economy is at full employment?
First, when you can see the next recession coming: that would be a moment to try to see if you could push the next recession further off.
Second, if it would help you prepare you to better fight the next recession whenever it comes.
The second applies now whether we are near full employment or not.
Under any sensible interpretation of where we are now, using some of our fiscal space would put upward pressure on interest rates and so open up enormous amounts of potential monetary space to fight the next recession. It would do so whether or not it raised output and employment today as long as it succeeded in raising the neutral interest rate . . .
Like Mae West, they seem to think that too much of a good thing is . . . wonderful. In my view, one of Bob Lucas’s greatest insights is that you need to think in terms of coherent policy regimes, not just gestures that might or might not seem appropriate at a given point in time. In the standard Keynesian model, fiscal policy cannot be consistently expansionary. For every year of expansionary fiscal policy, there’s another year of contractionary fiscal policy. This is due to two factors:
1. What matters is not the cyclically-adjusted deficit, but rather the change in the cyclically-adjusted deficit.
2. In the long run the federal budget has a constraint; interest as a share of GDP cannot increase without limit.
In fairness, DeLong is focusing not on the direct impact, but rather the indirect effect on interest rates and monetary policy. But I’d also make a practical argument here. Any sort of plausible fiscal stimulus that might have a prayer of getting through Congress today (when the deficit is already $650 billion and rising), is likely to be on the order of a few hundred billion dollars/year, at most. And that’s simply not going to move the equilibrium interest rate enough to have a meaningful impact on the potency of conventional monetary policy. Big Japanese fiscal deficits also failed to significantly boost their interest rates. It will also mean less fiscal “ammunition” in the next recession, when it might be even more necessary (from a Keynesian perspective.)
Nor is the direct impact of stimulus likely to be significant. The Congress suddenly cut the deficit from about $1050 billion in calendar 2012 to about $550 billion in calendar 2013, and it had zero impact on growth (for standard monetary offset reasons). Fiscal policy is a waste of time and money.
I explored these issues in more detail in my recent Lake Wobegon post, and in an even more recent post I pointed out that Janet Yellen suddenly seems to have changed her mind, and now agrees with me.
I’d really like these new Old Keynesians to write down a model on exactly:
1. When do they want the cyclically adjusted deficit to be smaller than average?
2. And exactly when do they want it to be larger than average?
I think I know their answer to the latter question (always), it’s the former question that has me perplexed.
HT: Bob Murphy