Tuesday, July 27, 2010

There wasn't really any stimulus

David Leohnhardt makes the case.

I don't know why this is so hard for people to understand. Yet we still hear "we tried Keynesian stimulus and look - nothing happened". Explain to me precisely what "Keynesian stimulus we tried". The Feds filled a hole that the states were digging - once you net that out there was very little stimulus to speak of.

I'm making essentially the same point in an opinion piece I'm sending in to the Washington Post to coincide with the release of the second quarter GDP statistics. If it doesn't make it through, I'll post it here.

This really isn't that hard. We've done some monetary policy, although as many people point out the monetary environment was still contractionary, not expansionary. Fiscal policy was more or less a flat line. That's the policy environment, and the macroeconomic response is pretty much what I would have expected from that sort of policy environment.

21 comments:

  1. So, stimulus is only stimulus if it is some net increase in spending overall? That seems like moving goal posts to me - because I thought stimulus was filling in for decreases in spending in other areas.

    Anyway, I am reasonably skeptical of the whole notion to begin with.

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  2. I'm not exactly sure what the difference between those two is.

    Here's how I think of it: fiscal stimulus is an increase in government spending, as you say, to counteract decreases in private spending. That's a very "crude Keynesian" way of putting it, and there's more sophisticated theory behind it - but that's more or less it.

    By that definition there hasn't really been that much stimulus to speak of.

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  3. So, how do you determine if the stimulus is enough? If it is more than filling in for spending that isn't being done? Given that, the sky is the limit under at least one plausible scenario. BTW, I would guess this is a major reason most of the public is skeptical of government spending meant to boost the economy.

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  4. Jonathan M. F. CatalánJuly 27, 2010 at 12:13 PM

    "We've done some monetary policy, although as many people point out the monetary environment was still contractionary, not expansionary."

    While I'm sure that you're not trying to be misleading, I think the way you put it makes it misleading. The Federal Reserve didn't do "some" monetary policy; the money base grew exponentially directly after the crash. Ben Bernanke's Federal Reserve's response to the recession has been the strongest in history.

    The "problem" (at least, the problem according to Krugman's framework) is not that it was only "some" monetary policy, but that money creation was not sustained for long enough to allow for an escape from the liquidity trap.

    By the way, that criticism of Krugman should be coming out sometime this week on Mises Daily. My criticism of government spending you've probably already heard, but nevertheless you might be interested in reading it.

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  5. And exponentially is probably an understatement. It was practically hyperbolic.

    "Some" monetary policy may be a little too light on my part, but I'm actually with you and not in the Scott Sumner school of thought that actually says that the Fed was contractionary. It really wasn't - it was expansionary, and as you say - historically so.

    But Sumner is still right that the monetary environment has still been contractionary - which is just to say that it it is less contractionary than it would have been without the Fed's intervention.

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  6. "The "problem" (at least, the problem according to Krugman's framework) is not that it was only "some" monetary policy, but that money creation was not sustained for long enough to allow for an escape from the liquidity trap."

    Could you explain this?

    Krugman's view of the liquidity trap is based on the zero lower bound, which we hit pretty soon after expansionary policy started. Do you mean that Krugman's complaint is that they didn't start early enough? I'm with Sumner on Krugman to a certain extent - he's consistent on fiscal policy but it's a little hard to follow exactly what he's thinking on monetary policy.

    He is probably more consistent than he appears - I'm guessing the distinction he's making is just over my head.

    I look forward to the new Mises Daily piece - this is one that you've had bits and pieces of on the blog, right?

    How was Mises University?

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  7. Jonathan M. F. CatalánJuly 27, 2010 at 12:34 PM

    I'm actually not attending Mises University (although, I should have applied), Mattheus is. I'm not sure when it ends (probably at the end of this week).

    "Krugman's view of the liquidity trap is based on the zero lower bound, which we hit pretty soon after expansionary policy started. Do you mean that Krugman's complaint is that they didn't start early enough?"

    Krugman's complaint is that the Federal Reserve didn't pump enough liquidity. Krugman believes that to a large degree monetary stimulus fails to boost aggregate demand because of future deflationary expectations, and as such the solution would be to pump enough money to give credibility to the Fed's monetary policy.

    In an older blog post he suggests that the Federal Reserve should have increased the money base by $10 trillion, basing this off a figure from Goldman Sachs (this is the figure I quote in my article). More recently (and I saw this only after writing my article), he gives a smaller figure.

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  8. Increasing the supply of base money is not the same as increasing the supply of money, and it is certainly not the same as increasing aggregate demand.

    While the supply of base money increased, the quantity of base money demanded by banks also increased--partly because the Fed started paying banks to hold base money! In other words, while the supply of base money was increasing, the money multiplier fell dramatically. Since the money supply is a function of both the supply of base money and the money multiplier, the Fed was being expansionary with one hand and contractionary with the other. However, the net effect of these two policies appears to have contracted the money supply, especially recently.

    In any case, the most important variable (from a Keynesian perspective) is aggregate demand. Even if the Fed kept the money supply constant (on its previous growth path), aggregate demand would still be down, because velocity has declined.

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  9. Jonathan M. F. CatalánJuly 27, 2010 at 3:16 PM

    Lee Kelly,

    I'm not sure what the money multiplier has to do with an "increase in demand" for base money. I think you are using these terms erroneously and missing the larger point.

    Demand for money should be treated from the individual's perspective, not the bank's. While banks do currently prefer holding money in reserve, as opposed to lending it, as a result of increased uncertainty, I'm not sure that this necessarily means that bank's "demand for money" rose proportionally with the increase in base money as a result of monetary pumping by part of the Federal Reserve.

    Sure, this bank was not lent out, but it's not because the demand for money rose equally, but only because we are in what can be called a liquidity trap, where the costs of lending are believed to be well above the benefits of lending.

    Regarding your argument that the Fed was being both expansionary and contractionary, I'm not sure this makes a lot of sense. An increase in the demand for money is not a product of Federal Reserve action after the onset of a recession. So, the Fed's policy was clearly expansionary. It just has had no effect (except maybe marginally inflate some prices).

    Now, back to my original point (which you seemed to miss), Krugman's argument is that liquidity traps are intertemporal in the sense that the demand for money can remain high if individuals believe that deflation will occur in the near future. As such, Krugman presents two solutions. The first is government spending. The second is a far more expansionary monetary policy which changes society's expectations.

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  10. Mankiw on stimulus: http://www.nationalaffairs.com/publications/detail/crisis-economics

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  11. Thanks for that - I saw that, I think at Marginal Revolution (?) and was going to post it soon.

    He essentially makes the same identification problem points that he has been making for a while (and that I have too, for that matter).

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  12. Oh. Sorry to steal your thunder.

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  13. No! Not saying that at all :) I earmark a lot of posts in my head to repost here, and inevitably many of them don't get reposted. I'm thanking you for reminding me - it's a good one.

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  14. FYI & OT: Roberts' discussion with Service is one of the best EconTalk podcasts I've ever heard.

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  15. Jonathan,

    Centaris Paribus, if the quantity of base money that banks wish to hold increases, then the supply of money will contract. Paying interest on reserves increases banks' demand for base money and is contractionary. Whatever other reasons banks may have for holding more base money, paying interest on reserves creates an incentive to hold even more. Therefore, if the Fed to fight its own contractionary policies, then its expansion of the monetary base must be sufficient to offset banks' additional demand for base money.

    Moreover, the Fed has been signaling that aggregate demand will continue to drag for years to come--the Fed's own projections predict that its present policy will not achieve its purported goals! Such projections will further suppress velocity and reduce the incentive of banks to lend (especially while they receive interest on reserves). All the while, aggregate demand remains well below its previous growth path. We would need about 8-9% inflation this year to return aggregate demand to its pre-2008 trajectory. Ultimately, the Fed's policies have not been expansionary in the way that counts.

    With regard to Krugman: I see fiscal stimuli as the least desirable means of resolving the current problems, and, unlike Krugman, I do not believe that monetary policy has "run out of ammunition."

    All that said, ideally, I would abolish the Fed.

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  16. Jonathan M. F. CatalánJuly 27, 2010 at 4:37 PM

    Lee Kelly,

    I'm not sure that the Federal Reserve is "paying banks" to hold reserves at this point in time, or at least across the board. Currently, it's a question of the discount rate, factored in with the rate of inflation (the payment is in the form of falling purchasing power per dollar).

    I'm not sure what you don't understand from my points. Krugman doesn't claim that monetary policy has "run out of ammunition". I keep on writing what Krugman actually says, but for some reason it's not registering. Krugman argues that the Federal Reserve should be more expansionary.

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  17. Jonathan,

    So far as I am aware, there is still a small interest rate on accounts held with the Fed. Numerous commentators have been complaining about its contractionary implications.

    With regard to Krugman, I am not familiar with his most recent claims. I know that in the past he has argued that monetary policy can do little in the present circumstance.

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  18. Yes - they are still paying interest on reserves. It is contractionary, but I kind of doubt it's excessively contractionary.

    Jonathan, the discount rate is the rate that banks pay to borrow from the Fed. This is a relatively underutilized facility, ever since the 1920-21 recession actually. Its the "lender of last resort" function, and it is traditionally used in emergency situations.

    Most member banks augment their reserves by borrowing from other banks at the "federal funds rate", which is what the FOMC targets.

    Ever since the fall of October, though, the Fed has been paying interest on reserves held at the bank, regardless of whether they are borrowed reserves or not.

    I think it's a good move - it's one more tool for them to use. They should probably pay zero or negative interest on it right now - that would be more expansionary. But I can't see how that is the source of our problems.

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  19. Jonathan M. F. CatalánJuly 27, 2010 at 6:03 PM

    Lee Kelly,

    Krugman's beliefs on monetary policy have been the same since Krugman applied his liquidity trap theory on Japan.

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  20. Daniel says..."Here's how I think of it: fiscal stimulus is an increase in government spending, as you say, to counteract decreases in private spending. That's a very "crude Keynesian" way of putting it, and there's more sophisticated theory behind it - but that's more or less it.
    "

    This is clearly a case of circular logic.

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