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In the immortal words of a cross-dresssing British comedian--you're a bad man but I like you :)

I am a bit confused by professor Rowe's assertion that there is no room for the idea of keynesian (fiscal) stimulus in the US. The Obama administration began it's first term with just such a stimulus and although it ended up being too small there clearly isn't any aversion towards using fiscal stimulus to stimulate demand. Both Clinton and Obama have shown themselves willing to reduce the amount of government spending when they felt it neccessary so I don't see any problem with that part of the "neofiscalist" position either. The democrats may not have gotten there yet but a policy of fiscal support at the ZLB could easily be fitted into their present policy platform.

Looking at the opposite side, a large part of the GOP, including it's intellectual leaders, seems to believe that an activist monetary policy debases the currency, they spend a lot of time talking about the value of 'sound money'. There just isn't any equivalence between the two sides.


Some other parts of the blogpost don't seem to fit either. For example, to quote: "And because if monetary policymakers do want to target too low a level of aggregate demand, then fiscal policy won't work, because the monetary policymakers will simply offset it."

First, as anyone who has been reading Krugman is aware, he already knows this(For example, see the post about Liquidity Preference, Loanable Funds, and Niall Ferguson). Second, this just hasn't been a problem for most of the financial crisis since the Fed itself has said that it's preferred interest rate would be several percentage points negative.

The post begins by saying "It's the neofiscalist position that is new" and ends with "Where is the constituency for neofiscalism? People who can't escape from conventional ways of thinking? Make up your mind, please.

I almost always enjoy the posts written by Professor Rowe but this one was a letdown.

Lorenzo: That's going back a long way: Dick Emery's Mandy (I had to google, because my memory was slipping). But it's: "Ooooh! You are awful. [Pause] But I like you!"

Thanks!

Hugo: OK, maybe my brain is still getting up to speed, after my 5,000kms Canada/US road trip. But I didn't think I was *that* unclear.

Clinton did not AFAIK use fiscal policy for aggregate demand management. He tightened fiscal policy to reduce the debt/GDP ratio, not to reduce AD.

And didn't Obama start to tighten fiscal policy well before the Fed has left the ZLB? Again to reduce (reduce the increase in) the debt/GDP ratio. Which is not what the neofiscalist would want.

The Canadian Conservative government, by contrast, has already been following a neofiscalist policy. They didn't need much (any?) persuading.

Paul Krugman should be praising Stephen Harper (which would really confuse Canadian lefties).

Economists used to be aware of the "monetary offset" argument. But some of them suddenly forgot it when the ZLB appeared.

Neofiscalism appeared when economists trapped in the old way of thinking about monetary policy (as setting interest rates to target inflation) were suddenly faced with a new problem (the ZLB) they couldn't handle within that way of thinking, so thought they needed to resort to fiscal policy instead. It's a new policy position, but it's a consequence of the conventional way of thinking.

Hayek endorsed both neofiscalism and neomonetarism in the 1970s -- and supported both with much better economics than that coming from Krugman or Sumner.

It's patent brain-death to talk of "shortfalls in aggregate demand" without a wider account of the changing valuation and changing liquidity of money substitutes, financial assets, and production assets, and the whole changing structure of interdependent and hierarchically arranged production good values across time.

Reject any fiscal policy as capable of working or desirous of working? Some have argued it incapable of working which misjudges the Fed's reaction function. Buying unconventional assets is fiscal policy, even if the Fed is doing it, because they are choosing which assets to buy. You should just say yes to fiscal policy but want to require the Fed to do it. Good luck with that, because bankers aren't known for their creativity.

Nick, in the first part of your narrative, you seem to be assuming that fiscal policy at the ZLB always means more government spending, but in fact it can also mean leaving spending alone and cutting taxes, right? Thus when the responsible small-c conservative neofiscalist government leaves the ZLB, they might find themselves raising taxes again, true? You made it sound like they would always be shrinking the size of government in such a case.

Also, what if a completely different basis for macro theory (not mine!!) resulted in a formula like this for the price level:

log P = (1/k - 1) * log M

Where k = log M / log NGDP

Thus economies like Canada (with k closer to 1/2) find that the QTM works great when their CB targets inflation, price levels, NGDP levels, etc. But another country, with k closer to 1, finds that P is insensitive to M. The theory may be wrong, but at least it offers a concrete explanation for why there are differences across countries, and it opens itself up to falsification. This chart shows how the theory compares with the empirical data for a lot of different countries. That chart caught my eye. Another consequence of this theory is that for k=1 countries, fiscal policy remains effective. So if the theory turns out to be true, then maybe there's room for both neofiscalists and neomonetarists depending on measurable circumstances. That'd be an interesting result, wouldn't it?

Greg: "Hayek endorsed both neofiscalism and neomonetarism in the 1970s"

I don't think that's possible. Neofiscalism and neomonetarism are two contradictory positions. One says you should and the other says you should not, use fiscal policy at the ZLB. (And the ZLB was hardly a problem in the 1970's).

Lord: whether fiscal policy is capable of working depends on what the central bank is targeting. But it isn't desirable, if fiscal policy is torn between two different objectives, while monetary policy is idle.

" Buying unconventional assets is fiscal policy, even if the Fed is doing it, because they are choosing which assets to buy."

Conventions can change. Gold? Government bonds? Banks' IOUs? The ECB thinks buying government bonds is "unconventional". The Bank of Canada thinks it is conventional.

Tom: Yep. In principle, fiscal policy could be either. Depends on the model.

Tom:
"log P = (1/k - 1) * log M

Where k = log M / log NGDP"

So: logP = (logNGDP/logM -1)*logM = logNGDP - logM

That equation doesn't make any logical sense. The units are wrong. NGDP has the units $/year. M has the units $.

And we can derive: P = NGDP/M, or M*P = NGDP = P*Y (by definition), so M = Y??

M has the units $, and Y has the units apples per year.

Nick,

Krugman is criticizing a false claim that there is a (conservative political) constituency for "neo-monetarism".

He's not (falsely) claiming that there is some analogous (political) constituency for "neo-fiscalism" (in the US). He'd probably be doing less ranting in general if he believed that.

Nick, sorry, I probably oversimplified a bit. My understanding is that this shows the complete price level model from which the plot above was produced (first equation). Regarding dimensional analysis issues... I'll pass that question on. Thanks!

Nick, Tom,

The equation is the solution to the diff eq.

P = dNGDP/dM = k NGDP/M so that

NGDP/NGDP0 = (M/M0)^k

and therefore (substituting in the RHS of the first equation)

P = k (M/M0)^(k - 1)

I took k = (log NGDP/c)/(log M/c) as an approximation because it seemed to work (and had some theoretical justification). The constants NGDP0, M0 and c all have units of dollars so unit-wise it all works out (the original equation has homogeneity of degree zero, so the solutions should too).

e.g. here:

http://informationtransfereconomics.blogspot.com/2014/02/i-quantity-theory-and-effective-field.html

"We want to get to the root of the problem of insufficient aggregate demand."

Is real AD unlimited? Yes/No

"And which is riskier? Having the central bank hold "unconventional" assets? Having the central bank hold an "unconventionally" large balance sheet of both assets and liabilities?"

Do you worry about the central bank going insolvent?

"Clinton did not AFAIK use fiscal policy for aggregate demand management. He tightened fiscal policy to reduce the debt/GDP ratio, not to reduce AD."

I seem to remember Clinton talking about the private sector saving/the gov't sector dissaving and vice versa.

JKH, can you check on my bank comments on loan repayment here?

http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/06/repeat-after-me-people-cannot-and-do-not-spend-money.html

Thanks!

In reply to Nick Rowe:

Some economists (who?) may have forgotten monetary offset but Krugman is not one of them. In one of the small group of blogposts that he often links back to he deals with this and explains why he doesn't think it's a big issue in the current circumstances. The reason is again that the fed would've liked an even looser monetary stance but did not dare to because of uncertainty about the effects of unconventional monetary policy.

Perhaps he should, as you say, be praising Stephen Harper but in his blogpost he was clearly talking about US conservatives, not conservatism in general. As anyone with knowledge of both countries is aware, Canadian conservatives and US conservatives are a world apart. Krugman almost certainly doesn't agree with a lot of other things done by Stephen Harper but he surely supports this one thing.

Thanks for the clear explanation of new conventionalism though! I simply misunderstood what you wrote in the blogpost.

This is a good post, however it misses one main Krugman's which is tha "change inflation expectations, which is far beyond conventional monetary policy." Now I am wondering - how does he think fiscal stimulus works under condition of ZLB/Liquidity trap? I can argue that it works only if it increases inflation expectations - which makes it some sort of "unconventional monetary policy" int the same way that "taking risk" in Krugman's eyes turns monetary policy into fiscal policy.

So the key question for Krugman is this - out of all possible ways to increase inflation expectations during ZLB why should we focus just on fiscal stimulus? This is where responses by Krugman and other fiscalists like Simon Wren-Lewis fall flat. I mean we all agree that under current interest rate operational regime ZLB is a problem. But do Krugman and other fiscalists really think that there should be some kind of ceremony where CB board officially declares its impotence during ZLB and officially handles monetary policy into treasury hands which then has to increase inflation expectations by fiscal stimulus? Or should it be the other way around that CB will automatically get new operational powers from treasury when ZLB hits? How is this not highly unconventional monetary policy that is almost impossible to construct realistically?

TMFed,

looks fine

but remember that payment of interest (at the margin) coverts a demand deposit to equity

repayment of principal is an elimination of loan and a matching demand deposit

JKH: If someone says "policy option A is unlikely to get political support", you would expect him to say at least something about the likelihood of alternative policy option B getting political support. Perhaps I am reading too much between the lines, but to my mind his message was: "Look, you Market Monetarists might as well give up, and join us neofiscalists, because nobody would ever implement your wacky unconventional ideas".

Hugo: "Krugman almost certainly doesn't agree with a lot of other things done by Stephen Harper but he surely supports this one thing."

Suppose it had been a Canadian Liberal government that had followed exactly the same fiscal policy as the Conservative government actually did. Do you think Paul Krugman would have done a post or two praising enlightened progressive government in the Great White North? Or is Canada just too boring? Who knows. Maybe he will write such a post now.

I feel sorry for our government. They get no praise from either side.

JV: That one statement in particular by PK is what really caught my eye, and made me want to respond. "change inflation expectations, which is far beyond conventional monetary policy." WHAT? The whole point of introducing inflation targeting in 1992 was to change inflation expectations: to lower them; and to make them more stable! Absolutely nothing unconventional about that. Giving that as one of his two reasons for not buying neomonetarism on the economics is just....blinkered, narrow-minded, stick-in-the-mud. I can't find the right words. But conventional thinking in the worst sense.

In a standard NK model, fiscal policy works through two channels at the ZLB: 1. increasing expected inflation, and thus reducing the actual real rate of interest; 2. increasing the natural rate of interest, by reducing the expected growth rate of G going forward, and thus increasing the expected growth rate of C going forward.

In reply to J.V. Dubois

As Krugman, Wren-Lewis and other keynesians have said again and again and again, they believe that both fiscal and monetary stimulus should be used to combat a below ZLB recession. They both have doubts about unconventional monetary policy's ability to stimulate the economy in a way that is sufficient.

Hugo: "They both have doubts about unconventional monetary policy's ability to stimulate the economy in a way that is sufficient."

But this is a bit puzzling. If you think X amount of "unconventional" monetary policy will be insufficient, then just do more than X. Is there some upper limit on "unconventional" monetary policy too?

Nick: "In a standard NK model, fiscal policy works through two channels at the ZLB ..... 2. increasing the natural rate of interest, by reducing the expected growth rate of G going forward, and thus increasing the expected growth rate of C going forward"

I suppose this is about this post of yours. I did not see any serious response to that post by any fiscalist (which is a shame) so I have my doubts if Krugman meant that type of fiscal policy.

JV: Yep. Second only to my disappointment at the little response I got from the fiscalists on the debt burden post. I got a little bit of a response from Simon Wren-Lewis when I raised the same point in comments on one of his posts. But otherwise the neofiscalists have carefully ignored it. It's just too awkward for them. "New Keynesians for (announced) expansionary austerity!" is an uncomfortable slogan for them. They ignore their own models, when they give results they don't want to hear.

I guess there is an upper limit on unconventional policy by the name of congress. Look at all the gruff the Fed have gotten doing what little they have. Congress seeing that would might just try taking it on themselves, but at least they would be competing against each other in right direction. More likely they might just try to shut them down but then they can take the blame.

How, exactly, is changing inflation expectations "far beyond conventional monetary policy"? If inflation expectations were 5% and the central bank was targeting 2%, would it be "unconventional" for the central bank to take action to try to change those expectations? Isn’t that what Volker did in 1981? Isn't that what some people are arguing Rajan will try to do now at the RBI? Wasn't falling inflation expectations one of the reasons for the 50bps cut from the Riksbank just yesterday? If Janet Yellen communicated an “optimal control” path for monetary policy (allowing inflation to run above 2% for a period of time if the economy is still in excess supply) would that be “unconventional” too? If so, I have no idea what “conventional” policy looks like.

My reading of Krugman’s line of attack is that it is a tacit admission that monetary policy is the preferred tool for managing AD even at the ZLB. And as for Krugman’s argument that advocates of NGDP targeting should give up because they have no political home, I refer to Friedman himself:

“There is enormous inertia—a tyranny of the status quo—in private and especially governmental arrangements. Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.”

Milton Friedman would not be an outcast in today’s conservative movement because, had he been alive during the crisis and post-crisis period, he would have drastically changed the movement’s views on monetary policy.

Gregor: very good comment. Maybe what I should have said.

And no disrespect to Scott Sumner, who is doing an excellent job, but he does not have Milton Friedman's stature in the profession. And it took Friedman a long time to change policy, but change it he did.

Monetarist policy is like jiggling the needle on the speedometer when the car slows down instead of stepping on the gas. It can work, but only in rare cases where demand is limited by the availability of credit in the private sector. Usually demand is, in the end, limited by wages.

In answer to "... but how many are there who would immediately shrink the size of government, and stop using fiscal policy for aggregate demand management, when the economy lifts off the ZLB?" - Historically a lot of them. That's why they argue for social safety network spending which falls as wages rise.

What is actually the difference between monetary and fiscal policy? Or is it as simple as: The Fed buys asset X it is monetary policy, the Treasury buys same asset X it is fiscal policy?

Forgot to add that for me "changing expectations" requires real actions by the Fed. I have my doubts that making nice speeches but not following them up with some real tangible actions will convince the market of altering their inflation expectations.

JKH said: "TMFed,

looks fine

but remember that payment of interest (at the margin) coverts a demand deposit to equity

repayment of principal is an elimination of loan and a matching demand deposit"

OK. So if the private non-banking sector continues to repay a bank loan, there will probably be a shortage of demand deposits. I'm going to call that a shortage of MOA and MOE.

Assume the shortage is $100 mil. Let's assume a levered hedge fund does "QE" by putting up $10 mil to buy $100 mil for "QE". Will that completely (emphasis) fix the shortage?

"We want to get to the root of the problem of insufficient aggregate demand. We see aggregate demand as a monetary phenomenon, that only makes sense conceptually in a monetary exchange economy. And we see insufficient aggregate demand (just like an inflationary surfeit of aggregate demand) as due to an underlying failure of monetary institutions"

This is a statement that I can get 100% behind.

I'm just not sure that I draw the conclusion that I take to be implicit that monetary institutions should operate solely by swapping base money for other assets. Particularly as interest rates approach zero I question if such asset swaps are the most efficient way of managing aggregate demand. There is a worry that when the monetary authorities have to buy riskier assets in order to affect the real economy they will start to mess with people's assessment of risk and there will be a potential (if markets are not optimally efficient) to drive asset-price bubbles.

For this reason I think a rules-based aggregate-demand management policy needs to include a combination of "monetary policy" (assets swaps and expectations settings) and "fiscal policy" (adjusting the size of the deficit via rules-based adjustment to , for example, income and sales -taxes).

Hayek endorsed these as theoretical positions for particular situations, he did not obviously endorse them as policy responses to the inflation and stagflation of the 1970s -- Hayek was rather famous at the time for endorsing a rather different position in the major magazines and on television.

Nick writes:
Greg: "Hayek endorsed both neofiscalism and neomonetarism in the 1970s"

I don't think that's possible. Neofiscalism and neomonetarism are two contradictory positions. One says you should and the other says you should not, use fiscal policy at the ZLB. (And the ZLB was hardly a problem in the 1970's).

Looks like I typed part of my previous comment in the "posted by" box...

Hasn't the Fed in the US given neo-monetarism a good test, which it has failed? It hasn't failed as badly as European policy, but it has not produced a robust recovery in a reasonable time, either. Do you claim that more fiscal stimulus would not have helped?

Do you think that the US would have avoided another Great Depression without the massive bank bailout? Wasn't that a fiscal response? Could the Fed alone have done so well?

Congratulations to Canada and Australia, BTW. :)

Excellent. But I think PK agrees with all u write except that for practical purposes he thinks fiscal policy is politically more acceptable, thus easier to achieve. Imagine if the Fed announces an inflation target at 3,5%: those crying wolf ('the fed is debasing the dollar' stuff) would gain too much political ground. But yes, for h sake, you're right: demand is about spending money so the straight policy solution must involve the central bank.
Comsider however that this implies not so much relying on monetary polilcy instead of fiscal policy, but rather blurring their boundaries. To put it simply, distributing money is a highly political exercise, better done by a fiscal authority. Furthermore, what they did in the US, albeit timidly - QE plus deficit spending - is not too far from 'money financed fiscal deficit', which in turn is not so far from targeting NGDP in an efficient manner.

PierGiorgio Gawronski: "demand is about spending money so the straight policy solution must involve the central bank."

Isn't the claim a stronger one? Not that the central bank must be involved (assuming that there is a central bank, OC), but that the central bank can, on its own, provide or induce sufficient spending.

"Do you think Paul Krugman would have done a post or two praising enlightened progressive government in the Great White North? Or is Canada just too boring?"

WTF? It's thanks to Krugman that I know what the phrase "worthwhile Canadian initiative" refers to. His point, in that famous piece, is that Canada is admirably boring and the US insufficiently so.

"Clinton did not AFAIK use fiscal policy for aggregate demand management. He tightened fiscal policy to reduce the debt/GDP ratio, not to reduce AD."

The story is that Clinton dropped his campaign promise for a middle class spending bill in the face of opposition from Robert Rubin and Greenspan. They convinced him to turn towards deficit reduction. Greenspan said that the bond markets would raise rates without it. Clinton advisor Carville later quipped that he wants to be reincarnated as the bond market, everyone's afraid of you. My sense is that Greenspan was threatening to raise rates and offset Clinton's fiscal spending.

DeLong who was there at the time claims that the bargain worked and deficit reduction helped convince Greenspan to lower rates later on helping growth in the late 90s. My view is that it lead to the secstags as in the late 90s growth was dependent on tech stock bubble generated demand rather than more sustainable government and middle class spending. And of course the tech stock bubble morphed into the housing bubble.

I'm with Simon-Wren Lewis that both fiscal and monetary measures should be employed in booms and recessions. At the ZLB the central bank becomes politically constrained, not economically as Krugman suggests. Robert Rubin and Wall Street did give the Democrats growth and campaign contributions but it wasn't sustainable. I'm with Yellen that central banks should focus more on macroprudential policy.


Min: "Isn't the claim a stronger one... that the central bank can, on its own, provide or induce sufficient spending?"
Keynesians have been caught for too long by the claim by JMK that in a liquidity trap monetary policy becomes ineffective. It’s true, but JMK was referring to traditional open market operations. We are 80 years later and a bit more sophisticated. Filling a demand gap means spending some more money. So there are two tasks here for the state: (1) money procurement; (2) money spending (or distribution to potential spenders). As for (1), where do you get the extra money to be spent? You may borrow it, and that’s ‘fiscal’ policy, deficit spending. Or you may print it (and inject it in the economy), and that’s monetary policy. The problem is: sometimes the government is not an efficient purchaser of money (for ex. It has too many debts so it pays high risk premia), but is good at spending it (or granting it to would-be spenders). A central bank, on the other hand, is an efficient money procurer, but is bad at spending it and at distributing it to economic agents with a high propensity to spend. Thus the straight and most general solution for 'great' depressions would be: the central bank is assigned task 1, and the government is assigned task 2: and what you get is ‘counter-cyclical deficit spending financed by the central bank’. A major variant would be: the central bank admits it is a lender of last resort and insures public bonds, so that long term interest rates fall to very low levels... while the government borrows and spends. That’s fiscal policy, but behind there’s the central bank. Another variant is: the government issues bonds, the central bank buys them (with a QE) in secondary markets, and handles back to the Treasury the yields, so the Government becomes indirectly an efficient money raiser (pays zero on its bonds).
My point is: a dogmatic and excessively independent central bank, as in Europe is detrimental. Fiscal and monetary policy must coordinate. Hence, blurring the boundaries between monetary and fiscal policy is the way to go.

PierGiorgio Gawronski: "Fiscal and monetary policy must coordinate."

Thanks. Sounds good to me. :)

Peter K.,

"The story is that Clinton dropped his campaign promise for a middle class spending bill in the face of opposition from Robert Rubin and Greenspan. They convinced him to turn towards deficit reduction. Greenspan said that the bond markets would raise rates without it. Clinton advisor Carville later quipped that he wants to be reincarnated as the bond market, everyone's afraid of you. My sense is that Greenspan was threatening to raise rates and offset Clinton's fiscal spending."

Which is funny since the Greenspan Fed commenced raising short term interest rates from 1994 to early 1995 (3% short term to 6% short term). Long term interest rates moved up in lockstep with the Fed - moving from 6% at the beginning of 1994 to 8% by mid 1995.

The act responsible for Clinton's deficit reduction

http://en.wikipedia.org/wiki/Omnibus_Budget_Reconciliation_Act_of_1993

was signed into law in August 10, 1993.

So the story is that Greenspan / Fed / markets threaten to raise interest rates unless Clinton agrees to deficit reduction. Clinton gets deficit reduction passed in 1993. Greenspan / Fed / markets raise interest rates anyway from 1994 to 1995.

I guess that is why they call it a story instead of history.

"And because if monetary policymakers do want to target too low a level of aggregate demand, then fiscal policy won't work, because the monetary policymakers will simply offset it."

True. So what? What you are describing is a political problem. Not a hard fact of econ. The "Sumner Critique " is a political argument disguised as a econ argument.

It's like arguing that ngdp targeting won't work because the Fed will not do it...and calling that an econ argument.

If the Fed is going to insist on a bad target, it won't work no matter what the approach. The "Keynesian approach" is not disapproved because the Fed refuses to try it any more than Market Monetarism is disproved because the Fed refuses to try it.

But, The M&Ms did have a pretty good experiment when the Fed went to "QE ∞" ... And the results of that experiment were less than impressive. At the very least the QE∞ experiment proved that monetarism is not nearly as potent at the ZLB as it was sold to be.

Nick,

"If you don't want to change the 2% inflation target, and if you don't want to change the monetary-policy-as-setting-an-interest-rate operational framework, then when the ZLB hits you can only think of managing aggregate demand by using fiscal policy."

Or you think of using fiscal policy to overcome the ZLB rather than direct management of aggregate demand. Not sure that counts as Neofiscalism.

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