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When fiscal tightening is not correlated to economic contraction it can either be attributed to monetary offset or "other things".

Monetary offset would imply a growth in base money.
"other things" would imply an increase in velocity of money

In theory at least it should be possible to look at a change in NGDP in a given country and see what part of it is down to a change in base money and which to "other things".

Do any of the studies attempt to do that ?

Nick, I asked Scott this and he responded here. Also, if you read through the comments there's some question about including Estonia, Lithuania and Latvia and about the outsized influence of Greece and if there's any statistical significance w/o Greece. Removing the countries not in a liquidity trap did not seem to dramatically improve the p-value (Mark & I discuss this in the comments).

So do you think we can tell much from these plots overall? Maybe Scott is right: maybe more work (e.g. detrending areas for historical growth rates?) needs to be done by anybody (Scott says by Keynesians) trying to show something statistically significant with this data?

MF: splitting the sample into places on fixed exchange rates vs others was designed to test whether it's monetary offset. Because if you have a fixed exchange rate you can't do monetary offset. You could argue that "other things" were correlated with both fiscal policy AND fixed exchange rate, in some way, but it would be a weird correlation.

Tom: my preference: first come up with some plausible alternative explanation, then try to figure out how to test between those two alternatives.

Nick- I have mentioned this before either on SS's blog or on one of his posts at econlog, and it seems no one is particularly interested, but it is obvious (at least to me) that 2009 is eitehr a blind and uneducated starting date or cherry picking.

Keyensian theory is explicit that fiscal spending is most effective early in recessions (the multiplier) and Bernake testified in front of Congress in late 2007/early2008 that there was a risk of recession and stimulus would be positive. In Feb 2008 congress passed a ~150 billion stimulus bill (mostly tax rebates that went out very quickly) and the official start of the recession is known to be the final quarter in 2007. Using 2009 is clearly incorrect when trying to determine if the US gvernment engaged in austerity or stimulus during this recession, and is also clearly incorrect when building a database of countries that entered recession at different times.

I cannot think of a single honest reason (beyond ease to gathering the data) that would support the use of 2009 as a start date.


Regarding "splitting the sample into places on fixed exchange rates vs others was designed to test whether it's monetary offset"...

I understand that by looking at various correlations and making appropriate assumptions you can draw some conclusion from the datasets. However its obvious that there is a lot of disagreement about what the "appropriate assumptions" are so no consensus is likely. But (at least for countries with there own currencies ) it should be possible to see for any given change in NGDP how monetary base and money velocity changed to drive the NGDP change.

For example an increase in NGDP could be caused in 2 ways (and of course with a continuum between them)
1) fiscal_contraction->fall in V->rise in M
2) fiscal contraction->increase in V->no change in M

If the data shows that the reality is closer to 1) than 2) then this would support monetary-offset theory at a deeper level than just looking at correlations, wouldn't it?

bacon: so if 2009 is a bad start date to show that fiscal policy works, why does fiscal policy still work in fixed exchange rate places if we pick 2009?

MF: if we observe 1, those who reject the monetary offset theory could (quite reasonably) say that M didn't increase enough, or that increases in M don't do anything.

Oops, yes - expansionary monetary policy will increase M and probably decrease V whether it has any effect on NGDP or not !

so my scenario 1) would prove nothing. But wouldn't my scenario 2) (fiscal contraction->increase in V->no change in M) tend to support the "other things" theory ?

Nick, you write:

"first come up with some plausible alternative explanation, then try to figure out how to test between those two alternatives."

Mark wrote here:

"So which of these monetary policy zones are, or have been, at/near the zero lower bound in interest rates during 2009-2014 AND have independent central banks?
Well that would be the Czech Republic, the Euro Area, Japan, Sweden, Switzerland, the UK and the US. That’s only seven observations, but regressing change in NGDP on change in CAPB for these zones results in a p-value of 0.6705. (And, not that it really matters, but the slope is positive 0.39131.)"

I don't know how this will come out, but perhaps if these seven areas that Mark identified are detrended (for some "other" effect such as historical growth for example) prior to calculating a change in CAPB vs a change in NGDP the resulting regression will be statistically significant. How's that for an explanation that we can test? It's not really a case of choosing between two explanations (like you state) but it does seem like something we can test. If the regression is then statistically significant, and the resulting slope is either positive or negative, then we can try to find competing explanations for this and then try to find a way to test between those alternatives.

It seems difficult to come up with an alternative explanation prior to having anything statistically significant to explain. For example, maybe the slope will continue to be positive once we find a statistically significant regression. That's going to be an entirely different alternative explanation than if the slope is negative, isn't it? What am I missing?

... are you saying that MM explains why we lose statistical significance in Mark's (unplotted) seven area regression, and you'd like to see an alternative explanation for a loss in the significance?

Tom: that's an economically small, and statistically not very significant fiscal multiplier, but let's run with it. So why was the fiscal multiplier negative in the non-ZLB countries that are not on fixed exchange rates? (If some are positive, the others must be negative, if you get zero when you add them together.)

MF: it would tend to work against the monetary offset theory. But monetary offset supporters would (reasonably) say that an increase in the expected inflation or NGDP growth rate target could have increased V without M needing to increase. (Zimbabwe had very high V, and small M/NGDP.)

"So why was the fiscal multiplier negative in the non-ZLB countries that are not on fixed exchange rates?"

Good question. Maybe the 1st step is to calculate the p-value and R-squared for that regression.

Here is my question on this: does it really make sense to say that countries in the Eurozone (more generally, a common currency area) "lack an independent monetary policy"? For sure, there's some constraints and no country (maybe) gets what it wants.

Suppose the monetary policy of the Eurozone is secretly set to accommodate German preferences. Then all countries in the Eurozone but one lack an independent monetary policy. Suppose the monetary policy of the Eurozone is secretly set to accommodate German and Luxemburgian preferences. Then all countries in the Eurozone but two lack an independent monetary policy with those two having something like "quasi-independent" monetary policy. Etc.

Basically what you need to do in a graph like the second one in that blog post is somehow weight the observations by how much input you think a particular place has in determining overall monetary policy for the eurozone. And that's just to take care of the t-stats, not even beginning to address bias. Still, the conclusion might hold even then (or it might even be stronger), so this is just some speculation.

On the other hand, doing some eye-squinting, it does seem like dropping "Euro Area" from the third graph, and moving Germany, Luxembourg and France from the second into the third graph is gonna pull up the slope of that third graph regression line a bit. Drop Greece from the first graph, because it's Greece, and the two are going to start looking a lot a like. Switzerland and Iceland seem like the really weird ones though.

notsneaky: good question. I *think* this is the answer:

Start with 2 equal-sized countries sharing a common currency, with uncorrelated fiscal shocks, and a central bank that targets the sum of their NGDPs. The estimated fiscal multiplier should be 1/2 the fiscal multiplier with zero monetary offset. If one country gets bigger (or the central bank is biased towards that country) its multiplier should get smaller, and the other country's multiplier bigger, but the average of the two multipliers should stay the same. As the number of countries gets bigger, the multipliers should get bigger. As the fiscal policies get more correlated, the multiplier should get smaller.


" My argument against Scott's and Mark Sadowski's analysis was that it failed to properly select data given the conditions and then failed to properly measure effectiveness (on the graph at the original post from Scott has issues with both the selection of points to use and their x-axis and y-axis positions). They failed to treat the monetarist model and the Keynesian model on equal footing.

Scott's defense:

So what’s my defense? Here’s how I look at it. The Keynesians did several studies of the relationship between austerity and growth that were highly flawed, for too many reasons to mention. Confusing real and nominal GDP. Mixing countries with and without an independent central bank. Wrongly assuming correlation implied causality. Mixing countries at the zero bound with countries not at the zero bound. Just a big mess. ... And then the Keynesians did blog posts suggesting that these studies provided some sort of scientific justification for the claim that austerity slows growth.

Basically -- other people do it too. Modus omnia facere."

Jussi: what was Jason's argument? ""it failed to properly select data given the conditions and then failed to properly measure effectiveness""

@ Nick-

How would we know fiscal policy works in 2009 if the recession started in 2007, and we are using 2008 as our baseline.

Four identical economies A, B, C and D go into recession in 2007, government spending is 10X for each where X your preferred method of measuring "austerity" (ie 10X could mean government spending is 10% of GDP in 2007, so government spending that is <10% of gdp in 2008 = austerity, >10% = stimulus, or it could be pGDP, or some weighted cyclical variable).

Country A introduces stimulus in 2008 so government spending goes to 11X, and then in 2009 "reduces" back to 10.5X.
Counrty B holds firm at 10x in 2008, then increases to 11X in 2009
Country C reduces to 9X in 2008 then increases to 10X in 2009
Contry D sticks at 10x in both 2008 and 2009

Taken from the 2007 baseline Country A is the most stimulative (increasing total G byan average of 0.75X over two recession years), B is 2nd (0.5X per year) D is neutral, and C is austere (-0.5X per year).

Taken from 2008 baseline Country C is the most stimulative (tied with B, but an increase of 11%, not 10% from base), B is 2nd, D is neutral, and A is a country suffering from austerity.

bacon: suppose we have the wrong measure of "fiscal policy", either because we use the wrong start (or stop) date, or because we use the wrong measure of "X". (And we almost certainly will get it wrong, to some degree, and the biggest thing that I see wrong with Mark's measure is that the actual deficit is endogenous (recessions cause deficits, holding tax rates constant), so we have reverse causality to some extent.) That "wrongness" in properly measuring "fiscal policy" will bias the estimated coefficient on fiscal policy (presumably downward).

But I can see no reason why it would cause a **smaller** downward bias in the fixed exchange rate countries than in the other countries. If that bias is what is causing fiscal policy to appear ineffective in the other countries, why doesn't it also cause fiscal policy to appear ineffective in the fixed exchange rate countries?

I would disagree with your first point (to an extent). The Kyenesian framework is pretty explicit that the issue is a shortfall in AD as compared to full employment (and that the economy prior to the recession is a good, if imperfect, proxy). The proper start date for measuring austerity is clearly the beginning of the recession. There are arguments for or against definitions of austerity/stimulus, but none of them justify using a different starting date. Consistently using the correct point would go a long way to to evaluating metrics of austerity and of analyzing the effectiveness of fiscal stimulus.

To the second point I could come up with some hypotheticals (some would expose my knowledge of international politics to be laughably inadequete), but I think the assumption that countries or places that opt for fixed exchange rates probably differ from those that don't in some systematic ways is reasonable. That fixed exchange countries could on average enter recession earlier or later and engage in fiscal stimulus earlier or later or engage in less or more (again just on average) than non fixed countries seems very reasonable. But without a proper start date and agreed upon definition of stimulus/austerity it seems unlikely that we could uncover those differences.

Just for the record I am not a Keyenesian. My eyeballing of the data since 2007 makes me think that if we took the start date of the recession in each country and measured austerity/stimulus we would find that fiscal stimulus has a negative sign.

bacon: " I think the assumption that countries or places that opt for fixed exchange rates probably differ from those that don't in some systematic ways is reasonable"

I agree. If I were looking for an alternative explanation, that is where I would start. Though I'm not sure where I would go next.

bacon: " My eyeballing of the data since 2007 makes me think that if we took the start date of the recession in each country and measured austerity/stimulus we would find that fiscal stimulus has a negative sign."

That makes sense theoretically, even if the true fiscal multiplier is big and positive. Because deficits are endogenous for two reasons: tax revenues fall in a recession (passive); and governments may actively increase G or cut tax rates when the economy enters a recession (or sometimes do the opposite, like Greece).

Actually, combining that last thought, and your point I referred to in my comment directly above, would be where I would start looking for an alternative explanation. Countries on fixed exchange rates both need to use fiscal policy and are scared to use fiscal policy. Add in some bias, and it could go either way. And if I thought about it longer, I could probably figure out which way it went, and figure out what I would need to say to interpret the results in a non-monetarist way.


Even with a recession causing deficits we should still see a positive slope for the fiscal multiplier if we had a good definition for austerity/stimulus (assuming a positive multiplier) unless a noticable number of countries were doing "too much" stimulus (I don't recall a Keynesian accusation of even a sigle country over stimulating in the past 8 years, so I doubt there are numerous examples skewing the data).

As an observer I find a few things infuriating when reading. One is that in any science you would expect a publication to be withdrawn if it was discovered that you had excluded a chunk of data without explicitly saying why (it still happens, it just seems very brazen in the econblogsphere to throw out time series without an explanation of why you started and ended where you did).

bacon: "Fiscal policy" is in this case a scalar, not a vector (or a 34x1 vector not a 34xT time periods matrix). There is one observation for each country, defined as the difference between start and end. So you change the data by making the start date 2009 rather than 2008, but you don't exclude data.

And my *guess* is that 2009 is the best start date because it has a better chance of avoiding the endogoneity problem. But I could easily be wrong about that.

Nick: "what was Jason's argument?


Jussi: Jason misses the point about splitting the sample in two.


I'm not sure this is such a strong point. All you have here is two really noisy signals. And to make the thing worse the data generating process is assumed to be different in both and thus also the source of the noise. So both coefficients are biased but in different ways. You basically have two regressions: y1 = (a + n1).x1 and y2 = (b + n2).x2, where a and b are latent variables and a+n1 and b+n2 estimated coefficients with noise component. How can one say that a != b based on a + n1 != b + n2?

Plus only a few data points dominate the inference. Take out the Portugal, Ireland, Greece and Spain (well known PIGS-countries) - which had rather unrelated problems (housing and banking busts) - and you actually don't have slope at all. So (again) there are plenty of other issues (i.e. noise) than just not having ICB (or actually semi-ICB).

And splitting doesn't refute the point (1 or Jason's point 4 and 5) that the test should include the union of ICB and ZLB.

I think Sumner pretty much admitted himself that the analysis is garbage but justified it as a counterstrike to some other bad studies. After that it doesn't deserve a response.

What about devaluation? Using data from BIS (http://www.bis.org/statistics/eer/), there is a strong negative correlation between the CAPB and devaluation. If devaluation is associated with high NGDP growth (which seems plausible) but under floating exchange rates occurs at the same time as austerity, then austerity could be ceteris paribus contractionary, but we would not see any such effect under floating rates - so e.g. in Iceland we see austerity (contractionary) and devaluation (expansionary) and overall not much impact on NGDP. In Eurozone countries we see only the ceteris paribus effect of austerity.


David: that is a good response. And it's constructive too. I left a slightly more detailed comment on your blog. I recommend others read David's post.

Edit: (Are you still at Stirling, or did you move to Zurich? My BA is from Stirling.)

My position (research only, no teaching) is at Stirling, but I live near Zürich and "work from home"

Thanks for your comment.

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