The term ‘Keynesian economics’ means different things to different people. But one thing almost everyone can agree on is that Keynesians believe that the 2009 fiscal stimulus boosted aggregate demand, at least compared to the no-stimulus alternative. Alternatively, Keynesians believe the fiscal multiplier is positive. In my view that’s a sort of sine qua non of modern Keynesianism. Yes, it has many other things to say, but without the fiscal multiplier there’s nothing particularly “Keynesian” about the rest of the theoretical apparatus.
Even if you don’t agree with me, surely you’ve read dozens of pundits, reporters, economists and politicians make the argument for a positive multiplier, and call that argument “Keynesian.” Indeed many go further and suggest that only unenlightened conservative ideologues could question something so obvious, so well established by both theory and empirical studies.
I’m here to tell you that it’s all a fraud. There is no empirical study that shows the 2009 stimulus was effective. It’s not even clear new Keynesian theory implies it was effective. It might, but it also might not. There is nothing scientific about “the multiplier.” And many of the arguments made by pundits (with a few notable exceptions like Avent and Yglesias) are deeply misleading to readers.
Let’s start with the easy part. New Keynesian theory predicts that the fiscal multiplier will be zero if the central bank is targeting inflation in a forward-looking fashion. That is, increased deficit spending will not increase expected future growth in aggregate demand. The smarter Keynesians know this, but the “smarter Keynesians” are a very, very small group. If you polled PhD trained economists in America, I’d guess less that 10% know this, maybe less than 2%.
Even worse, many of the Keynesians who do know this fail to mention it in most of their “pro-stimulus” screeds, thus giving average readers the impression that a positive multiplier is the default assumption, and that it’s up to those who disagree to explain why. No, it’s up to those who believe fiscal stimulus would cause the Fed to stop targeting inflation (or stop Taylor Rule-type policies) to explain why they believe this.
Long time readers of this blog know that the monetary offset problem quickly degenerates into debate over whether the Fed would “sabotage” fiscal stimulus. I don’t like that framing, because it implies monetary policy forces the Fed to “do something” to offset fiscal stimulus, or more precisely to “do something that looks like it’s doing something” to offset fiscal stimulus.
In a recent comment section, Statsguy asked if I thought the Fed would have offset a lack of fiscal stimulus in 2009. I do think so, indeed I believe that the current unemployment rate would probably be lower than 7.7% if there had been no fiscal stimulus in 2009. I will explain why, using what I hope everyone will see as eminently reasonable assumptions. I’m not claiming that I know exactly what would have happened, but rather that quite plausible counterfactuals can leave us with a negative multiplier, contrary to the claims of Keynesians. Here are my assumptions:
- In early 2009 there were fears of depression. Stock prices had collapsed and unemployment was soaring. People were frightened.
- If the fiscal policymakers provided no stimulus, Bernanke and the Fed would have felt an incredible burden to save the economy.
- However, I would not expect the Fed to do anything that looked radical or dangerous.
- I would have expected them to take off the shelf the most highly regarded models of how to save an economy with monetary policy when stuck at the zero bound. That would be the Woodford model, which calls for level targeting of prices.
- I would have expected them to use at least some of the ideas that Bernanke suggested the BOJ employ. One of those was level targeting of the price level.
- They would have been reluctant to abandon the 2% inflation target, with level targeting of the price level they would not have had to.
- Do you see where I’m going? Level targeting of the price level along a 2% path is the overwhelmingly most likely “nuclear option” to be employed by the Fed if the economy is falling off the cliff and the fiscal policy makers are doing nothing.
- The level targeting theory suggests you want to make up ground lost in the crisis period where monetary stimulus is (supposedly) ineffective. I think they would have started the trend line for the price level in September 2008, which is both the peak month for the price level (it started falling in October) and also the month the financial crisis blew up.
- The Fed uses the PCE price index, so we’ll assume they targeted that index (although the CPI or the core PCE would give you similar results.) The PCE on September 2008 was 110.275. That means the PCE for January 2013 should have been 120.165.
- The actual PCE in January 2013 was 116.342, well below the Fed’s likely target under PLT regime. In other words, under the most likely alternative (no fiscal stimulus) policy, prices would have likely risen much faster than the actual path of prices, assuming the Fed was able to hit its target.
- Because both fiscal and monetary stimulus impact the demand-side of the economy, the depressed price level of January 2013 means, ipso facto, that AD and NGDP have also risen more slowly than under the no-fiscal stimulus PLT alternative. We are worse off after having wasted hundreds of billions of dollars in fruitless deficit spending.
I can anticipate the objections: ”What makes you think the Fed would have hit its price level target?” Initially I think they would have failed, but recall that even in the NK model a higher inflation target is far more effective than QE. As prices fell in 2009, the expected inflation rate would tend to rise under PLT. So even using the assumptions of the NK model, the Fed would have been doing a policy that is far more effective than the policy they actually conducted. Surely that counts for something! Indeed, with a higher inflation target you don’t even need to do as much QE, other things equal. If you add in the lack of fiscal stimulus, then it’s unclear whether the PLT regime I propose would have required more or less QE than what we actually saw.
To be clear, I am not claiming that I “know” that this counterfactual would have occurred. But I think any fair-minded person would admit that it’s a plausible counterfactual. Here’s what I am claiming:
- My counterfactual is plausible.
- Almost all Keynesian discourse on fiscal stimulus, multipliers, neanderthal conservatives, etc, implicitly implies that my counterfactual is not plausible.
- Hence Keynesianism is nothing but a sandcastle built on a pile of flawed assumptions.
Maybe the 2009 fiscal stimulus helped a lot. That’s possible. But don’t pretend that your belief in the 2009 fiscal stimulus is any different from blind faith in some sort of religious dogma. There’s no science to back it up, and none of the empirical studies I’ve seen have any bearing on the counterfactual I just presented. None.
PS. Remember those Keynesians telling us that higher payroll taxes would slow retail sales in Q1? Looks like they might want to revise their models:
WASHINGTON (Reuters) – Retail sales expanded at their fastest clip in five months in February, the latest sign of momentum for an economy facing headwinds from higher taxes and pricier gasoline.
The solid sales last month comes on the heels of strong gains in employment and manufacturing. But the improvement in the economic picture is likely insufficient to shift the Federal Reserve from its very accommodative monetary policy stance.
“The economy in February is looking solid. None of this, however, is likely to cause the Fed to change tack in the near term,” said John Ryding, chief economist at RDQ Economics in New York.
Retail sales increased 1.1 percent, the largest rise since September, after a revised 0.2 percent gain in January. That was well above economists’ forecasts for a 0.5 percent advance.
So-called core sales, which strip out automobiles, gasoline and building materials and correspond most closely with the consumer spending component of gross domestic product, rose 0.4 percent after increasing 0.3 percent in January.
The upbeat report helped to lift to the dollar to a seven-month high against a basket of currencies. Prices for U.S. government debt fell and stocks on Wall Street slipped after a recent rally.
The healthy gains in retail sales came despite the end of a 2 percent payroll tax cut and an increase in tax rates for wealthy Americans on January 1.
Spending is being supported by the stock market rally, rising home prices and sustained job gains which are starting to push wages higher.
GROWTH FORECASTS RAISED
The gains in core sales in the first two months of the year offered hope that consumer spending, which accounts for about 70 percent of the U.S. economy, would probably not slow much this quarter after growing at a 2.1 percent annual rate in the fourth quarter.
A second report from the Commerce Department showed business inventories rose by the most in more than 1-1/2 years in January.
Retail inventories, excluding autos – which go into the calculation of gross domestic product – recorded their largest increase since August 1995.
That and the rise in core retail sales should help boost economic growth after output barely expanded in the last three months of 2012.
Economists raised their first-quarter growth estimates by as much as eight tenths of a percentage point after the reports.
Despite paying 35 cents more for gasoline at the pump, consumers also bought automobiles last month.
Receipts at auto dealerships rose 1.1 percent after falling 0.3 percent in January. Excluding autos, retail sales increased 1.0 percent, also the largest increase in five months. That followed a 0.4 percent advance in January.