A “nuanced” hawk

Josh Hendrickson calls attention to this paper by St Louis Fed President Bullard. From the conclusion (my bolds):

Fiscal policy as a macroeconomic stabilization tool enjoyed renewed popularity in the past several years, contrary to a conventional wisdom that had been established during the two decades before the financial crisis that began in 2007. However, the conventional wisdom is turning out to be correct after all, and so the theory is dying (note: Are Krugman´s recent “attacks” on those that say fiscal policy cannot stimulate a “swan song”?)

The academic case for turning to fiscal policy to offset macroeconomic shocks can be made in a New Keynesian DSGE model in which certain assumptions hold. In this paper, I have largely accepted the New Keynesian story as it is usually told I have not tried to challenge the many assumptions that lie behind the analysis, even though one could take that approach as well. Instead, I have argued that, even accepting most of the analysis, one should have considerable doubt about the merits of possible fiscal stabilization programs.

I have argued that there are three key problems: (1) The types of Fiscal policy interventions recommended in the literature are fairly intricate and must be designed carefully if they are to have the desired effect. This delicacy is at odds with the conventional wisdom on fiscal stabilization policy as I have laid it out, which emphasizes that political processes in the U.S. and elsewhere are not well-suited to make timely and subtle decisions like this;

(2) The theory critically relies on monetary policy being ineffective once the zero bound is encountered, but many have argued that the zero-bound constraint does not limit present-day monetary policy because there are many other tools that the monetary policy authority can use to influence inflation and inflation expectations. In fact, many analyses of FOMC policy over the past three years have suggested that monetary stabilization policy has been fairly effective (note: Nick Rowe and market monetarists in general argue that Western central banks missed the point with current QE policies – they printed the money without making the promise. Nobody who looks at the Federal Reserve’s divided board, for example, expects it to print unlimited assets to reflate the US economy);

(3) The actual Fiscal stabilization policy experiment did not involve funding increased government spending with lump-sum taxes, as contemplated in the theory, but instead involved heavy borrowing on international markets. In models, the borrowing would be interpreted as promised future distortionary taxes, but it is exactly the shifting of distortionary taxes into the future beyond the period of the binding zero lower bound and financial market turbulence that can undo most or all of the benefits that might otherwise come from the Fiscal stabilization program.

I conclude that the recent turn toward fiscal approaches to stabilization policy has run its course. The conventional wisdom of the past several decades is reasserting itself because it has proved to provide wise counsel.

Stabilization policy should be left to the monetary authority, which can operate effectively even at the zero lower bound. Fiscal policy should return to being set for the medium and longer run. A stable tax code that does not change very often lays down the rules inside the macroeconomy and allows businesses and households to make investments effectively. And a government spending program that adds up over a 50-year time horizon increases confidence that the tax code will not have to be altered too much going forward.

The problem with Bullard is that he favors the wrong target – IT.

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