The guys back in the 1960s understood it better: There´s no Fiscal “Stimulus” without Monetary “Stimulus”

I was just reading this post by Laura D´Andrea Tyson:

The output gap reflects a deficit of more than 12 million jobs – the number of jobs needed to return to the economy’s peak 2007 employment level and absorb the 125,000 people who enter the labor force each month. Even if the economy grows at 2.5% in 2012, as most forecasts anticipate, the jobs deficit will remain – and will not be closed until 2024.

The US does indeed face a long-run fiscal deficit, largely the result of rising health-care costs and an aging population. But the current fiscal deficit mainly reflects weak tax revenues, owing to slow growth and high unemployment, and temporary stimulus measures that are fading away at a time when aggregate demand remains weak and additional fiscal stimulus is warranted.

So, how should the US economy’s jobs deficit, investment deficit, and long-run fiscal deficit be addressed?

Policymakers should pair fiscal measures to ameliorate the jobs and investment deficits now with a multi-year plan to reduce the long-run fiscal deficit gradually. This long-run plan should increase spending on education, infrastructure, and research, while curbing future growth in health-care spending through the cost-containment mechanisms contained in Obama’s health-reform legislation.

Approving a long-run deficit-reduction plan now but deferring its starting date until the economy is near full employment would prevent premature fiscal contraction from tipping the economy back into recession. Indeed, enactment of such a package could bolster output and employment growth by easing investor concerns about future deficits and strengthening consumer and business confidence.

Painful choices about how to close the long-run fiscal gap should be decided now and implemented promptly once the economy has recovered. But, for the next few years, the priorities of fiscal policy should be jobs, investment, and growth.

What a waste. No mention of monetary policy at all. Would it be because MP is “working double-time” to keep inflation close to the 2% target?

Scott Sumner has an illuminating discussion on Krugman and austerity:

So I read the UK austerity critics as saying:

Because you guys are too stupid to raise your inflation target to 3%, or to switch over to NGDP targeting, fiscal austerity will fail.  We believe the solution is not to be less stupid about monetary policy, but rather to run up every larger public debts.

Is that right?  Is that what critics are doing?

Now go back 50 years and see what the guys that “invented” the “output gap” concept thought (and this from the pen of non other than 1981 Nobel Laureate James Tobin, member of the CEA in 1961-62):

  1. The “new economics” (read “Keynesian economics) sought to liberate federal fiscal policy from restrictive guidelines unrelated to the performance of the economy.
  2. The Council sought to liberate monetary policy to focus it squarely on the same macroeconomic objectives that should guide fiscal policy.

Yes, they went too far in pursuing policies (fiscal and monetary) to close the gap. The charts below show Arthur Okun´s output gap from the Economic Report of 1969 (Okun was then Chairman) and the CBO based counterpart. It appears that the 1964 tax cut was “overkill” as a stabilization tool.

3 thoughts on “The guys back in the 1960s understood it better: There´s no Fiscal “Stimulus” without Monetary “Stimulus”

  1. Nice post. I like the point about fiscal and monetary policy having the same target. What target for fiscal policy do advocates of fiscal “stimulus” believe in? “Higher real GDP”!?

    • Those guys “invented” the “gap model”, only then it was the “unemployment gap” because employment was what they had to “target” from the 1946 Employment Act. They went about it with gusto and verve, so much so that the decade became known as “Golden Age”.
      In 1968 Friedman threw “cold water” with his “What MP can do”, arguing the Phillips Curve was not stable. A little after that inflation “blossomed” and the “GA” became the “Great Inflation”.

  2. The Fede, ECB and Bank of Japan need to practice Market Monetarism—certainly that would work better than the directionless mush we have today.

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