In a “Man for all seasons”, we get the story of Thomas More who stood up to King Henry VIII when the King rejected the Roman Catholic Church to obtain a divorce and remarriage.
Now we have a duo – Larry Summers and Brad Delong – that “adapt” to the season at hand. In their just released paper – Fiscal Policy in a Depressed Economy – they say that in the “liquity trap” situation America is in today temporary stimulus “may actually be self-financing”.
Interestingly, when he was number two to Rubin (and later top Treasury honcho) during the Clinton Presidency (1993 – 2000), Larry Summers peddled “stimulative austerity”, the idea that to cut deficits would lower interest rates by enough to produce stronger growth.
“Stimulative austerity” worked wonders, but not by lowering long term real interest rates. The charts below shows that in early 1998 deficits turned into surpluses (at the time long term CBO long term projections had surpluses extending over the years). Note that deficit reduction/surplus generation came predominantly from a decrease in government expenditures. To Keynesians that should be contractionary, not expansionary.
But note that Summers saw increased growth conditioned on rates coming down. That excessive attention to the level of interest rates is, according to market monetarism precepts, highly misleading. So Summers had his “wish come true”, but not from the reasons he advanced.
In the background, both then and today, there lurks monetary policy. Again, according to market monetarists precepts, to gauge the so called “stance” of monetary policy look at market indicators. “Stimulative” monetary policy will be associated with rising (not falling) real interest rates and asset prices (stock prices, for example).
The next chart shows what was happening to those objects at the time Federal government surpluses became a fixture of the environment. Real rates quickly reversed and stock prices “flourished”.
The next chart shows the behavior of NGDP (nominal spending) relative to the trend path. At about the time the fiscal surplus showed up, nominal spending began to grow above trend, an almost sure fire way to gauge the stance of monetary policy. In fact, those years mark the one mistake (in my view) Alan Greenspan made during his long tenure, resulting in a period of instability within the “Great Moderation” (see here for a discussion).
You may think Summers got it right by advocating “stimulative austerity”. But his indicator variable – interest rates – moved in the “wrong” direction. Yes, you guessed, monetary policy did it! And it´s monetary policy that can turn things around today. So that´s where the advocates of fiscal stimulus should band together and stop wasting precious time.
Note that inflation stops falling, the natural result of an increase in productivity, as soon as monetary policy becomes “easy”. One could say that the Fed was being symmetrical, expanding MP because inflation was below “target”. But this episode just shows how misleading inflation targeting can be, especially when the economy is buffeted by (positive or negative) supply shocks. And unemployment falls well below the most liberal measure of the natural rate.
Observation: Summers and DeLongs idea of a “self-financing” deficit is not new. President Kennedy was strongly advocating tax cuts all the way from 1961 to his untimely death. The legislation was finally passed a few months after his assassination. From 1962:
“It is a paradoxical truth that tax rates are too high and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now … Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus.”
– John F. Kennedy, Nov. 20, 1962, president’s news conference
De Long put up a comment to the effect I should have read the article. I think I read the relevant parts. Going to his site I found this succinct summary (see below). It says it all, in particular the first bullet point. If it´s because their argument applies ONLY as long as the monetary authority cannot or will not…, I would think the first best solution is not to bring in a different policy strategy, and one that has much against it, but instead “battle” for the Fed to carry out the stabilization mission.