David Beckworth presents this chart
This first figure shows that aggregate demand growth has not been affected by a tightening of fiscal policy since 2010. Specifically, it shows that nominal GDP (NGDP) growth has been remarkably stable since about mid-2010 despite a contraction in federal government expenditures. The same story emerges if we look at the budget deficit relative to NGDP growth.
Both figures seriously undermine the argument for countercyclical fiscal policy and suggest a very a low fiscal multiplier.
In response, Krugman writes:
What Beckworth does is show that there isn’t a correlation between either federal expenditures or the federal deficit and nominal GDP growth in recent years; Noah’s point is that fiscal policy is endogenous, affected by the state of the economy. When things seemed to be collapsing, Washington managed to pass a stimulus bill; when they stopped collapsing, the stimulus was allowed to fade away. So?
It is, by the way, kind of dispiriting to see this kind of argument still being trotted out four years into this whole debate — and presented as if it were something new, too. Been there, addressed that; is it really so hard to make any sort of progress here?
“Allowing the stimulus to fade away” was certainly not what Krugman desired and he normally argues that the stimulus should be increased. But Beckworth´s point is exactly that even with “stimulus fading away” the Fed has kept the economy humming. Beckworth also notes, taking a cue from a comment by Benjamin Cole, that:
P.S. Though the Fed has been doing a remarkable job keeping NGDP growth stable since mid-2010, it has yet to allow a period of catch-up nominal spending growth that would return NGDP to its pre-crisis trend. So the Fed’s work is not complete.
Let´s take Beckworth´s chart back a couple of decades.
The same pattern emerges. During the 1990s – halcyon days of the “Great Moderation” – nominal spending growth was stable along a trend level path. The drop in government spending (G/Y) and deficit had no negative (and likely positive) impact on the economy´s performance. The 2001 recession brought forth a rise in G/Y – the endogenous part associated with “automatic stabilizers” plus government purchases associated with the Bush wars.
In a sense, the Fed has the economy where it wants. Inflation is subdued, just as the Fed wants, but unemployment/employment is too high/low so the Fed is discussing establishing “thresholds” to guide monetary policy.
In mid-2009 nominal spending began to grow, marking the start of the recovery. As Beckworth notes, this growth still leaves a big “hole” relative to trend (even if the trend is reduced somewhat) that “houses” the unemployed. The chart below illustrates.
Krugman´s view is that monetary policy is more or less powerless to “fill the hole” – his liquidity trap argument – so that fiscal stimulus should be increased. But Bernanke knows this is not true. And for knowing so and not doing near enough to get the job done he is acting “criminally”.
Let us move over the Atlantic and check on France – inside the EZ – and Sweden, outside.
Swedish nominal spending growth was on trend after the adjustments of the early 1990s while G/Y was shooting down. In France, nominal spending growth was also close to trend while G/Y was relatively constant.
When the crisis hit, G/Y rose in both countries. But while in Sweden it has “faded away”, in France it remained at the higher level. Nevertheless, spending growth in Sweden picked up, lifting spending back towards trend with real growth picking up and unemployment coming down. Lately, as noted by Lars Christensen in this post, Swedish monetary policy has taken a “turn for the worse”. Note that spending is not converging to the trend any longer.
In France, despite the increase in G/Y, since nominal spending remains well below trend the economy is much worse shape, with higher unemployment and lower (or no) real growth.
Bottom line: It´s nominal spending, i.e. monetary policy, not fiscal policy (stimulus) that “rules the waves”.
Addendum: Knowledge evolves and new evidence become available
In a post from December 2009, at the time of Paul Samuelson´s death, Paul Krugman wrote on Samuelson, Friedman, and Monetary Policy:
Paul Samuelson was a great economic theorist. But he was also an acute observer of the real world, to such an extent that many of the things he said in his 1948 textbook ring truer than what many, perhaps most economists believed on the eve of the current crisis.
This is especially true with regard to monetary policy. By the 1980s, I think it’s fair to say that the vast majority of economists had been convinced by Milton Friedman’s assertion that aggressive monetary policy could have prevented the Great Depression. Some of us started to have doubts after contemplating Japan’s troubles in the 1990s; but as late as 2002 Ben Bernanke declared, on behalf of the Federal Reserve, “You’re right. We did it. But thanks to you, we won’t do it again.”
But here’s Paul Samuelson, from pages 353-4 of his 1948 textbook:
Today few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle. Purely monetary factors are considered to be as much symptoms as causes, albeit symptoms with aggravating effects that should not be completely neglected.
But Krugman neglects to indicate that almost four decades later, in the 1985 edition of his textbook, Samuelson (now writing with W. Nordhaus) wrote: “Money is the most powerful and useful tool that macroeconomic policymakers have, and the Fed is the most important factor in making policy.”
So by 1985 Samuelson had come to agree with Friedman. It was a long road travelled since 1969 when in one of his Newsweek columns he nastily referred to Friedman saying:
“There´s no sight in the world more awful than that of an old-time economist, foam-flecked at the mouth and hell-bent to cure inflation by monetary discipline. God willing, we shan´t soon see his like again.”
It seems our present day monetary policy makers have to relearn Milton´s lessons.
PS: Tyler Cowen, in commenting on the debate writes:
My view is this: The Fed cannot very well control ngdp during a credit collapse (parts of 2008-2009) but it can control ngdp in a so-called “liquidity trap.”
Why would this be so? In fact, the intensity of the crisis was the result of the Fed allowing NGDP to tank after mid-2008. Before that, even with nominal spending falling a bit below trend the recession was certainly not “great”. It was by “not controlling” NGDP that the Fed made the recession became “great”.
Update: Tim Congdon has a good discussion in: