If only monetary policy in 2008 had been what it was in 2020.

Many like to compare the Covid19 contraction with the Great Depression. In addition to the nature of the two contractions being completely unrelated, while in the first two months of the Covid19 crisis (from the February peak to the April trough) RGDP dropped 15%, it took one year from the start of the Great Depression for RGDP to drop by that amount.

Although the Covid19 shock has also no common element with the Great Recession, a comparison between the two is instructive from the monetary policy point of view. This is so because the Great Recession was the “desired outcome” of the Fed´s monetary policy. Bear with me and I´ll try to convince you that is not a preposterous statement.

Motivated by the belief that the 2008-09 recession originated with the losses imposed on banks by their exposure to real estate loans and propagated through a consequent breakdown in the ability of banks to get loans to credit-worthy borrowers, government, the Fed and regulators intervened massively in credit markets to spur lending.

Bernanke´s January 13, 2009 speech “The crisis and the policy response” summarizes that view:

“To stimulate aggregate demand in the current environment, the Federal Reserve must focus its policies on reducing those spreads and improving the functioning of private credit markets more generally.”

Bernanke´s “credit view” of the monetary transmission process is well established. Two articles support that view.

His flagship 1983 article is titled “Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression.”

“…we focus on non-monetary (primarily credit-related) aspects of the financial sector–output link and consider the problems of debtors as well as those of the banking system. We argue that the financial disruptions of 1930-33 reduced the efficiency of the credit allocation process; and that the resulting higher cost and reduced availability of credit acted to depress aggregate demand.

His 1988 primer “Monetary Policy Transmission: Through Money or Credit?

“…The alternative approach emphasizes that in the process of creating money, banks extend credit (make loans) as well, and their willingness to do so has its own effects on aggregate spending.”

For details on the Fed´s credit market interventions (with the purpose of reducing spreads, which to the Fed is a sign of credit market dysfunction), see chapter 15 of Robert Hetzel´s “The Great Recession

“The answer given here is that policy makers misdiagnosed the cause of the recession. The fact that lending declined despite massive government intervention into credit markets indicated that the decline in bank lending arose not as a cause but as a response to the recession, which produced both a decline in the demand for loans and an increase in the riskiness of lending.

In their effort to stimulate the economy, policy makers would have been better served by maintaining significant growth in money as an instrument for maintaining growth in the dollar expenditures [NGDP growth] of the public rather than on reviving financial intermediation

The charts below attest to that fact insofar as spreads began to fall, the dollar exchange rate began to depreciate and the stock market began to rise, only after the Fed implemented quantitative easing (QE1) in March 2009.

The purchase of treasuries by the Fed was what “saved the day”, not the array of credit policies that had been implemented for several months prior. Note, however, that the monetary policy sail was only at half-mast. On October 2008, the Fed had introduced IOER (interest on reserves), so that the rise in the monetary base from all the Fed´s credit policy would not “spillover” into an increase in the money supply. (The rise in the reserve/deposit (R/D) ratio in fact more than offset the rise in the base, so money supply growth was negative).

What QE did was to increase the velocity of circulation. With that, spending (NGDP) growth stopped falling and then began to rise slowly. As the next chart shows, the Fed (due to inflation worries) never allowed NGDP growth to make-up for the previous drop, “calibrating” monetary policy to keep NGDP growth on a lower trend path and lower growth rate.

Skipping to 2020, when the Covid19 shock hit, NGDP tanked. With spreads rising, the Fed again, now under Jay Powell (who must have learned “creditism” from his time with Bernanke), quickly announced a large batch of programs to intervene in credit markets to sustain financial intermediation.

While in the U.S., it was all about “closing spreads”, in Europe the sentiment was the opposite:

Christine Lagarde (March 12): “We are not here to close spreads”

Laurence Meyer (March 17): “The Fed is here to close spreads”

In “Covid19 and the Fed´s Credit Policy”, Robert Hetzel writes:

“…When financial markets actually did continue to function, Chairman Powell claimed that it was because of the announcement effect that the programs would become operational in the future…”.

Looking at the charts for the period, we again observe that spreads fell (markets functioned) when monetary policy – through open market operations, with the Fed buying treasury securities – becomes expansionary. The difference, this time, is that the monetary policy sail was at “full mast”, so that money supply growth rose fast.

Compared to the post 2008-09 period, NGDP reversed direction in a V-shape fashion (data on monthly NGDP to June from Macroeconomic Advisers). This time around, it seems the Fed is set in making-up for the lost spending, returning NGDP to the trend level that prevailed from 2009 to 2019.

Going forward, once the economy fully reopens the Fed will have to make clear that monetary policy will the conducted to maintain nominal stability (i.e. NGDP cruising along the trend level path it was on previously). Given the degree of fiscal “overkill” that has been practiced, the Fed will have to resist pressures to maintain an overly expansionary monetary policy to relieve fiscal stress through inflationary finance.

On Fiscal policy and the ZLB (What´s he on about?)

A Mark Sadowski post

Evan Soltas writes on a theme that is much in vogue lately: “Fiscal Policy and the ZLB”:

I have been doing some reading for my undergraduate thesis, which looks at the role of credit-supply shocks in the Spain during its housing boom and bust, and I came across some interesting thoughts from Bob Hall. Commenting on research by Alan Auerbach and Yuriy Gorodnichenko, Hall makes some useful points that contradict a lot of the received wisdom about the efficacy of fiscal policy:

I conclude that the chapter uncovers a proposition of great importance in macroeconomics—that the response to government purchases is substantially greater in weak economies than in strong ones. The finding is a true challenge to current thinking. The first thing to clear away is that the finding has little to do with the current thought that the multiplier is much higher when the interest rate is at its lower bound of zero…Standard macro models have labor and product supply functions that are close to linear over the range of activity in the OECD post-1960 sample. The simple idea that output and employment are constrained at full employment is not reflected in any modern model that I know of. [Bolding is by me, not Hall.]

On the economics blogosphere, the “current thought” is also that, because monetary policy is in certain respects (that is, if only by social convention) constrained when the policy rate hits zero, fiscal policy becomes discontinuously powerful at the zero lower bound. Once the policy rate is a quarter of a percentage point, time to turn off fiscal policy, one might infer. Scott Sumner is one of the clearest and most persuasive exponents of this view—see here, for instance.

It turns out that the best evidence on fiscal policy does not support it. That conclusion is new to me, which is to say that I think I have written things that rely on that view, and I would now consider them to be wrong.


To be clear on what I mean here: First, it is a classic result that, when the efficacy of monetary policy is uncertain, it should not fully stabilize demand. Second, if the zero lower bound poses any restrictions on monetary policy, and it obviously does, if only in many indirect ways, then the appropriate amount of conservatism actually increases the risk of a future zero lower bound event rises, which is basically a function of the current policy rate. Fiscal multipliers are, as a result, well above zero when the policy rate is positive and decrease slowly and smoothly in the policy rate.

It makes sense if you think in terms of the fiscal multiplier being a measure of monetary policy incompetence. But just because monetary policymakers may be less than fully competent doesn’t mean that monetary policy is impotent.

Soltas’ reference to Scott Sumner needs explaining (perhaps even to Evan). When Scott says that the fiscal multiplier is zero above the zero lower bound he is not suggesting it is positive at the zero lower bound. Scott doesn’t believe in the liquidity trap, so when Scott says this what he is really saying is that even under the assumption of the existence of the liquidity trap, monetary policy makers should be held fully accountable for the level of nominal income away from the zero lower bound (as they clearly are now in the US). 

Seven years of US experience in steering nominal income without the use of the fed funds rate as the policy instrument should completely disabuse us of the existence of the liquidity trap. When you take into account the ability of monetary policy to offset fiscal policy, the fiscal multiplier is zero, even at the zero lower bound in interest rates.

The chart illustrates:

MS Comment

Contrasting views on negative rates

By two former central bankers.

Narayana Kocherlakota writes:

So, going negative is daring but appropriate monetary policy.   But it is a sign of a terrible policy failure by fiscal policymakers.

The reason that the FOMC has to go negative is because the natural real rate of interest r* (defined to be the real interest rate consistent with the FOMC’s mandated inflation and employment goals) is so low.   The low natural real interest rate is a signal that households and businesses around the world desperately want to buy and hold debt issued by the US government.   (Yes, there is already a lot of that debt out there – but its high price is a clear signal that still more should be issued.)  The US government should be issuing that debt that the public wants so desperately and using the proceeds to undertake investments of social value.

But maybe there are no such investments?  That’s a tough argument to sustain quantitatively.  The current market real interest rate – which I would argue is actually above the natural real rate r* – is about 1% out to thirty years.  This low natural real rate represents an incredible opportunity for the US. We can afford to do more to ensure that all of our cities have safe water for our children to drink.  We can afford to do more to ensure that our nuclear power plants won’t spring leaks.  We can afford to do more to ensure that our bridges won’t collapse under commuters.

These opportunities barely scratch the surface.  With a 30-year r* below 1%, our government can afford to make progress on a myriad of social problems.  It is choosing not to.

If the government issued more debt and undertook these opportunities, it would push up r*.  That would make life easier for monetary policymakers, because they could achieve their mandated objectives with higher nominal interest rates. But, more importantly, the change in fiscal policy would make life a lot better for all of us.

William Poole writes:

It won’t work. Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved.

Part of the impetus behind a central bank’s negative interest-rate policy is a desire to devalue the currency. With lower market interest rates, holders of euros, for example, may sell them to flee to countries with higher interest rates—driving down the euro’s exchange rate, boosting European exports and growth. But it is impossible for every country in the world to depreciate its currency relative to others. If the European Central Bank hopes to force euro depreciation against the yen and the Bank of Japan hopes to force yen depreciation against the euro, one or both of the central banks will fail.

Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. In the U.S., Congress should force the Federal Reserve to come clean about why growth has been so slow. The forthcoming congressional monetary policy oversight hearings—Feb. 10 for the House Financial Services Committee and Feb. 11 for the Senate Banking Committee—are the right place to explore what is wrong with the U.S. economy.

These committees ought to insist that the Fed, with its large and expert staff, present relevant studies by mid-June, in time for the annual oversight hearings in July. At the July hearings, the Fed can discuss its research. Academic and other experts can offer their analysis of the Fed’s findings. Instead of vague Fed statements about “headwinds,” the nation deserves solid empirical work on the problem.

Note, however, that both appeal to monetary policy to correct fiscal/structural failures! NK, for example, did much better in a previous post:

The Committee needs to change its basic policy framework.  Monetary policy is not about targeting the level and volatility of interest rates. The FOMC needs to have a framework in which the fed funds rate (and its other tools) are much more responsive to its medium-term forecasts of inflation and employment shortfalls.  Markets would then have to adjust to the possibility that interest rates might have to change rapidly, at any time and in either direction, if the FOMC believes that change is necessary to achieve its macroeconomic objectives more rapidly.

The economy behaved just a ‘prescribed’ by monetary policy

Econbrowser links to a study by Blinder and Zandi, who develop the counterfactual::

Or, one can appeal to extant estimates of multipliers to estimate how the economy would have performed in the absence of fiscal and monetary stimulus and financial system rescuses. That is exactly what is done in a Blinder-Zandi CBPP study, with the results shown in Figure 1.


My take is simpler. There was an initial massive monetary failure, which allowed nominal aggregate spending (NGDP) to crumble. A belated and timid monetary policy reaction, starting with QE1 breathed a little air into the tire, enough for it to “slowly” roll up the hillside.


I agree that the rescue operation for banks and others, in addition to the timid monetary policy reaction, “saved” the economy from the financial propagation mechanism that continued to punish the economy in 1931/32.

In their exercise, B-Z write:

To quantify the economic impacts of the aforementioned panoply of policies, we simulated the Moody’s Analytics model of the U.S. economy under different counterfactual scenarios. In all scenarios, the federal government’s automatic stabilizers—the countercyclical tax and spending policies that are implemented without explicit approval from Congress and the administration—are assumed to operate. So is the traditional monetary policy response via the Federal Reserve’s management of short-term interest rates, albeit constrained by the zero lower bound

To assess the full impact of the policy response, the “No Policy Response” scenario assumes that, apart from the above, policymakers simply sit on their hands in response to the crisis.

So I wonder what makes the economy turn around so briskly after 2011. The turnaround in March 1933 was the direct and immediate result of a monetary regime change.


Permanent Effects of Fiscal Consolidations or Permanent Effects of Monetary Crashes?

From the abstract of Fatás and Summers “The Permanent Effects of Fiscal Consolidations”:

The global financial crisis has permanently lowered the path of GDP in all advanced economies. At the same time, and in response to rising government debt levels, many of these countries have been engaging in fiscal consolidations that have had a negative impact on growth rates. We empirically explore the connections between these two facts by extending to longer horizons the methodology of Blanchard and Leigh (2013) regarding fiscal policy multipliers. Using data seven years after the beginning of the crisis as well as estimates on potential output our analysis suggests that attempts to reduce debt via fiscal consolidations have very likely resulted in a higher debt to GDP ratio through their negative impact on output. Our results provide support for the possibility of self-defeating fiscal consolidations in depressed economies as developed by DeLong and Summers (2012).

In early 2012, I commented on Summers and DeLongs “Self-financing deficits:

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.

There was certainly a lot of consolidation, although real interest rates rose instead of fall. 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.

Now Summers argues that fiscal consolidation has had a permanent negative effect on the level of RGDP. From the conclusion:

The global financial crisis has permanently lowered the path of GDP in all advanced economies. In none of these countries GDP is expected to return to its pre-crisis levels. At the same time, many of these countries have been engaging in fiscal consolidations in response to rising government debt levels that had a negative impact on growth rates. In this paper we use the methodology of Blanchard and Leigh (2013) to show that fiscal consolidations had long-term effects on GDP, at horizon much longer than the traditional analysis of fiscal policy multipliers.

As the charts below show, it is more likely that what has “permanently” lowered the path of RGDP is the “permanent” monetary crash that took place in 2008 (both in the US and Europe).

Summers Permanent Effects_1

During the Great Inflation NGDP was growing on a rising trend, with RGDP remaining much of the time above trend (“potential”). During the Great Moderation, with NGDP evolving very close to the trend path, RGDP was also very close to trend. The monetary crash (that was never offset) has doomed RGDP to a permantly lower level!

Simon says: monetary policy is better, when possible

Simon Wren-Lewis writes:

There are practical reasons for preferring interest rate changes (when possible) to changes in government spending as the stabilisation tool of choice, although the extent to which these are inevitable or just conditional on current institutional arrangements is an interesting question. Here I want to give an economic reason for this preference.


The government could prevent waste in two ways. It could persuade consumers to hold less money and buy more goods, which we can call monetary policy. Or it could buy up all the surplus production and produce more public goods, which we could call fiscal policy. Both solutions eliminate waste, but monetary policy is preferable to fiscal policy because the public/private good mix remains optimal.

Three comments on this reason for preferring monetary policy. First, if for some reason monetary policy cannot do this job, clearly using fiscal policy is better than doing nothing. It is better to produce something useful with goods rather than letting them rot…

He would have naturally come to the “solution” if he freed himself from the “monetary policy=interest rate policy” constraint and thought of monetary policy as providing a stable nominal background with, for example, a nominal spending (NGDP) target.

Osborne needs to learn some Market Monetarism

A James Alexander post

Keynesians, especially left-wing ones, are hyper-quick to attack George Osborne, the U.K. Chancellor of the Exchequer (aka the Finance Minister or Treasury Secretary) for the smallest attempts at controlling the budget deficit and howl him down whenever he is so economically illiterate to think there is the smallest problem with Britain’s 80% debt to GDP ratio.

Perhaps on the day when Osborne’s deficit reduction plans went a bit astray they were all too busy cracking open the prosecco that they failed to spot significantly worrying remarks about monetary policy.

The Times reported thus , while Osborne was tripping through ChIna:

Mr Osborne hinted earlier yesterday that interest rates were going to rise, clearly siding with Mark Carney, the Bank of England governor, against Andy Haldane, its chief economist, who recently suggested that rates might have to stay low for longer because of problems in the Chinese economy, or may even need to fall.

Mr Osborne appeared to play down last week’s decision by the US Federal Reserve to hold rates rather than put them up, saying it had been dictated by the circumstances at the time.

Then he added, in what was close to a departure from the traditional reluctance of chancellors to interfere with the independence of the Bank, that the signals of rate rises in recent weeks reflected the growth in the American and British economies and that the “general signal coming from the Bank and the Federal Reserve is that the exit from very loose monetary policy is going to come”.

For starters, I thought this might trigger a debate about Central Bank Independence. (CBI) which has been filling then UK macro blogs like here and here since the Corbynomics debate exploded. Personally, I am CBA about CBI, the policy is the key, and often central bankers can’t be trusted to make good policy, but governments can, eg Japan. Of course, we see things often the other way around, too, but it is a sterile debate about means rather than ends.

The bigger issue is why Osborne thinks monetary policy is very loose. To be fair mainstream macro and “mediamacro” (HT Simon Wren-Lewis for the term) make the common mistake all the time of confusing interest rate levels and the amount of QE with the stance of monetary policy. The stance of monetary policy can only be measured by looking at whether demand for money is outstripping supply of money, and that can only be seen by looking at where nominal growth (aka Aggregate Demand) is headed. If on a downward trend money is tight, if on an upward trend money is loose. If in trend monetary policy is just right.

The recent historical economic evidence is that UK NGDP is slowing down, 2Q15 was quite poor. The relevant inflation rate for macro policy, the GDP Deflator was worse than poor. Tax revenue growth on incomes is still not great, just like the more difficult to measure wage growth itself. Looking forward, implied UK NGDP growth forecasts are weakening too, judging by market indicators like Sterling strength, long term bond yields, commodity prices and the stock market.

Despite some interestingly radical thoughts from the BoE Chief Economist Andy Haldane, Governor Carney seems squarely in the Janet Yellen/Philips Curve camp of warning rates must rise soon.

Hopefully, Osborne’s Treasury advisers will get him to see sense, if not things won’t turn out well. They won’t turn out disastrously as markets will force more delays in further monetary tightening. But the guidance on policy from Carney and his boss Osborne (and Yellen) will remain a mess. And the mess will, of itself, crimp NGDP growth.

Why the recovery has been so weak: an extension

Kevin Drum posts:

I don’t really have any good hook for posting this chart, but it’s one of the most important ones you’ll ever see. It’s from the Wall Street Journal and it shows total government spending (state + local + federal) during the recession and its aftermath:

Kevin Drum_1

For about a year following the Obama stimulus, total spending was a bit higher than average for recession spending. But after that, spending fell steadily rather than rising, as it has after every previous recession. The result: a sluggish recovery, persistent long-term unemployment, and anemic wage growth.

Not so fast Kevin. The chart below compares Aggregate Nominal Spending (NGDP) on the same basis.

Kevin Drum_2

While spending fell a little for the first two years of this recession, it never faltered on the other occasions.

But, one might argue that in many other instances inflation went up a lot. Therefore, the next chart compares NGDP only for the noninflationary occasions, considering only the previous 3 recessions/recoveries. The pattern is the same.

Kevin Drum_3

The least one could say is that you also have to consider monetary policy. This time around both fiscal and monetary policy have been tight!

How can we distinguish their relative “guilt”? The next chart compares fiscal policy (government spending) in the 1990 and 2007 episodes.

Kevin Drum_4

Initially, fiscal policy was more expansionary in the present episode, although this expansion has been weaker throughout.

Now, contrast nominal spending in the two episodes.

Kevin Drum_5

Maybe monetary policy really trumps fiscal policy!

Failed Fiscalist Forecasts

A Mark Sadowski post

The subject of the United States “fiscal cliff” as a test of monetary policy offset at the zero lower bound in interest rates has recently come up yet again. Russ Roberts brought it up here.

Simon Wren-Lewis responds here.

To which Scott Sumner replies here.

For what it’s worth, here’s my two cents worth. I’ve said some the following before in more than one place, but this time I’ll try and be even more complete and explicit.

To begin with, the sequester was only a small part of the U.S. fiscal consolidation that took place in 2013. The “sequester” refers to the automatic spending cuts in particular categories of outlays that were initially set to begin on January 1, 2013, as a result of the Budget Control Act (BCA), and were postponed by two months by the American Taxpayer Relief Act of 2012 (ATRA) until March 1. ATRA also addressed the expiration of certain provisions of EGTRRA and JGTRRA (the “Bush Tax Cuts”), the 2-year old cut to payroll taxes (the “Payroll Tax Holiday”) and federal extended unemployment insurance. An increase in income tax rates applicable to high income tax payers, an increase in the payroll tax, and a continuation of federal extended unemployment insurance went into effect on January 1, 2013.

In short, the sequester only refers to the spending cuts that went into effect on March 1, 2013 and does not include the two major tax increases that went into effect on January 1, 2013. Based on the CBO’s November 2012 analysis of the “fiscal cliff”, and adjusting for the late start of the sequester, the tax increases that went into effect constituted  approximately 70% of the budgetary effect of going over the “cliff”. This is why analyses such as these are far less than fully satisfactory.

Furthermore, none of the forecasts concerning the effects of fiscal consolidation, by either the CBO, or the major private forecasters, referred to annual 2013 RGDP growth. They all referred to quarterly RGDP growth in 2013 or to year on year RGDP growth in 2013Q4. This because this is the more reasonable measure when the question is what impact a budgetary change starting at or near the beginning of a given year will have on subsequent growth. The Q4/Q4 measure is approximately the average of the four quarterly growth rates following the budgetary change, whereas the Year/Year annual measure is essentially a weighted average of the previous and current year’s quarterly growth rates. In this particular instance 3/8ths of the weights in the Year/Year measure come from quarters that occurred before even a single act of the federal fiscal consolidation went into effect on January 1, 2013. For more on why the Q4/Q4 measure might be preferred to the Year/Year measure in this case, see this for example.

The CBO’s last full economic forecast of 2012 (which came out just weeks before QE3 was announced) called for 0.5% year on year decrease in RGDP in 2013Q4 assuming all of the projected fiscal tightening went into effect (Table 2-1).

The previously mentioned November 2012 CBO analysis of the effects of the fiscal cliff states that eliminating all of its components would result in year on year RGDP growth in 2013Q4 being 2.9 percentage points higher (Figure 1). This implies that the CBO was forecasting that year on year RGDP growth would be 2.4% in 2013Q4 without any of the components of the fiscal cliff.

A careful reading of the CBO’s estimates from November 2012 indicates that the fiscal consolidation (the 2% payroll tax increase, the high income tax increase and the sequester) should have subtracted 1.4 points from year on year RGDP growth through 2013Q4.

Figure 1 shows that the CBO were estimating that extending the reduction in the payroll tax and extending emergency unemployment benefits would increase year on year RGDP growth by 0.7 points in 2013Q4 (line five). Footnote 15 on page 11 indicates that approximately 80% of the budgetary effect of this component was due to the reduction in the payroll tax. Assuming the fiscal multiplier for the reduction in the payroll tax and emergency unemployment benefits is about the same, the economic effect of not extending the reduction in the payroll tax thus was about 0.56% of RGDP (i.e. 80% of 0.7 points).

Also, Figure 1 suggests that the economic effect of not extending lower tax rates for those with high incomes (the difference between line three and line four) is 0.1% of RGDP. The increase in income tax rates applicable to high income tax payers that went into effect under ATRA was actually somewhat smaller than what the CBO estimates were assuming, but probably not significantly enough to make it worth refining any further.

And lastly, Figure 1 shows that the CBO were estimating that eliminating the defense and nondefense spending reductions (i.e. the “sequester”) would increase year on year RGDP growth by 0.8 points in 2014Q4 (the sum of lines one and two). But the implementation of the sequester was delayed by two months. A crude adjustment to this figure may be obtained by reducing it by one sixth (two out of 12 months) or to about 0.67% of RGDP.

The sum of these three components totals about 1.4% of RGDP. Combining the CBO’s estimated effect of the three components of the fiscal cliff that actually did go into effect, with the CBO’s implied forecast in the absence of any of the components of the fiscal cliff of 2.4% RGDP growth, results in a forecast of 1.0% year on year increase in RGDP in 2013Q4.

A similar thing applies to the major private forecasters. (Sorry, no links, but some of this can probably still be googled.) The effect of the fiscal consolidation (again, the 2% payroll tax increase, the high income tax increase and the sequester) according to Bank of America, IHS Global Insight, Moody’s, Goldman Sachs, Morgan Stanley, Macroeconomic Advisers and Credit Suisse ranged from 1.0% to 2.0% of GDP, with the average estimate being about 1.6%. The baseline forecast (i.e. the RGDP growth without any components of the fiscal cliff) prior to the beginning of 2013 of these same seven private forecasters was for year on year RGDP growth of 2.0% to 3.5% in 2013Q4 with the average forecast being about 2.7%. Thus the average forecasted year on year RGDP growth in 2013Q4 adjusted for fiscal consolidation was about 1.1%. This is almost exactly the same as the CBO forecast that I’ve teased out above.

We now know that year on year RGDP growth in 2013Q4 was 3.1%, or significantly higher than what the CBO was forecasting, and higher than what most of the major private forecasters were estimating would occur without any fiscal consolidation at all.

Or, in plain English, taking into account the monetary policy offset, the fiscal multiplier still appears to be zero, even at the zero lower bound in interest rates.

Fiscal deficits continue to be the best advice!

A recent example from Simon Wren-Lewis:

 …I would much prefer additional public investment, for which there is a strong microeconomic as well as macroeconomic case. [1] Michael Spence [2] is one of a huge list of eminent economists, which includes Ken Rogoff, who think additional public investment across the OECD would be beneficial.

We should continue to urge governments to recognise this, but we also have to accept the awkward fact that they are not listening. In political terms, the need to reduce deficits trumps pretty well anything else. (Perhaps things are turning in the US, but until the Republicans start losing power I’m not counting chickens.) One of the many depressing things about the Conservative election victory in the UK is that it looks like deficit obsession is an economic strategy that can win, as long as the austerity is front loaded, which is why Osborne fully intends to do it all over again.

Why, then, did Japan not grow for the last quarter century despite doing all sorts of public investments (even building an airport over water) and running persistently very high public deficits?

Appealing to the opinion of “eminent economists” is not evidence. In 1981 a list of 364 British economists, many of them “eminent” signed a letter saying that the Howe budget would “destroy” Britain. It certainly didn´t, quite the opposite happened!

What did happen in Japan to offset any fiscal stimulus was a very tight monetary policy (don´t confuse that with high interest rates). In fact, interest rates were essentially zero. Just look at what happened to nominal spending (NGDP) after 1990. No growth and even sometimes contraction.

SWL Advice

After something has been dormant for so long it´s hard to make it move up, despite the best efforts being made by Abe and Kuroda!