For the past month or so, I’ve made it a habit to ask fellow economists how the response to the financial crisis has been improved by the past few decades of macroeconomic theorizing. Dozens of conversations later, I don’t have much to report.
Today’s big question is whether government spending can pull us out of this recession. We want to know what sort of oomph to expect from fiscal policy. In technical terms, this is a question about the multiplier: if the government starts spending more today, how much more spending will that stimulate tomorrow? And how worried should we be about government investment crowding out private investment?
If you took your first economics class 50 years ago, you’ll recognize all this talk about marginal propensities, multipliers, and crowding out. Fifty years later, it’s still the same debate, and it’s still unresolved. Why are we so reliant on mid-century macro for understanding our current predicament? And why haven’t we developed better answers?
Unfortunately, fiscal policy has largely disappeared from the research program of modern macro. Here are some facts, courtesy of my research assistant who searched Econlit (the guide to published economics). We searched for the number of papers published each year that mention monetary policy versus fiscal policy, in either the title or the abstract.
The rise in both lines reflects the increasing production of economic research, and the widening scope of the EconLit database. But the main point is evident throughout this period: there are about three papers written on monetary policy for each paper mentioning fiscal policy. And there are only a few dozen papers written on the multiplier each year.
The N.B.E.R. working-paper series has a similar flavor: you have to comb through a decade of yellow books to find 40 papers written on fiscal policy, while the past two years have generated an equal number of monetary policy papers.
I’m not sure why fiscal policy is the ugly stepsister. Perhaps the problem is ideology, and pro-market economists don’t like any discussion that gives government a greater role. Or perhaps there are just too many temptations for young economists — monetary policy research pays off because there’s a comfortable career path running from monetary research to the money markets.
Another possibility is research funding: there are 12 regional Federal Reserve banks subsidizing research on monetary policy, and almost no one provides similar subsidies for fiscal research.
Whatever the reason, the failure of macroeconomists to speak to this critical policy issue undermines our claim to relevance.
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Or, perhaps Friedman’s Theory of Consumption proved Keynes wrong…..
I’d say it comes down to non-existant risk managment for the field of economics. As you said, the Federal Reserve naturally funds research on monetary policy. Who was systemically looking out for the overall development of the field? Who really considered that monetary policy would be at its limit, like it now is, with really only fiscal policy left to turn to?
No one.
Maybe in the future economics folks will be better at promoting both sides, even when things are comfortable and monetary policy is in vogue.
We don’t have many fiscal “events” to study, thus we argue about what happened in the Depression or in Japan. Second, we argue about the facts of what happened because, again, we don’t have enough events.
Third and certainly not least, economists were actually arguing recently that macro events such as great shocks were either things of the past or were naturally confined by the changes in the financial system. Of course, it turned out they were enabled by the changes but the entire idea was wrong.
i’ll go with the cynical explanation: that economists have become mere apologists for corporate power- hence all the claptrap about ‘free markets’ and private enterprise/profit- the responsibility of any intellectual is to enlighten understanding of the way the world works, not obfuscate with propaganda- but there certainly are macroeconomists that have earned their integrity, e.g. Dean Baker has been a solid advocate for market regulation long before the houses hit the fan
I would think it is because monetary policy is checked and balanced with every other currency. Fiscal policy has no such limit. As such we can (and have) spent far more than we should have been allowed to before lenders stoped lending to the government. The point is that when studying monetary policy the outcome in knowable, with fiscal policy it is far more dificult to decipher and more importantly it is not knowable when the effects of a fiscal policy stop changing the fisca situation. For example the federal tax rates change long before any kind of stasticaly significant data can be drawn from it.
I also very much like the funding argument. All else being equal people will do their research where they get funding for it.
Poor Keynes – he was essentially correct in all major respects but is only rememebered for exactly half of what he said.
It is certainly true that increased governmental spending to spur the economy comes with possible inflationary side effects. Hence the reason he recommended an expanded role for government during economic recessions and down turns.
What everyone forgets is the second part. You know, the part about government reducing deficits and cutting back spending during upward swings in the economic cycle.
Problem is now as it was in Keyne life: government leaders who lack the discipline to assist the markets when necessary and get out of the way the rest of the time. Wisdom to know which time is which would also be useful.
The problem with all of the talk of the effects of stimulus is that it all assumes that 2006 was some sort of equilibrium.
2006 was a bubble in housing prices, stock markets, bond markets, credit, employment, income and consumption. It was fueled in part by massive ongoing stimulus from the Federal government deficit.
To debate over how best to get back to the height of the bubble is a foolish and childish exercise. Better to discuss how to get from where we are to where we can reasonably expect to be as quickly fairly and cheaply as possible.
Personally, I think that that all the government can reasonably do is: offer retraining assistance, force the derivatives markets (a major source of instability) to become transparent or to unwind and pump liquidity into the commercial paper market. The rest will have to be done by individuals seeking their own advantage.
Who cares what the multiplier is? The government has got to make clear what it is going to do or not going to do so that private investors can fix that variable in their forecasts. It’s more important for the government to make a public commitment to do something definite and then stick to that than it is what the government does in my opinion.