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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I’ll take the hard-boiled, profoundly cynical view:
Economists delight in believing they are some sort of “scientists”, while in reality, they are simple pedants who worship supposed authorities and artfully mumble quasi-scientific cliches. If ever confronted with their wildly-buffoonish errors, they spout evasive answers–and blame reality for not “behaving as predicted”. The “Dismal Science” is certainly not science.
What really scares me is that fundamental economic health is based on faith and trust. When enough “bad actors” scam the system, the faith and trust simply disappear. Now you can’t trust the banks or the government (or even the Church). Wall Street crooks are rewarded handsomely. CPAs, after Enron, seem simply skilled at cheating the system.
I remember when announcing that “A government study says…,” would settle any bar bet. Now finding someone to trust at all seems a naive and childish dream.
I don’t necessarily blame macroeconomic research for keeping up and predicting the current crisis or what to do about it. Academics, unfortunately, usually lags behind current events and we’re best at developing post hoc explanations, not predicting future events. Besides, there is exact predecessor for these events. For instance, the economy before the Depression – caused by a bubble, yes – lacked the government entanglement in the market we see today.
http://kingpolitics.blogspot.com/
I’m not sure if fiscal policy directly encapsulates things like taxes and subsidies or simply just “independent” government spending. In my mind, I’m aligned with what #6 said: it certainly would be ideal if the government always knew how (and how much) to interfere with free markets to improve efficiency in cases of market failures and then when to back down when they are not needed. However, those 3 criteria are, as evidenced by most actions taken by our government in its current state, rarely if ever met. A large reason for this is due to the way our government and political system has blossomed into one giant conflict of interest for politicians.
As such, I have very little confidence in the efficiency of our government and practically would prefer market failures than the government attempting to fix them. I consider myself a much more responsible spender than the US government and as such would want to trust them with as little of my money as possible. Fiscal policy almost always demands more taxes to be spent on likely hugely inefficient government programs that are virtually impossible to stop from a legislative standpoint. Not to mention the incentive destruction that comes with increases to taxes like income tax and capital gains.
Bottom line: please let me keep my money.
The JME exists, there is no corresponding Journal of Fiscal Policy.
I think the explanation is simple. There is basically a consensus among macro-economists that, except maybe when the economys is in a liquidity trap, monetery policy is at least as good an approach to macroeconomic fine tuning than fiscal policy. The disagreement was whether it was better or whether they were equally worthless.
The case against fiscal policy is simple — first economists since Keynes have argued that public spending arrives too late after the downturn is over. Second the effectiveness of temporary tax cuts can’t be elegantly reconciled with the permanent income hypothesis which sure is nice and elegant. Third fiscal policy is set by congress and no one who eats sausage and believes in fiscal policy should watch either being made. Fourth (well third and a halfth) any excuse for deficit spending will be abused by politicians who enjoy it.
Now the rate on 3 month T-bills is essentially zero and the consensus gives us no guidance on fiscal policy.
Fiscal policy is inherently messy and political. What kind of stimulus and what does the money get spent on? Fiscal stimulus can be quite ineffective, think of 2001, or effective depending on what is done. Crowding out is only a concern in a strong economy, otherwise every expanding industry would induce the same crowding out and there would be no growth. In the absence of growth and inflation, crowding out is fantasy.
“The rest will have to be done by individuals seeking their own advantage.”
Blah blah blah. When will economists learn that rational choice is dead–better yet, it was never alive.
More deeply, I think the situation that would call for fiscal stimulus has been consciously avoided because the implications and solutions are highly unpleasant to economists. Instead the belief that monetary policy would always be sufficient and superior held sway. Economists want to believe markets are always and everywhere superior to government, that they are always more efficient, that their distribution is optimal, and that the worst market failures are less than the least government imperfection. There have been circumstances where they have had to confront externalities and failures, but have done so only at the greatest reluctance. Something as deeply problematic as catastrophic economic failure is confronted with shock, denial, and all of grief.