Wednesday, January 07, 2015

On Sachs on Krugman

cross posted at angrybearblog I have been pinged

and am so flattered to be pinged in such company that I decided I had to read the Jeff Sachs article on Krugman Austerity and the Obama recovery and comment on it. It isn't quite as bad as I feared.

My comment is really here. I note that the actual pattern corresponds to Krugman's descriptio of growth of real GDP speading up exactly when the long decline of government purchases (G) reversed in 2014q2. I fear I will be posted the graph of US real G for the rest of my life.

The graph shows steadily increasing austerity along with consistently disappointing recovery, then an end to the reduction in G and rapid growth. The data perfectly fit both the vulgar Keynesian story and the fancier Krugmanite story that vulgar Keynesianism is valid when the economy is in the liquidity trap.

Krugman's response is extremely convincing. Brad DeLong is impressively shrill. Simon Wren-Lewis found a new way to illustrate the fact that the recovery was disappointing.

So what was Sachs thinking ? First, in his defence, I am sure the "brisk" growth he had in mind was in 2014q2 and 2014q3. He should note that some is the economy unfreazing after 2014q1, but the word isn't crazy.

I think he made one polemical choice and one mistake. The mistake is to consider only Federal fiscal policy. This is a natural simplification if one relies on daily newspapers for news of fiscal policy, but Sachs should know how to FRED and should know to FRED. For aggregate demand, it doesn't matter if government consumption and investment is federal state or local. The graph above is for all together. This mistake is less excusable in a critique of Krugman, as Krugman often discusses the 50 little Hoovers.

Second the polemical choice is to focus on the deficit and not on G. This is totally unreasonable in a critique of Krugman. Krugman has repeatedly stressed the difference between the Government expenditure multiplier and that tax cut multiplier. He denounced Obama for (among many other things) including too largetax cuts as well as too small spending increases in the ARRA (Sachs made the same objection).

Krugman has made a proposal for optimal fiscal policy in a liquidity trap. In it he did not mention the timing of taxes at all, because he used a model with Ricardian equivalence in which this timing doesn't affect aggregate demand. The post is flagged as "ultra-wonkish" but it isn't too wonkish for Sachs.

Importantly, Keynesians all agree that balanced budget spending increases (as proposed by Sachs) stimulate. Therefore the structural deficit is not an adequate index of the fiscal stance. Some New Keynesians go so far as to use models in which deficits don't matter (By my rules I must name names, so I name Smets and Wouters). I consider myself an extremely old fashioned Keynesian who thinks the timing of taxes matters a lot. Krugman and Sachs are somewhere in between, and at almost exactly the same point. Being (even) less enamored of Ricardian equivalence than Krugman, I have more of an intellectual problem due to the absense of noticeable damage due to the end of the partial payroll tax holiday in 2013q1 (this not being the NYT I can just say that is just one data point and that shit happens). Oddly Sachs and Krugman agree on policy, yet Sachs continues to insist that Krugman disagrees.

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