Sunday, February 01, 2015

A Question for Those Skeptical about Fiscal Stimulus

There are many opponents of fiscal stimulus that argue that it doesn't work (e.g. Robert Lucas (search for (Laughs.) & Eugene Fama (search for Fama:)). Some argue that nominal aggregate demand affects only the price level. But others argue that fiscal stimulus doesn't affect aggregate demand. My question is what about Argentina.

Argentina has fairly high inflation. Amost no one trusts the official number (11%) and sober serious people are Argentine inflation truthers estimating the rate as about 30%. People with normal dislike of inflation might think ARgentina could use a reduction of aggregate demand. Do fiscal policy skeptics who think Argentina would benefit from lower aggregate demand think that a temporary reduction in Argentine public spending would cause reduced aggregate demand ?

The point of asking oneself about Argentina is that it reverses the relationship between disliking government spending and doubting the effects of fiscal policy on aggregate demand.

If someone who considers himself a fiscal stimulus skeptic realizes that he thinks that austerity is a good anti inflation tool, then he has a puzzle to solve.

I also ask those who believe in expansionary austerity if they think that Argentina should cut aggregate demand and inflationry pressure by raising public spending. If the problem is the over exuberant confidence fairy, then policy should be designed to damage confidence.

update: as usual, I didn't expect anyone to link here. Given the traffic, I have updated two ways. First I have added links to the stimulus skepticism I have in mind. Note the claims to which I link are not qualified by any assertions about monetary policy. Also I added paragraph breaks.

8 comments:

Peter said...

The answer is that Argentina needs to cut taxes (for the wealthy), deregulate and privatize. This will boost long-term productivity.

Also cut social insurance. It will make people work harder.

Kaleberg said...

I assume you are being ironic. Cutting taxes on the wealthy, deregulating and privatizing might boost productivity, but they lower wages and living standards. Lower living standards are not going to make people work harder, look at the Soviet Union or the modern US.

Anonymous said...

What's it like being on the dark side, Peter?

Nick Rowe said...

Robert: fair question.

If we have fiscal dominance, where the central bank has no independence, and is forced to print enough money to finance the exogenously-chosen deficit, then the "monetary offset" argument cannot apply, and the only way to bring down inflation is to reduce the deficit.

In the long run: 1. Does the monetary authority print what the fiscal authority spends? Or 2. Does the fiscal authority spend what the monetary authority prints?

For Canada (and I think the US) I think that 2 is true. For Argentina, I suspect 1 may be true.

Anonymous said...

Put people to work building stuff and pay them well. Impose capital controls and whatever other controls one needs to take speculators to the cleaners. You guys over think things, in my opinion.

dwb said...

This is a false comparison.

In the US fiscal stimulus would be offset by monetary policy. There would be no change in aggregate demand.

In Argentina, fiscal stimulus (or it's opposite) might work because the monetary authorities are pursing the wrong policy (too low interest rates). So, this is less of a case of fiscal stimulus working, than a case of monetary policy *not* working.

Robert said...

I should have linked to Lucas and to Fama (as usual I didn't expect Thoma to link to me). Their argument did not depend on monetary policy at all -- it would work with a fixed money supply and with a monetary authority which targetting the nominal interest rate.

In the question I should have specified that the growth of money is the same no matter what fiscal policy is followed.

@dwb your comment, in particular, is odd. The skeptics of fiscal policy definitely didn't include Ben Bernanke who asked Congress for help stimulating. I see no basis for the idea that the FOMC would have offset stimulus. Yet, at the time, there were stimulus skeptics (including among others a solid majority in Congress)

You use "working" with two different meanings -- ineffective and suboptimal. The question (again I should have linked) is whether fiscal policy can affect aggregate demand. the Nobel Laureates said or wrote no.

Fama
http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans.html

the link seems to be dead, he is quoted by DeLong
http://delong.typepad.com/sdj/2009/01/eugene-fama-rederives-the-treasury-view-a-guestpost-from-montagu-norman.html


Lucas
http://www.cfr.org/united-states/why-second-look-matters/p18996?breadcrumb=%2Fregion%2F210%2Famericas

search for (Laughs.)

You see no specification of monetary policy in either case. Their claim is made for any monetary policy.

Nick Rowe said...

Robert: "In the question I should have specified that the growth of money is the same no matter what fiscal policy is followed."

OK. Then the only way the government can reduce inflation is by reducing the deficit. Standard Keynesian ISLM reasoning. It only works temporarily, but it's better than nothing. (Unless you get fancy with micro tax reforms that will permanently increase the real growth rate.)