The "Treasury View" and Fiscal Policy J. Bradford DeLong U.C. Berkeley and NBER May 29, 2009 http://delong.typepad.com delong@econ.berkeley.edu 'I can call spirits from the Vasty Deep!" "Why, so can I, and so can any man. But do they come when you call them?" Felix Salmon calls Alan Beattie of the FT and Justin Fox of Time: What use economic history? : How relevant is economic history at times like this? I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve? Successfully: Beattie replied first: yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I donʼt think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon - something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.) but of course you need to learn the right lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one. it is good that an economist who is also an economic historian is Fed chairman. Not sure youʼd want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example. Then Justin weighed in:
My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial marketsʼ future. That didnʼt work out so well, so yeah, knowing economic history would seem to be useful. But Alanʼs right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle. On Bernanke, Iʼd certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics donʼt happen... And then Felix summons me: Iʼd be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesnʼt seem to have been mentioned much since January 20. And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset. I am here: (I) With respect to the “Treasury View” that Obama's fiscal policy will be ineffective--well, I think it is very common. In the past two months across my desk I have seen it advocated by Robert Barro; Eugene Fama; John Cochrane; Luigi Zingales; Michele Boldrin; Niall Ferguson; Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas; John Cogan; John Taylor; and Peter Klenow. Of these, only John Taylor and John Cogan on the one hand and Pete Klenow on the other had even a slightly-coherent argument based on a slightly-recognizable model. And I'm stretching it to call Taylor and Cogan's argument slightly coherent. It was that: (a) Jared Bernstein and Christie Romer say that fiscal expansion is likely to be powerful, (b) they assume a certain reaction by the Federal Reserve to fiscal expansion, (c) a reaction that makes fiscal policy so powerful that we cannot calculate its effects--our model explodes--(d) so we assume a different reaction by the Federal Reserve that makes fiscal policy much less powerful, and so (e) we find that fiscal policy is not very powerful. To which my reaction is: Huh!? Assuming that fiscal policy is not powerful is a reason to think that it is not powerful. That simply will not do. Klenow said that (a) the Federal Reserve is not powerless to affect spending right now, (b) the Federal Reserve is happy with the projected growth path of spending, so (c) policy moves by Obama that raise the projected path of spending in the future will be offset by the Federal Reserve's raising interest rates to keep the projected growth path of spending the same. This seems to me to be false as a description of what the Federal Reserve is doing. But at least it is coherent--you can at least have a response to it other than "Huh?!" The assumption of some version of the quantity theory of money plus the recognition that money demand is usually interest elastic create a presumption that fiscal policy is effective. There are then four coherent ways to argue to try to rebut that presumption and arrive at the "Treasury View": 1. Klenow's--that the central bank is happy with the projected growth path of spending and both can and will take action to make sure that fiscal policy is ineffective by offsetting its effects.
2. The goods-crowding out argument: that we are at full employment so workers have so much bargaining power at the moment fiscal policies that increase spending will go 100% into increasing wages and prices and 0% into increasing production and employment. This seems to me to be false. 3. The the interest-crowding out argument: that when the government sells a bond interest rates will rise and induce a private-sector firm not to sell a bond, and thus investment spending falls by as much as government spending increases. This requires that in this particular case the increase in interest rates resulting from a higher government budget deficit have no effect on the velocity of money, which could happen as a limiting case but I see no reason to think that it would happen now. 4. Increases in government spending now lead private individuals to cut back on their spending out of fear of future tax increases by so much that total spending is unchanged. This seems to me to fundamentally misunderstand the permanent income hypothesis. The interesting thing from my perspective is that Barro, Fama, Cochrane, Zingales, Boldrin, Ferguson, Becker, Prescott, and Lucas don't appear to be making any one or any combination of the four coherent arguments for the "Treasury View." They do believe in the quantity theory of money. But either they don't believe that households and businesses respond to incentives in their moneyholdings or they have not tought about the issue. And so they don't recognize that they have to make one or more of the four valid argumentative moves if they are to be coherent. (II) Nevertheless analytical incoherence seems to be no barrier to influence. Last January I thought that the numbers from the fourth and forecast for the first quarter told us that we should (a) immediately do $1.2T of effective fiscal stimulus, and (b) stand ready--preferably by putting the money into the Budget Resolution--to do another $1.2T of effective fiscal stimulus in October with the Reconciliation Bill if things turned out to be worse than expected. We did about $0.6T of effective fiscal stimulus, nothing got into the Budget Resolution, and there is no legislative prospect for additional fiscal stimulus this year. By my count that is at least a 2/3 victory for the "Treasury View"-we are doing less than we should be doing, and certainly much less than it would be prudent to be doing, and we are doing less than we should be doing because the "Treasury View" advocates have muddied the analytical waters. (III) As to history--well, yes, of course. Economics does not have solid foundations. We pick episodes from history that seem interesting and informative, and we crystalize these historical episodes into economic theory. But then theorists teach this crystalized history as if it were handed down from Mount Olympus. And so we wind up with a lot of young and many old economists who can manipulate theories but who do not understand what they are good for or where they come from.