The "Treasury View" and Fiscal Policy
6/17/09 9:17 PM
Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
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The "Treasury View" and Fiscal Policy '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?
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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 don’t 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 you’d 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 markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s 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, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen... And then Felix summons me: I’d 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 doesn’t 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 http://delong.typepad.com/sdj/2009/05/the-treasury-view-and-fiscal-policy.html
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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 money-holdings 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. rated 4.18 by you and 13 others [? ] http://delong.typepad.com/sdj/2009/05/the-treasury-view-and-fiscal-policy.html
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The "Treasury View" and Fiscal Policy
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Comments I think you guys (Delong, Krugman and the Administration) are winning on this point. It is true that many high-profile economists are taking the opposing and often incoherent position. But I think it is widely understood that they are either very stupid or -- much more likely in my view -- so blinded by their partisan bias that they are willing to embarass themselves professionally. A reasonably empirical and sensible trader with whom I work just assumes that John Taylor must have had a burst anuerysm, sort of like Cheney's defenders claim he must have. I try to talk him down from Taylor-impaired to Taylor-lying and he claims to be openminded. But he is going with Taylor-impaired as his base case. Lying is the risk case. And today I spoke with a fairly influential journalist, who is never allowed to write under his own name at his "newspaper". He told me that Taylor is happy surrendering seriousness for mere appeal to the base. Based on two whole observations, then, I infer that people in the middle who influence other people in the middle are with you guys on this issue. There is some sense that it may eventually go inflationary. And there is also that normative thingy about how we are just avoiding the punishment that nature will eventually impose on us for having been BAD. I wouldn't bother fighting this last one, as it is normative/spiritual rather than technical and thus a no hoper. But nobody who is capable of changing his or her mind seems to believe the nonsense of the Treaury View or her evil twin sister the Insane Fed View. I am not saying you should rest easy. Rather, I am saying that you are winning. Your opponent just hit the dirt and now is an excellent time to start ki... ...oops I almost forgot we are liberals. Posted by: Gerard | May 29, 2009 at 03:03 PM Lovely post. How much did the Treasury View really preclude a proper amount of stimulus? Seems that Obama's team was regrettably unwilling to go to 1.2 trillion before they had to deal with this crap. I don't know the political calculations -- Rahm Emmanuel patting Krugman on the head and telling him he doesn't understand what can get passed, etc. -- but I didn't see a lot of effort to go big. On the other side, I think the Treasury View has been used, as Gerard says, to keep in touch with the base. Those folks weren't going to support stimulus, and the justification didn't really matter. Look at Sotomayor -- when you tweet racist from Auschwitz, you're not really in the market for thinking. Posted by: david | May 29, 2009 at 04:33 PM Obama is repeating Clinton's historical experience with those f^!*ing bond traders. Then, no middle class tax cut - comedy, now, no functioning economy - tragedy. http://delong.typepad.com/sdj/2009/05/the-treasury-view-and-fiscal-policy.html
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Posted by: pebird | May 29, 2009 at 04:59 PM "Seems that Obama's team was regrettably unwilling to go to 1.2 trillion before they had to deal with this crap." We got all the stimulus President Collins and President Nelson would let us guess. Posted by: Davis X. Machina | May 29, 2009 at 06:19 PM I think you should be firmer on the point that argument 4 is a mathematical error. It is on the order of saying 1+1=1. You can't believe in Ricardian equivalence and believe that temporary public spending has no effect on aggregate demand. This is simple accounting. I think you are being to cautious and understating your case (reminds me of a conversation you once had with Jim Hines about negative probability events). In particular I it seems to me that you should not have typed "seems to me" in your description of argument 4. 1 and 3 can't be what they think. They know interest rates are very low and that the FED wants them much lower but can't make nominal rates negative. I think there are 2 things going on. 1) They are used to assuming full employment and so believe argument 2. They know they can't convince any non economists that there is no unemployment. So they conclude without explaining how they got there. 2) they hate government spending with a passion. In particular if one thinks that public spending is usually twice what it should be, then the cutbacks in state and local spending are good. This argument is made coherantly by Becker and Murphy, but it is too openly political for macro (and finance) economists who claim to be writing as experts. But I can't read their minds. Posted by: Robert Waldmann | May 29, 2009 at 08:52 PM "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. " Do the critics of fiscal stimulus share this assumption? Friedman's early work assumed that the velocity of money is constant. This was more or less true from the 50s to 1978 when Friedman did his seminal work. However, since that time, velocity has fluctuated quite a bit. Building models on top of Friedman's seminal work without recognizing that velocity is no longer constant leads to models with incorrect assumptions. GIGO. Much of the increase in velocity since the 1980s has been driven by "financial innovations". However those innovations are now a train wreck and velocity has dropped. Efforts at monetary stimulus are failing because raising the money supply causes further decreases in velocity it is not translating into increases in demand. The failure of "financial innovations have broken the ability of money supply to stimulate demand. Current, demand is at a level that is too low to sustain non-recession levels of employment. In order to escape the current crises we need to stimulate demand more directly. Fiscal stimulus works by increasing demand directly. It puts money in the hands of people who have unmet demand. The money supply does not limit demand if the increase in demand creates an increase in velocity. This seems to be the sticking point for critics of fiscal stimulus. They don't predict that increases in demand will increase velocity (which is "assumed" to be constant!!). At some point, velocity will return to a level where fiscal stimulus cannot push it much higher and assuming a constant velocity will once again be reasonable. However, we are well below that velocity and fiscal stimulus is needed to push velocity upward. A better economics would recognize that certain assumptions are NOT valid for all economies at all times. Models that assume velocity is constant are NOT applicable to our current economy. Posted by: bakho | May 30, 2009 at 07:25 AM The economy has already produced some feedback on the last round of stimulus. More of the same gives us more of that feedback. Where is the analysis of the feedback in this post? Posted by: Mattyoung | May 30, 2009 at 07:39 AM eric, as a non-macro-economist, perhaps you don't have the tools to understand the technical aspects of what the prof is talking about, but here's what you can do: click on the prof's link in the paragraph where he discusses taylor. when you do, you will discover that taylor's critique is fundamentally dishonest in a way that taylor knows (since he admits it in the paper). why should you pay any http://delong.typepad.com/sdj/2009/05/the-treasury-view-and-fiscal-policy.html
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that taylor's critique is fundamentally dishonest in a way that taylor knows (since he admits it in the paper). why should you pay any attention to a fundamentally dishonest critique? mattyoung, what feedback do you discern? that's some pretty sharp eyesight you have there, given that most of the stimulus hasn't been spent yet, but maybe you've got an honest observation? Posted by: howard | May 30, 2009 at 08:11 AM I have a question for somebody. From my layman's understanding I am a believer in the efficacy of fiscal stimulus. But I am puzzled by the argument that the amount of stimulus is grossly inadequate. I recall some months ago a Krugman column in which he said something like the output gap is x, and the stimulus is only 1/2 of x, so it is inadequate (I forget the exact numbers). I thought that fiscal stimulus was supposed to work by stimulating private spending through the multiplier, the old "pump priming" idea, and not fill the whole output gap. Anyone have any thoughts on this? Posted by: Phil P | May 30, 2009 at 08:59 AM "what feedback do you discern? " The big issue that many economic blogs have been watching is the effect on the Treasury yield curve from the last set of Treasury auctions. Bond markets used the increase Treasury activity to give their estimate of the effectiveness of deficit spending. They answered the question, Does the proposed spending help or hinder the constraint that caused the recession? That the spending has not completely filled the pipeline does not indicate the bond markets are wrong. Bond markets are estimating the impact of the spending plans relative to the constraint we suffer based on the very first observable results, the planning. Posted by: Mattyoung | May 30, 2009 at 09:13 AM well, mattyoung, bond markets are not the economy, so at least try to get your terms straight. and the vote of the bond market is that the stimulus will work; otherwise, we wouldn't see the yield curve steepening: i assume that was the point you wanted to make. Posted by: howard | May 30, 2009 at 09:34 AM The point I am making here is that Brad skipped his analysis of the feed back. The other point is that the Bond market is part of the economy, the part that estimates the other parts of the economy. I specifically avoided the part of interpreting the rise steepness of the yield curve. I think the last stimulus worked to its maximum capacity. Any further stimulus will be ineffective until the economy can find investment opportunities that lower the steepness.
Posted by: Mattyoung | May 30, 2009 at 10:23 AM mattyoung, the bond market provides feedback every single day; sometimes that feedback is an accurate perception of the future of the economy and sometimes it isn't. it is neither more nor less than the distilled wisdom (and ignorance) of the participants in the market. it isn't the economy, and to call it economic "feedback" in a meaningful sense isn't on. gdp growth, job formation, real median household income - these are pieces of economic feedback. Posted by: howard | May 30, 2009 at 11:59 AM Howard, I make the case that the yield curve (bond market) is the fastest aggregate measuring thing. When an event happens, we look for the effects, and three months later compare our estimates via the yield curve. Absent the bond market you have no tool for getting at the priority of the sub components of interested. Ultimately we want to measure the future course of the components you listed. That means we have to get an estimate of interest rates. Posted by: Mattyoung | May 30, 2009 at 12:13 PM
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