Response to Kevin C. on How Long is This Economic Slump Going to Last
This weekend Kevin, a brilliant PhD Economist posted the following comment in response to my post on the economic slump:
“Robe– Interesting piece; I’d tend to agree that the worst possible approach is the one we’re taking now, i.e., failing to pursue fiscal or monetary expansion going forward. With a slump this bad, you’re probably best off trying both approaches, somewhat better off trying one but not the other, and almost certainly worse of tying your hands and doing neither.
PS: A while ago you mentioned you were hunting for articles in this vein (showing that proponents of fiscal expansion tend to favor monetary expansion).
Here is a link to the initial article he was commenting on:
Certainly, Kevin’s enthusiasm for a monetary solution leaves me even more convinced that it is necessary. I am less sanguine about further fiscal expansion than Kevin for a few reasons.
1) I am fairly convinced by the general evidence that fiscal stimulus, as it is usually practiced, isn’t particularly effective. Here is an editorial by the eminent economist John Taylor suggesting that the previous stimulus was largely ineffective:
Here is an editorial by the eminent economist Robert Barro:
2) To the extent that we are in a balance sheet recession, I do think there is a strong possibility that economists like John Taylor are right that further indebtedness could be counter-productive. (I am not sure they’re right, because I think there still isn’t enough empirical evidence to be certain).
3) The best sort of fiscal expansion would be an infrastructure building campaign. From a cost benefit perspective, this is the case because even if the fiscal expansion is particularly effective in ending the economic downturn, it has a lot of positive benefits for the economy in general. Also, it is well known that America’s once great infrastructure is in disrepair – see:
But I caution, that there is good reason to think it might not be very effective as stimulus. Here is a link to some thoughts from Nobel Laureate, Gary Becker, via Greg Mankiw:
Also, for political reasons, this sort of fiscal stimulus plan is difficult to enact, so those are the reasons that I am a bit skeptical about fiscal expansion through government spending. However in another post, I will soon argue that the Republican plan to roll back the payroll tax cut is a mistake, which I think Kevin would almost certainly agree with.
Finally, Kevin finds an interesting article where Paul Krugman advocates for monetary stimulus. I wasn’t sure what Krugman’s views on that were because he has been more vocal about fiscal stimulus and has raised arguments that when interest rates are low, monetary stimulus might not be particularly effective (this theory is known as a liquidity trap).
This gives me a great opportunity to say that I agree with Krugman that monetary stimulus would be a good thing! However, I totally disagree with Krugman’s assertion that Bernanke will not act because of rhetoric from Rick Perry and Paul Ryan. I think it is far more likely that Barack Obama will remain President than Rick Perry getting elected President (supposedly the only Republican Candidate Obama insiders take seriously as a threat is Mitt Romney), so from a perspective of pure self-interest, Bernanke has no reason to pander to Perry. Furthermore, Bernanke has demonstrated during the financial crisis willingness to place his view of what is best for the economy above political concerns. I see no reason why his attitude would change now. I think Bernanke is being cautious because he genuinely is not sure what is best for the economy. Very eminent economists including John Taylor, Allan Meltzer, Gary Becker, and Anna Schwartz have opposed further monetary expansion based on concerns about uncontrollable inflation resulting. At the moment, I tentatively disagree with them, but there still is a strong possibility they are correct. Marcoeconomics is a very young field and the evidence either way is far from definitive and won’t be anytime soon. I suspect that Bernanke’s current behavior reflects caution, rather than personal weakness as Krugman would have it.