Collective Conscious

As a result of a con­ver­sa­tion in com­ments over at The­Money­Il­lu­sion, I thought a lot about what exactly Scott Sum­ner has been say­ing all this time and what I think about it. Basi­cally, it comes down to this: I agree with him on the facts, but dis­agree about what the facts mean, and I think this is basi­cally what the Keynesian-​​Market Mon­e­tarist divide is all about.

First and fore­most, I want to say that Key­ne­sians agree to the core ele­ment of the  Mar­ket Mon­e­tarist the­ory:

Instead of mon­e­tary aggre­gates and sta­bil­ity of veloc­ity, Mar­ket Mon­e­tarists advo­cate the use of mar­kets as an indi­ca­tor of mon­e­tary disequilibrium.

Brad DeLong and Paul Krug­man, for exam­ple, do this all the time.

I think Key­ne­sians broadly agree with the Mar­ket Mon­e­tarists that “the pri­vate sec­tor can’t cre­ate NGDP, only the Fed can.”  But by broadly, I mean that the Key­ne­sian take is a bit more nuanced than that. At The­Money­Il­lu­sion, I argued:

There’s an upper limit to the total amount of (fis­cal + mon­e­tary) stim­u­lus the Fed will allow, but the Fed itself is not putting us there – and we don’t know whether it will. We also know that the Fed will prob­a­bly not engage in QE that takes infla­tion above 2%. There­fore we can boost the econ­omy through fis­cal pol­icy rather than wait­ing for the Fed to act, and we know at about what point they will start off­set­ting fis­cal expansion.

So while I believe that the Fed con­trols the band in which NGDP growth can occur, I also believe that they can announce a pol­icy of pas­siv­ity within that band which sig­nals that fis­cal pol­icy will have a real effect. In 2009 this was true: the Fed was will­ing to allow fis­cal stim­u­lus take the driver’s seat (and it did). When it turned out that that wasn’t enough, they brought in QE, and nom­i­nal growth was brought back up to its trend growth but not its trend level (see DeLong), which retroac­tively meant that the stim­u­lus was net­ted out of 2011 NGDP (but not out of ²⁰⁰⁹⁄₁₀ NGDP). I argued:

[T]he Fed stopped QE2 when infla­tion ran to around 2% and NGDP around 4%. There’s no rea­son to expect more mon­e­tary stim­u­lus given that the Fed seems con­tent at that level, so there’s no rea­son to believe that fis­cal stim­u­lus which pushed those met­rics above those lev­els would be reduc­ing the scope of future QE. Then we also have the interest-​​rate com­mit­ment, which is a strong sig­nal that there won’t be off­set­ting *con­ven­tional* tight­en­ing. So I think we have clear sig­nals that fur­ther fis­cal stim­u­lus will not be off­set like 2009’s (either implic­itly or explic­itly) was and will actu­ally increase NGDP – if only because the Fed is allow­ing it, but also because we don’t believe the Fed would do it on their own, *even though I agree they could*.

Scott said:

I wouldn’t be sur­prised if you are proved wrong within 24 hours.

And then in a post fol­low­ing the Fed announce­ment, he said:

The yield spread is the long rate minus the short rate.  Koz­icki says the con­ven­tional view is that a lower yield spread means tighter money.  Today the Fed made the yield curve flatter.

So what do you think, mon­e­tary stim­u­lus or mon­e­tary tight­en­ing?  The only thing that’s “twisted” is the Fed’s logic.

Let me get this out of the way: I was proven right. But it doesn’t mat­ter in terms of the­ory, because, like I said:

If I am [proven wrong], then I would absolutely agree that fur­ther fis­cal stim­u­lus would be totally off­set in NGDP terms.… But I still think that the weight of con­ser­v­a­tive voices on the FOMC make it unlikely that they will drive NGDP so high that suf­fi­cient fis­cal stim­u­lus could not be func­tional. That’s a ques­tion of ‘am I read­ing the Fed right’ and, well, I can very eas­ily be wrong on that, but that doesn’t spoil the the­o­ret­i­cal argu­ment that fis­cal stim­u­lus can be effec­tive under a cer­tain set of cen­tral bank behaviors.

In the wake of the pol­icy announce­ment, I main­tain that we are see­ing exactly those behav­iors from the Fed today, and had bet­ter take notice of it — fis­cal stim­u­lus is the only tool we have left to boost the economy.

Let me pivot here and address the core area where Key­ne­sians and Mar­ket Mon­e­tarists can legit­i­mately diverge. Their posi­tion seems to occa­sion­ally go as far as what I’ll call the “strong ver­sion”, which goes some­thing like: “never use fis­cal stim­u­lus because the cen­tral bank is implic­itly set­ting NGDP any­way”. First off, I’m going to reject this posi­tion because, as I think I’ve shown in this post, the Fed can and does cre­ate space for fis­cal pol­icy to function.

So let’s ignore that extreme ver­sion of the argu­ment, and take the “weak ver­sion,” which runs more like “fis­cal pol­icy works, but it has no net impact if the Fed decides to tar­get NGDP any­way.” This is the ver­sion of the Mar­ket Mon­e­tarist the­ory that I think is true and accu­rate, but it’s impor­tant to real­ize that it does not imply the strong-​​version pol­icy, even if the Fed does tar­get NGDP.

Let’s parse the state­ment care­fully so its impli­ca­tions are clearly vis­i­ble. The Mar­ket Mon­e­tarist is basi­cally say­ing that, due to the boost in NGDP cre­ated by the fis­cal pol­icy, the Fed engaged in an exactly off­set­ting reduc­tion in its own activ­i­ties to main­tain NGDP at a tar­get level. So the point isn’t that fis­cal stim­u­lus is pow­er­less; it’s that it’s pow­er­less to affect NGDP.

But there are other things that fis­cal stim­u­lus is good for, and there are per­fectly good rea­sons to think that we might want to do it even if it’s going to be ‘implic­itly off­set’ later on by the Fed. I noted:

Fed eas­ing rarely gets bridges built, so we’re look­ing at a qual­i­ta­tive dif­fer­ence in outcomes.

Let’s agree that the Fed is set­ting the total amount of stim­u­lus that the econ­omy is going to receive. But once you assert that the mech­a­nism of con­trol is implicit off­sets, then you have also admit­ted that the fis­cal author­ity is allowed to decide the com­po­si­tion of that stim­u­lus. This takes three ele­ments: first, the public/​private com­po­si­tion, sec­ond, the pro­gres­siv­ity of the stim­u­lus, and third, the labor-​​intensity of the stimulus.

Public/​private com­po­si­tion is exactly what it sounds like: are we build­ing bridges or mak­ing pri­vate invest­ments? Argu­ments can always be made for both, but in times when stim­u­lus is required, pub­lic bor­row­ing is often avail­able at the low­est pos­si­ble rates, mak­ing it the ideal time to engage in this type of invest­ment anyway.

Pro­gres­siv­ity also takes the stan­dard def­i­n­i­tion: is stim­u­lus going out via top-​​down (i.e., giv­ing bankers cash in exchange for bonds) or bottom-​​up (i.e., giv­ing poor peo­ple cash in exchange for noth­ing, or to local con­trac­tors in exchange for their work on said bridges) meth­ods? The impacts on income dis­tri­b­u­tion and over­all inequal­ity are impor­tant here, espe­cially given the amount of money that needs to be allo­cated in a proper stim­u­lus pro­gram. Choos­ing between mon­e­tary and fis­cal stim­u­lus is key here, as mon­e­tary stim­u­lus has the poten­tial to be very regressive.

Labor-​​intensity is per­haps the most impor­tant ele­ment of com­po­si­tion in a reces­sion, how­ever: it deter­mines the amount of employ­ment that will be cre­ated by the addi­tional stim­u­lus. When we use mon­e­tary stim­u­lus, we let that deci­sion to mar­ket forces; but there is absolutely no guar­an­tee that those forces will put peo­ple to work here rather than, say, hir­ing work­ers abroad, or increas­ing exec­u­tive com­pen­sa­tion. When you decide that the money is going to be spent on paving roads, how­ever, you know you are hir­ing a lot of peo­ple, and they are doing a labor-​​intensive job over a fair amount of time. In turn, this means that more of the gains will be allo­cated to employment/​wages than to prof­its. Again, the dis­tinc­tion between a pref­er­ence for mon­e­tary vs. fis­cal stim­u­lus should be clear.

So, like I said: it’s all well and good to acknowl­edge that the cen­tral bank may be set­ting the bounds of net expan­sion, but the fis­cal author­ity reserves the right to con­trol the char­ac­ter of the expan­sion. And that’s exactly what leg­is­la­tion is for in the first place.