More than a few words on that little box from the WEO that's set off the econosphere. Before I get to it, there are some bits from DeLong and Krugman that should be thrown in for perspective. Before I get to them, here's an excerpt from the Summers-DeLong paper back in March, "Fiscal Policy in a Depressed Economy":
"Unless the real interest rate at which the government borrows on the left-hand side is greater than the right-hand side of (2.9)*, fiscal expansion now improves the government’s budget balance later. Arguments that economies cannot afford expansionary fiscal policy now because they should not raise their future debt financing burdens then have little purchase."
*2.9 is the equation that relates the real interest rate to the sum of the growth rate of the tax base and the short-term multiplier, the fraction of the depth by which the economy is depressed and the marginal tax-and-transfer rate.
Essentially, if the fiscal multiplier is larger than 1, suppose 1.5, and the marginal tax share is 0.33, and the economy can borrow at zero in real terms, then in the medium term, there's is no long-run cost to the budget. The thing here, as DeLong re-emphasizes, is that there is no short-term exit from the ZLB, which means that there is still time for governments to act.
Krugman makes it simpler to explain this "multiplier-mea-culpa". To him, it's the asymmetry in the effects of leveraging as opposed to deleveraging. Essentially:
1) Leveraging = higher AD, but this can be offset by tighter monetary policy
2) Deleveraging = lower AD, but the offset isn't as easy because of the ZLB and the uncertain impact of unconventional monetary policy measures.
This deleveraging constraint is responsible for the liquidity trap and hence the larger (>1) multiplier.
Kate Mackenzie has this to say about how the consensus was built over the range of the multiplier and how it gradually shifted and shifted further perhaps.
And finally, this is what the actual box in the WEO (written by Blanchard (Director) and Leigh (Senior Economist) of the Research department)) had to say:
"Based on data for 28 economies...the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2...
...Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7."
Think about that for a moment. It's big.
And this is based on hard data. Austerity is damaging, now more than ever. How else could you explain (for example) UK growth over the past few years? Look at the numbers:
The estimated equation is y = a + bx + e where:
y is the forecast growth of error = difference in actual cumulative real GDP growth ('10-'11) and the April 2010 WEO forecast.
x is the forecast of fiscal consolidation = forecast of the change in the structural fiscal balance ('10-'11) as of
the April 2010 WEO
Mathematically, if the multipliers used in the forecasting have been accurate in retrospect, then the equation should be y = a + e and we should get a zero coefficient.
Of course that's not the case.
Instead, the co-efficient is found to be "large, negative, and significant. The baseline estimate suggests that a planned fiscal consolidation of 1% (of GDP) is associated with a growth forecast error of about 1%...indicates that the multipliers underlying growth projections have been too low by about 1."
Furthermore, naturally other variables are analysed as possible triggers to consolidation and weaker-than-expected growth. Among these are the debt-to-GDP ratio, the sovereign CDS spreads, the impact of banking crises, the consolidation of trading partners, the external balance.
They conclude by commenting that more work is warranted yet unequivocally, "in today's environment of substantial economic slack, monetary policy constrained by the ZLB, and synchronized fiscal adjustment across numerous economies, multipliers may be well above 1".
As a Bloomberg editorial justifiably says, "...the new pragmatic IMF is the voice of reason. It’s impressive to see such a culturally conservative institution leading this change, rather than being reluctantly dragged along. We’ll be even more impressed when governments start acting on its advice"
About time. It's about time.
"Unless the real interest rate at which the government borrows on the left-hand side is greater than the right-hand side of (2.9)*, fiscal expansion now improves the government’s budget balance later. Arguments that economies cannot afford expansionary fiscal policy now because they should not raise their future debt financing burdens then have little purchase."
*2.9 is the equation that relates the real interest rate to the sum of the growth rate of the tax base and the short-term multiplier, the fraction of the depth by which the economy is depressed and the marginal tax-and-transfer rate.
Essentially, if the fiscal multiplier is larger than 1, suppose 1.5, and the marginal tax share is 0.33, and the economy can borrow at zero in real terms, then in the medium term, there's is no long-run cost to the budget. The thing here, as DeLong re-emphasizes, is that there is no short-term exit from the ZLB, which means that there is still time for governments to act.
Krugman makes it simpler to explain this "multiplier-mea-culpa". To him, it's the asymmetry in the effects of leveraging as opposed to deleveraging. Essentially:
1) Leveraging = higher AD, but this can be offset by tighter monetary policy
2) Deleveraging = lower AD, but the offset isn't as easy because of the ZLB and the uncertain impact of unconventional monetary policy measures.
This deleveraging constraint is responsible for the liquidity trap and hence the larger (>1) multiplier.
Kate Mackenzie has this to say about how the consensus was built over the range of the multiplier and how it gradually shifted and shifted further perhaps.
And finally, this is what the actual box in the WEO (written by Blanchard (Director) and Leigh (Senior Economist) of the Research department)) had to say:
"Based on data for 28 economies...the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2...
...Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7."
Think about that for a moment. It's big.
And this is based on hard data. Austerity is damaging, now more than ever. How else could you explain (for example) UK growth over the past few years? Look at the numbers:
The estimated equation is y = a + bx + e where:
y is the forecast growth of error = difference in actual cumulative real GDP growth ('10-'11) and the April 2010 WEO forecast.
x is the forecast of fiscal consolidation = forecast of the change in the structural fiscal balance ('10-'11) as of
the April 2010 WEO
Mathematically, if the multipliers used in the forecasting have been accurate in retrospect, then the equation should be y = a + e and we should get a zero coefficient.
Of course that's not the case.
Instead, the co-efficient is found to be "large, negative, and significant. The baseline estimate suggests that a planned fiscal consolidation of 1% (of GDP) is associated with a growth forecast error of about 1%...indicates that the multipliers underlying growth projections have been too low by about 1."
Furthermore, naturally other variables are analysed as possible triggers to consolidation and weaker-than-expected growth. Among these are the debt-to-GDP ratio, the sovereign CDS spreads, the impact of banking crises, the consolidation of trading partners, the external balance.
They conclude by commenting that more work is warranted yet unequivocally, "in today's environment of substantial economic slack, monetary policy constrained by the ZLB, and synchronized fiscal adjustment across numerous economies, multipliers may be well above 1".
As a Bloomberg editorial justifiably says, "...the new pragmatic IMF is the voice of reason. It’s impressive to see such a culturally conservative institution leading this change, rather than being reluctantly dragged along. We’ll be even more impressed when governments start acting on its advice"
About time. It's about time.
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