Brad DeLong managed a rough transcript of a panel discussion comprising him as the moderator, Carlo Cottarelli the IMF FAD head, the ever-effervescent Krugman, Valerie Ramey and the black sheep (if you could call it that!) Harald Uhlig from Chicago. The discussion tries to stay focussed on recessions from a macro perspective and the whole role of fiscal policy in a ZLB era with highly unconventional central bank measures. Here are DeLong's questions to get them started:
It's quite long so i'll just post some snippets from each of them that I thought were telling.
Cottarelli:
"This change (the IMF's fiscal stance post 2008) was prompted by three factors: First of all, it was felt that the magnitude of the shock was such that there was a risk of things getting out of control—it was not an ordinary recession. Second, it was felt that although the recession had originated in a house price boom and then dysfunction in the financial sector, it has turned quickly into a demand recession—a recession in which lack of aggregate demand was causing a further and further decline in economic activity, and as a result there was rising unemployment and a lot of uncertainty about future economic prospects. This was a world in which the relevant textbook was The General Theory of John Maynard Keynes. Third, it was felt that with credit markets not working properly monetary policy had exhausted its room for activity with short-term nominal interest rates at zero percent and could not provide enough support."
"But in general as much as possible we favor a gradual approach to fiscal adjustment—it should not be front-loaded. We have done this for two reasons. First, we feel that the fiscal multiplier is pretty large under current circumstances, essentially output right now is demand-determined. In principle, it would be preferable to postpone fiscal adjustment altogether until some future time in which there is too much private-sector demand rather than implementing it at a time when there is not enough private-sector demand."
"The second reason why we favor a gradual approach to fiscal adjustment is called “too much of a good thing”. It is possible that if you tighten fiscal policy up front with multipliers in their current range, you end up with a decline in GDP growth so large as to be counterproductive, to cause not a decline but an increase in interest rates as markets become worried about the decline in GDP."
"We have argued that gradual adjustment should be accompanied by a continuing use of monetary policy to support economic activity because there will be a cost of even gradual fiscal tightening. All of this focuses on the demand side. At the same time we have focused on the need for supply-side medium-term growth from structural reform. Although at present output is demand-determined, over the medium-term it is important for the advanced economies to raise their rate of potential growth. That has huge implications for the fiscal situation over the years.
- Are there policies the Federal Reserve, the ECB, and the rest of the government could adopt that would quickly move the civilian adult employment-to-population ratio back toward what from 1985-2007 we thought of as "normal"--that could produce in the next couple of years rates of employment growth within shouting distance of those the U.S. economy experienced over the Reagan boom of 1982-1989?
- If so, what are those policies?
- If so, are those policies desirable ones that the Federal Reserve, the ECB, etc. and the rest of the government should adopt?
- How is your view on questions (1) through (3) different today than it was six years ago?
It's quite long so i'll just post some snippets from each of them that I thought were telling.
Cottarelli:
"This change (the IMF's fiscal stance post 2008) was prompted by three factors: First of all, it was felt that the magnitude of the shock was such that there was a risk of things getting out of control—it was not an ordinary recession. Second, it was felt that although the recession had originated in a house price boom and then dysfunction in the financial sector, it has turned quickly into a demand recession—a recession in which lack of aggregate demand was causing a further and further decline in economic activity, and as a result there was rising unemployment and a lot of uncertainty about future economic prospects. This was a world in which the relevant textbook was The General Theory of John Maynard Keynes. Third, it was felt that with credit markets not working properly monetary policy had exhausted its room for activity with short-term nominal interest rates at zero percent and could not provide enough support."
"But in general as much as possible we favor a gradual approach to fiscal adjustment—it should not be front-loaded. We have done this for two reasons. First, we feel that the fiscal multiplier is pretty large under current circumstances, essentially output right now is demand-determined. In principle, it would be preferable to postpone fiscal adjustment altogether until some future time in which there is too much private-sector demand rather than implementing it at a time when there is not enough private-sector demand."
"The second reason why we favor a gradual approach to fiscal adjustment is called “too much of a good thing”. It is possible that if you tighten fiscal policy up front with multipliers in their current range, you end up with a decline in GDP growth so large as to be counterproductive, to cause not a decline but an increase in interest rates as markets become worried about the decline in GDP."
"We have argued that gradual adjustment should be accompanied by a continuing use of monetary policy to support economic activity because there will be a cost of even gradual fiscal tightening. All of this focuses on the demand side. At the same time we have focused on the need for supply-side medium-term growth from structural reform. Although at present output is demand-determined, over the medium-term it is important for the advanced economies to raise their rate of potential growth. That has huge implications for the fiscal situation over the years.
So this is essentially our view of what fiscal policy should do: gradual fiscal adjustment, as much as possible, accompanied by relaxed monetary conditions for as long as necessary, and structural reform."
Krugman:
"If an economist from 1958 had seen what is going on now, he—and back in 1958 it would have been “he”—would have said: “OK. Private sector does not want to spend. The government should spend. This is a powerful case for fiscal stimulus to prevent this from causing a persistent slump.” We have not done that."
"Think about the objections to stimulus. I would put them into three categories:
First, perhaps we do not have nearly as much economic slack as people like—well—me say. Perhaps there is something much more structural going on, and we do not have that much room to expand. We have a huge economic failure, but the failure is not for the most part a simple failure of aggregate demand.
Second—you do not hear this story that much, but it is important to set up the third—is that we should not be using fiscal policy but should instead by using monetary policy. That is a more popular argument in the more informal discussion in the econoblogosphere than it is in academia. But there is the question of what you can do.
Third, even though we are at the zero lower bound, fiscal policy is a lot less effective than the man from 1958 would say it is, and that multipliers are quite low even under urgent conditions."
"Monetary policy: When I arrived at Princeton in 2000 there was a group of us—“Japan worriers”. I am the only one still there. Mike Woodford, Lars Svensson, who is now run off to the Riksbank, me, and Ben Bernanke—I wonder what happened to him? All of us were very concerned by what was happening to Japan in the 1990s. Some people looked at it and said: “That just shows how messed up the Japanese are.” Some of us looked at us and said: “Surface differences apart, Japan looks a lot like us: big advanced country, lots of room to maneuver, government officials who might not be the most brilliant but who were not complete idiots, and if they could get trapped in this sort of deflationary stagnation then it could happen to us.” Sure enough, it did."
"Finally, Ricardian effects. It is really important to understand how many people misunderstand that. There are many people who believe that higher government spending now means higher taxes later and this will crowd-out private spending now. But higher spending now means higher incomes now as well. In the simplest Ricardian setup, if you believe that resources are unemployed and if interest rates are zero, the multiplier is not zero but one. It is very difficult to come up with a story in which the current multiplier would be less than one. Invoking the expectation of future tax increases as a reason for a multiplier less than one is a much more difficult story to tell than people seem to imagine."
"The immediate objection is that causation is not reversed? This is where the Blanchard-Leigh stuff comes in: They look at forecast errors in output growth and forecast errors in future policy, and find that their forecasts of output growth which assumed a multiplier of 0.5 underestimated the true multiplier by about 1.0, systematically understating economic contraction in countries with larger-than-expected degrees of austerity.
I think their work is good. Of course, it fits what I wanted to believe, so you have to be careful. But very important stuff, if true.
The final point is policy: Are we sure that expansionary fiscal policy is the right thing to be doing and that austerity is a terrible, terrible mistake? No. We are absolutely sure of nothing. But the consequences, if that is the truth, and I think the evidence tilts that way, is that what we are doing right now is absolutely disastrous. And that is where we are right now."
Ramey:
"I think a key structural reform that would significantly help the economy—the labor market and also the long-run budget deficit—would be to reform the health-care sector. I spend a lot of my time teaching micro pub(l)ic policy. There are huge potential efficiency gains, as I will show."
Uhlig:
"Here is a really simple picture. You just take government spending—the business cycle component—and do the same for real GDP. Government spending is cyclical. If you look at postwar data for the United States, government spending is simply the most cyclical macro variable that is out there. The U.S. economy got into recessions without government spending. It got out of recessions without government spending."
"When you talk about fiscal stimulus, doing back-of-the-envelope estimates, it is always surprising how different people look at the same data in different ways. For example, in 2009 did fiscal stimulus help us? Well, there is one view that suggests that it did not do very much because whatever the federal government did was offset by the states anyway. "
"You look at Japan. Japan has a debt to GDP ratio that is way in excess of 200%. Boy have they tried fiscal stimulus! Look where they are! It does not look like a huge success story to me, but of course you can make the case that if they had not done that they would be in much worse shape. So again, how do you tell these things apart?
You remember episodes of stagflation in the 1970s. I remember these charts when you were a kid where you could choose between 5% unemployment and 5% inflation and eventually you were getting all of that combined with high government debt. It took us decades to get out of these traps again. So I do not think that these episodes are encouraging. "
"Let me talk more about the theory side—quantitative theory. Most important theory is dynamics. We are beyond shifting IS-LM curves around. There are periods. There is 2013, and 2014. Life goes on. We use dynamic models. And there are lots of theories that try to look at that. For example, this comparison exercise where they looked at very quick stimulus: what does it do? They assume sticky prices—Keynesian features and all these other features, non-Ricardian agents, and so forth. They find a fiscal multiplier that is larger than one. That is informative. That is useful. That is good. But this is not the kind of fiscal stimulus that they have seen."
"There are fiscal limits. And they are serious. Valerie Ramey has shown us the plot on health care spending. I wish Alan Auerbach were here. He always shows these plots from the Congressional Budget Office that if we keep on going as we are with Social Security you eventually reach a debt-to-GDP ratio of 500% or 600% in 2100 or so. Ridiculous numbers. Clearly something is going to happen before that. But we do not want to wait until then. We want to get our fiscal house in order way head of that. It is a ticking time bomb. We should do something about this. And we should not be complacent about this."
"Right now it is easy to be complacent in the United States because you say well interest rates are really low so we could do a lot more spending and run up more debt and postpone adjustment into the future. What is there to worry about? Once this becomes a problem it will be signaled because interest rates will rise a little bit. Well they don’t. Interest rates in financial markets on government securities—once financial markets start to have doubts on whether governments are serious about repaying their debt they have a tendency to jump. And once they jump the catastrophe is there. Let’s not wait until that happens. I am not saying that that is going to happen anytime soon in the United States, but the dynamics you want to have in your mind is a dynamics where you keep on piling up these fiscal problems and eventually the problem hits you overnight. You may not have much time to react."
"I don’t want to be alarmist about the United States. In the United States there is still quite a bit of fiscal room. I think we still have some time to change paths. But in other countries—they are squeezed. See Greece there. The interest rates they are facing are just unsustainable. They cannot possibly repay them. You also get some of the other countries that are supposed to be the guarantors in the European system like Germany and France. We have to be really careful. Once financial doubts emerge their room for maneuver is not that high either to extract tax resources to be able to credibly say higher interest rates no problem. We can repay them.
The federal debt-to-GDP ratio has risen dramatically and is now at World War II levels and I want to get that genie back into the bottle, and I want to get it back into the bottle by getting the government out of private activity because it is private activity that makes stuff happen. That is how we get out of recessions. And so we have to cut back on fiscal spending rather than doing more fiscal stimulus."
"Now in the longer run we have to worry about taxes, we have to worry about debts, we have to worry about long-run sustainability with the Social Security system. These are real obligations. These are not nominal obligations. We cannot inflate them away. We have to get our house in order. We have to do something about them. And if we don’t, doubts in financial markets will lead to a situation in which disaster strikes."
As you may have noticed, most of it's from Krugman and Uhlig because they're so contrasting and well, Uhlig just sounds very run-of-the-mill not to mention right-thinking. So, in his honor (and Krugman's!), the last quote comes from Krugman:
"OK. I disagreed with everything Harald said. With respect to Valerie, there are two points I want to make"
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