"While I don't agree with Krugman's revisionist view that there really wasn't much austerity, I'd like to accept it as a working assumption for the rest of this post. And I'd like to analyze its implications.
1. First of all, it's worth pointing out that the same sort of mistake seems to have been made in Britain, for unrelated reasons. (S&L is less important over there.) At roughly the same time as the US misjudgment, many Keynesian economists were warning that austerity in Britain was a disastrous policy that would slow the recovery. But then Britain suddenly started doing much better, especially in the employment area. (Recall that British productivity was weak, but the Keynesian model says more AD will create jobs, it does not include a magic wand to make those new jobs more productive.) Once the strength of the labor market became apparent, many Keynesian economists decided that the austerity was actually much less than they had been assuming. Including during the period when they were loudly complaining about austerity.
So let's say there was nothing disingenuous about all these flip-flops. I've made similar mistakes at various times in my life. Even so, doesn't this call into question the effectiveness of fiscal policy? It's already a pretty blunt instrument; requiring politicians of different stripes to come together in a timely fashion to set the appropriate cyclically adjusted budget balance. If we are now to believe that even in real time it's extremely hard for the world's leading Keynesian economists to tell whether policy is contractionary or not, then how likely is it that this tool will be used effectively?
2. And if we have not one but two major misdiagnosis of the stance of fiscal policy in key economies, in just the past few years, how many others have occurred that we don't know about? How many posts by Krugman can you find that say "I claimed fiscal austerity in country X would lead to recession, and recession did occur as I predicted? But new data shows that there really wasn't any fiscal austerity. I now think the recession was due to other stuff." Can someone point me to these posts? Indeed how likely is it that Paul Krugman would have done the post I am commenting on, if the US and Britain had fallen into a euro-style double-dip recession in 2013? "Oops, no austerity, my mistake." In other words, using a legal analogy, is Krugman more like an impartial judge, or an attorney that advocates for his client, and only feels a need to present evidence that supports his case?
Now before commenters start claiming that everyone does this, let me admit that this is normal behavior in the blogosphere (with a few exceptions such as Tyler Cowen.) So then are we just left with a "he said she said"? Just a series of anecdotes that are open to interpretation? I'd make a couple observations here:
1. We do have some systematic evidence. The early cross-sectional regressions supported the Keynesian model. Later work by Mark Sadowski and others found this result only applied to countries that lacked an independent monetary policy. (And I'd add that there are some tricky causality issues for even those countries.) As of this moment, I know of no systematic evidence for the effectiveness of monetary policy under the current inflation-targeting regime used by most countries. BTW, I've acknowledged that fiscal stimulus is effective under other regimes, and have cited the boost to GDP provided by war spending in the 1940s. That spending did not boost welfare (consumption fell) but it undeniably reduced the unemployment rate. And certain types of fiscal stimulus can be effective even under inflation targeting; such as employer-side payroll tax cuts and VAT cuts.
2. In a sense this entire debate is an artifact of a flawed stabilization policy regime, with unclear lines of authority. As I just indicated, fiscal policy would be effective (i.e. effect GDP) in certain types of clearly defined monetary regimes. And Paul Krugman has agreed that fiscal policy would not be effective if interest rates were above zero. Indeed he has advocated a 4% inflation target precisely because that would eliminate the need for fiscal stimulus. If the precise role of the Fed at the zero bound were made explicit, then this debate would go away.
There are very few debates in economics that could be resolved by Congress, but this is one of them. In this post I explain how."
Tuesday, June 23, 2015
More Scott Sumner On Austerity
See The "other things." Excerpt: