But anyway, via Brad DeLong, I find Scott Sumner making this batty claim:
Keynesian economists have never been able to accept my assertion that the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy.
Translated roughly from Monetarese into English, this means: "If Congress tries to boost output by spending money, the Fed will counteract this effort by enacting tighter monetary policy. Thus, stimulus can never work."
Why is this a batty claim? Well, to see why, we must first identify the assumptions that would have to be true for the claim to hold. These are:
Assumption 1: The Fed can control the path of nominal spending (NGDP).
Assumption 2: The Fed does choose to control the path of nominal spending in a way that will cancel out any stimulus.
I admit to being dubious of the first assumption. I think that the Fed probably observes the factors that affect future nominal spending only with a lag, and that there is also a substantial unpredictable component of the effect of the Fed's actions, making it difficult for the Fed to steer nominal spending with precision. But this is not why I think that Sumner's claim is batty. Assumption 1 - that NGDP targeting could work - is something that is not obviously false. It's also something that Scott Sumner and many other smart bloggers say all the time.
The batty part is Assumption 2. This is an assumption about the Fed's "reaction function" - the way that the Fed actually does respond to changes in the economy. For stimulus to be ineffective, the reaction function has to cancel out any and all output changes that result from fiscal policy changes.
What kind of Fed policy would do this? Well, the Fed could target the growth rate of NGDP. Suppose that the Fed decides that NGDP should grow at 4% a year. Then a fiscal stimulus that tried to push NGDP growth up to 6% a year in the wake of a recession would cause the Fed to tighten (i.e. print less money), frustrating Congress and holding NGDP growth at 4%.
Alternatively, the Fed might target the level of NGDP. In this scenario, the Fed might not counteract fiscal stimulus, because stimulus after a recession might work to bring NGDP back to where the Fed wants it to be. However, in this world, the stimulus turns out to be completely unnecessary, because it's only doing what the Fed would do anyway; in the absence of stimulus, the Fed would print money and buy stuff until NGDP went back to pre-recession levels.
But now notice that there is one huge huge huge problem with either of these stories: If the Fed controls either the level or the growth rate of NGDP, where the heck did the recession come from in the first place?! If the Fed both can and does counteract shocks to the NGDP path, then recessions should never happen. In other words, if the positive demand shock of a stimulus must be canceled out by the Fed, then the negative demand shock of a recession should be canceled out as well!
But it isn't. Via DeLong, here is a graph of the recent path of nominal GDP:
As you can see, both the level and the growth rate experienced a massive swing in 2008. That swing was the Great Recession. It was not counteracted by the Fed.
So to believe Scott Sumner's claim about the powerlessness of fiscal stimulus, you must believe that the Fed can and does counteract stimulus, but either can't or chooses not to counteract recessions. Essentially, you must either believe that the Fed's powers of stabilization are severely limited (which Scott Sumner probably does not believe, given everything he writes), or that the Fed wants to torpedo the U.S. economy.
(Update/Aside: This last item deserves more explanation. It is theoretically possible that the Fed targets the NGDP growth rate, but occasionally makes mistakes, and never tries to correct its past mistakes. So when there are big recessions, the Fed simply lets them happen, and then actively prevents recoveries from returning us to our previous NGDP trend line. Since recessions are more abrupt than booms, this means the Fed is actively out to torpedo the U.S. economy. Now maybe this is true - if the Fed has a bizarre nonlinear hard-money bias that manifests more in recessions than booms, it could be true! - but it would mean that past recessions would have manifested as unit-root drops in output...in other words, a bunch of L-shaped recessions in the past. Most people think that that isn't what we've seen; that after past recessions, output has returned to trend, and that drops in output were not "frozen in" by a deranged Fed. Anyway, now back to your regularly scheduled ranting...)
(Update/Aside: This last item deserves more explanation. It is theoretically possible that the Fed targets the NGDP growth rate, but occasionally makes mistakes, and never tries to correct its past mistakes. So when there are big recessions, the Fed simply lets them happen, and then actively prevents recoveries from returning us to our previous NGDP trend line. Since recessions are more abrupt than booms, this means the Fed is actively out to torpedo the U.S. economy. Now maybe this is true - if the Fed has a bizarre nonlinear hard-money bias that manifests more in recessions than booms, it could be true! - but it would mean that past recessions would have manifested as unit-root drops in output...in other words, a bunch of L-shaped recessions in the past. Most people think that that isn't what we've seen; that after past recessions, output has returned to trend, and that drops in output were not "frozen in" by a deranged Fed. Anyway, now back to your regularly scheduled ranting...)
That is why the claim is a bit batty. If the Fed is truly omnipotent, then we shouldn't see any recessions, or any calls for fiscal stimulus in the first place. The fact that we're even having this debate makes the "helplessness" position untenable.
Incidentally, this is not the first time I've seen Sumner make this claim. In a post on trade policy back in October, he wrote:
If the Fed follows its announced policy of inflation targeting, the contractionary effect of China’s [decision to float its currency] on world output will not be offset by any expansionary effects on the US.
This is exactly the same idea. If the Fed both can and does control output, no (demand-side) policy other than a change in the Fed's policy rule can ever have an effect on output. It doesn't square with the very real fact of recessions.
But here's something else I've noticed - this "helplessness" perspective kind of clashes with Scott Sumner's usual line. Sumner spends a lot of time arguing that the economy would be OK if the Fed would just target NGDP. But if the Fed already effectively steers the path of nominal output - so effectively that stimulus and trade policy are ineffectual - then what is Sumner complaining about?
So anyway, I'm sorry Bat Boy had to be trotted out. I am sure it will be me making a batty claim sometime soon, and I hope someone out there cares enough to point it out. Speaking of which, I need some more iced tea...
Update: I wrote this in a comment and thought I should move it up to the main post:
Really what it comes down to is this: If you believe that the Fed can move around the NGDP path at will, it is possible to postulate a reaction function such that the Fed will always cancel out any fiscal stimulus. But to assert that such a reaction function does exist is a claim that has little or no evidence to back it up. And to assert that such a reaction function logically must exist, simply because it can, is nonsense. Hence, Bat Boy.
I'm not sure if this last, strongest, and most preposterous claim is the claim that Scott Sumner is making...it sounds like it might be. But even if it's simply an empirical claim that in practice the Fed does try to counteract stimulus, then I want to see the evidence.
Update: I may have overinterpreted Sumner's claim. If so, the Bat Boy is hereby revoked. This is important, since Bat Boy is only used when theoretical claims are made that are clearly false, and hence is not to be summoned lightly...
Update: I wrote this in a comment and thought I should move it up to the main post:
Really what it comes down to is this: If you believe that the Fed can move around the NGDP path at will, it is possible to postulate a reaction function such that the Fed will always cancel out any fiscal stimulus. But to assert that such a reaction function does exist is a claim that has little or no evidence to back it up. And to assert that such a reaction function logically must exist, simply because it can, is nonsense. Hence, Bat Boy.
I'm not sure if this last, strongest, and most preposterous claim is the claim that Scott Sumner is making...it sounds like it might be. But even if it's simply an empirical claim that in practice the Fed does try to counteract stimulus, then I want to see the evidence.
Update: I may have overinterpreted Sumner's claim. If so, the Bat Boy is hereby revoked. This is important, since Bat Boy is only used when theoretical claims are made that are clearly false, and hence is not to be summoned lightly...
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