Fiscal Multipliers

Moneybox summarizes an IMF report:

Kate Mackenzie at FT Alphaville gives us the latest from International Monetary Fund chief economist Olivier Blanchard who wrote a little box in the latest IMF World Economic Outlook report arguing that fiscal austerity has been more damaging than the pre-crisis consensus in the economics profession would have suggested. Here's Blanchard:

The main finding, based on data for 28 economies, is that 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, depending on the forecast source and the specifics of the estimation approach. 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.

This is part of an ongoing transformation at the IMF over the past decade to becoming a major international opponent of the kind of harsh austerity regimes that the IMF was known for in the mid-to-late 1990s.
The research issue here is that, methodologically speaking, it's difficult to know what "the" fiscal policy multiplier is supposed to be. A lot of good research has been done on the macroeconomic impact of deficit financed military spending. But such spending isn't meant to stimulate a depressed economy and in fact is often paired with monetary policy or other measures specifically designed to strangle domestic consumption (wage and price controls, rationing) and prevent total economy-wide spending from expanding. A country with a depressed economy and a central bank that wants to see total economy-wide spending go up but isn't willing to forcefully deploy tools beyond interest rates to make that happen can see a much bigger fiscal impact. Conversely, a country whose fiscal authorities are trying to paddle upstream in the face of a central bank that wants less demand and less inflation isn't going to get anywhere.
Back to Mackenzie, the bottom line is that we need less budget cutting from countries that have cheap borrowing costs:

And the IMF is urging that countries who have ‘room to maneuvre’ such as the UK, France and the Netherlands, should “smooth their planned adjustment over 2013 and beyond” if growth falls significantly below the IMF’s increasingly gloomy forecasts.

Now what it makes the most sense to do depends on circumstances. In Germany where unemployment is very low already and public services are quite good, it seems like a VAT cut to let Germans enjoy higher living standards (and perhaps buy more goods from southern Europe) would be ideal. In the US we should be avoiding a disastrous payroll tax hike and probably creating slush funds for our budget-strapped state and local governments.

If The Fed Could Not Raise Inflation

Moneybox:

John Cochrane has become well known in recent years for his conservative political views, but the opinion he expresses in today's NYT forum about inflation is strangely widespread across ideological lines. He says that not only would it be unwise for the Federal Reserve to try to create inflation, it would be impossible as well:

The fact is, the Fed is basically powerless to create more inflation right now -- or to do anything about growth. Interest rates can't go below zero, and buying one kind of bond while selling another has minuscule effects.

I've heard this from economists like Jamie Galbraith on the left and Lawrence Summers in the middle as well, and I don't buy it at all. The problem is that there's a huge logical gap between the sentences. It is true that those particular things don't create much inflation. But what if the Fed did other things? For example, consider the "minuscule effects" of quantitative easing. Those aren't zero effects. In fact, inflation expectations have risen when the Fed has announced rounds of easing.

Have they risen a lot? No. Presumably because the Fed doesn't want them to rise a lot. But suppose the Fed announced a big new round of Quantitative Easing and said "the purpose of this bond buying is to raise inflation expectations above 3 percent"? Suppose they said "the purpose of this bond buying is to raise inflation expectations above 3 percent and we'll keep on buying bonds until it happens?"

I think that small tweak in strategy gets you from "miniscule effects" to bigger effects. The issue is that the Fed gets what it wants. If it wants to raise inflation expectations a little, it gets a small effect. If it wants a bigger effect it needs to communicate that fact, and it'll get the effect.

The other way to look at it is not in terms of a policy recommendation, but it terms of what might be possible if the Cochrane viewpoint were correct. The Fed could, on that view, simply buy all the outstanding debt in the country and then tear it all up. Wouldn't that be a bonanza? Yes it would be "unfair" since the highly indebted would benefit more than the prudent. But virtually everyone has at least some debt or owns shares in companies that have debt, and absolutely everyone is implicitly responsible for different forms of public sector debt. And we're not talking about a Universal Jubilee at the expense of creditors here. Every creditor would be paid in full by the Federal Reserve, and every debtor would receive complete relief from debts. Wouldn't that be lovely? But of course it's a fantasy. If you did that there would be tons be inflation.

So I'm not saying we should do that. What I'm saying instead is that Cochrane is wrong. But what I'm saying more broadly is that if you do think the Fed can't create inflation, that's a view with some wild implications for the world beyond boring monetary policy conversations.

Sticky Wages - Unemployment & Recessions

Sticky wages = downward nominal wage rigidity. This creates the market failure of unemployment. Classical economists (and RBC-theorists) thought that if wages fell during a recession, then there would not be any unemployment because this is what a simple labor supply and demand graph shows.  It would cure unemployment, but it would do nothing to cure the recession; it would just spread the wealth around.  A better solution would cure the recession AND reduce unemployment.  Lowering wages would cure unemployment, but it would make the recession worse by lowering the incomes of most people which would create even more bankruptcies and money hoarding.  It is extremely hard to lower nominal wages, but you can solve the unemployment problem by lowering real wages which is much easier. If you want to lower real wages, the best way to accomplish that is through monetary policy.  There are two good options:
1.  Currency devaluation effectively lowers wages compared with the rest of the world.  This is a targeted inflation which raises the prices of all foreign goods (lowers the prices of domestic goods for export) and thereby increases demand for exports. 
2. General inflation also works to lower real wages (IF there is a recession) and it also lowers real interest rates which solves the problem of hoarding money, underinvestment, and excessive debt. 
Krugman comments:

I keep running into comments along the lines of “Well, if you think sticky wages are the problem, why aren’t you calling for wage cuts?”
This is a category error. It confuses the question “What do we need to make sense of what we see?” with the question “What is the problem?” So let me talk about that.
When Keynes argued against the “classical economists”, he was to a large degree arguing against the view that there is no such thing as involuntary unemployment — a view often defended, then and now, by an appeal to the usual logic of supply and demand. If we’re looking at the market for, say, wheat, and there’s an excess supply — sellers want to sell more than buyers want to buy — we expect to see the price fall rapidly to clear the market. So if there were really a large excess supply of labor, shouldn’t we be seeing wages plummeting?
And the answer is no — wages (and many prices) don’t behave like that. It’s an interesting question why, one that has to be answered in terms of psychology and sociology, but it’s simply a fact that actual cuts in nominal wages happen only rarely and under great pressure. So wage stickiness is an essential part of a demand-side story about what’s going on with the economy; it’s how you answer the question of why wages aren’t falling.
But that’s not at all the same thing as saying that excessive wages are the problem. ...[W]e are in a liquidity trap, and balance sheet effects [bankruptcy and household debt] are very important. So there is no reason to believe that cutting wages would be helpful; on the contrary, falling wages would worsen the balance-sheet problem, a point some of us have been making for quite a while.
So when I emphasize nominal wage rigidity, I am defending an analysis of how the economy works, which is not at all the same thing as saying that this rigidity is the problem. On the contrary, for the US (though not for countries like Spain), wage stickiness is if anything good for us right now, helping stave off destructive deflation.

a sovereign debt crisis?

In Greece, Italy, and Spain there is a problem, but the market is charging less and less to loan other rich governments money:

IMF: Balance-Sheet Recessions

The IMF has been famous for imposing austerity upon economies in economic crises in the past two decades.  RortyBomb says, "One has good reason to dread hearing the policies the IMF recommends for a country in a crisis. Maximal labor "flexiblity"? Cat food for old people? Picking government functions out of a hat to privatize?"  IMF privatization, deregulation, and austerity policies didn't work out too well in the Asian and  Latin American financial crises so the IMF has completely reversed their thinking for dealing with the present recession. 
RortyBomb summarizes their latest report:
"1. A run-up in household debt and leverage explains the economic collapse across countries."
 This means a balance-sheet recession.  That is where consumers increase their debt to savers (the elites and elderly) and then they try to pay it down which reduces consumption because the savers don't spend more just because the borrowers are spending less.  
"2. Financial crises are not a driver of prolongued recessions. If anything they are a symptom."
The recession caused the financial crises: 
recession+debt -> financial crisis
not  
financial crisis -> recession & debt 
"4. Foreclosures are a problem."  
It is amazing that most economists have ignored this part of the problem of this financial crisis.  The slow foreclosure process destroys housing value and suppresses home values which makes indebted homeowners feel poor and spend less.   
"5. Demand demand-side stimulus. Across the board. Now."

Temporary macroeconomic policy stimulus...simulations of policy models developed at six policy institutions suggest that, in the current environment, a temporary (two-year) transfer of 1 percent of GDP to financially constrained households would raise GDP by 1.3 percent and 1.1 percent in the United States and the European Union, respectively...Monetary stimulus can also provide relief to indebted households by easing the debt service burden...A social safety net can automatically provide targeted transfers to households with distressed balance sheets and a high marginal propensity to consume, without the need for additional policy deliberation...

Support for household debt restructuring: Finally, the government may choose to tackle the problem of household debt directly by setting up frameworks for voluntary out-of-court household debt restructuring—including write-downs—or by initiating government-sponsored debt restructuring programs. Such programs can help restore the ability of borrowers to service their debt, thus preventing the contractionary effects of unnecessary foreclosures and excessive asset price declines.

Two Articles On Inequality and One Defending RBC

First, Galbraith makes the old Keynsian argument that inequality makes the economy unstable.  Note that this is not a particularly mainstream Keynesian view and, for example, Krugman does not buy it. Interestingly, although Raghuram Rajan comes from the other end of the political spectrum from Galbraith, he seems to agree for somewhat different reasons. 
Another article is about Edward Conard who just wrote a book claiming that inequality is the best thing ever and that we need more inequality in the US.  He is a really rich Wall Street guy who seems like a character out of Margin Call, but he got a bunch of book endorsements from smart people, and he has some interesting things to say. 
The last article is a rare defense of RBC in the popular media. I almost never see a defender of RBC attempt to explain it to lay people because it does not make any sense, so this is a gem.  The author argues that fluctuations in technology (including the weather as a kind of technology) cause recessions by making the economy less productive during recessions when the technology (weather) turns bad. Thus the 2008 recession happened because we suddenly became less productive.  RBC does a great job of describing recessions in primitive agricultural economies where the weather really does mostly determine output because bad weather really does make agruculture less productive, but weather is a poor analogy for technology.  How could there be a great forgetting of productive technology that works  like a massive drought and makes us less productive than we were a year before?    RBC is vague on the specific cause of any recessions and does nothing to explain the housing bubble. RBC theorists never specify what specific technology decline (or adverse weather) caused the 2008 recession.  Instead, they often resort to vague mentions of 'confidence' which is an area that Keynesians have actually studied extensively as Cassidy discusses in his book, How Markets Fail.
Even though I disagree with each of the three articles, each author is smart in his own way and there are grains of truth in each argument:

1. Gailbraith: Inequality of borrowing is part of the core Keynesian story.  During a recession, some people have too much money and are not spending it and others have too little and cannot spend it and so there is a shortage of spending.  Inequality can contribute to economic instability via political channels if nothing else.  Highly inequal societies usually have poor economic growth. 
2. Conard: Too little material inequality can also be a problem as in the case of Cuba and North Korea. On the other hand, you can argue that these countries are not very equal in a more important dimension than market goods.  They have extremely high political inequality because the political elites have absolute power whereas everyone else has less political power than an impoverished voter in a democracy. 
3. RBC Guy:  It works well for explaining recessions in ancient Greece, Robinson Caruso, and to a lesser extent during the 1970s oil shocks. 

SR vs. LR Unemployment and Economic Growth

Moneybox:

Short business cycle downturns like the ones the United States had in the 1950s and 1960s shouldn't have any real long-term consequences even if they're severe. But prolonged spells of mass unemployment provoke things like the current trend of European employers reducing investment in skills training since if there's going to be a surplus of potential workers and a deficit of potential customers, high-investment firms are going to lose out unless they hit incredible home runs.

The same logic should apply to "hard" capital investments as well. When I was in Paris last fall, I was interested to see that Parisian McDonaldses have computer kiosks where customers can place orders without taking up the time of a human cashier. Rival fast food chains like KFC and Quick didn't yet seem to be using this technology and McDonalds was only employing it to a limited extent. If France was facing a high-demand tight labor market scenario for the future presumably McDonalds would double-down on this bet and rivals would either match their productivity-enhancing capital investments or else be displaced by McDonaldses high productivity model. But instead France has had, and looks scheduled to continue to have, a long period of depressed demand and elevated unemployment. Firms have little reason to spend money insuring themselves against workers quitting in search of higher wages and little reason to believe that increased output will actually be purchased.