In an email exchange with fellow economists from around the place I made the following wild conjectures on why fiscal stimulus could be seen as a good idea – but isn’t necessarily first best. Feel free to read and critique 😉
Email one – fiscal policy, and why it may be preferable
This link discusses some of the modern justification for “demand side” policies during a significant recession.
Note, when they say “demand side policies” this can mean either monetary policy or the government buying things.
The people that want higher fiscal policy fall into two (often intersecting) camps:
- They just want higher government spending to start with,
- They believe that once interest rates are close to zero we hit a “liquidity trap”.
I don’t believe in liquidity traps per see, as when we have a liquidity trap the issue is that we can’t cut interest rates. However, we can “print money” and buy things with that money – and if the real interest rate doesn’t fall (nominal rates – inflation) then we are effectively getting higher production for nothing …
That is the key – we could create inflation to get out of the environment. Now in the liquidity trap view there are two reasons why we have a liquidity trap:
- We can’t print money and buy stuff to create inflation
- We won’t print money to buy stuff and create inflation
The first view is just weird. The second view is actually fairly accurate – central banks are nervous about “just printing money” as they get attacked about “hyperinflation”. Of course, there is a gap between “deflation” and “hyperinflation” but if central banks just start printing money, and inflation expectations get loose as a result, we will have a more unstable environment.
As a result, fiscal policy can be seen as preferable if we think printing money would cause instability.
Email two – batting for New Keynesians
Here is more from Thoma,
He has good points, but I think he is too negative about the ability to adapt New Keynesian models – New Keynesian models are frameworks, the problem is that we haven’t got sophisticated enough descriptive knowledge to really get the most out of the framework.
Krugman is here:
He is writing as someone who pushed fiscal policy, and refused to really listen to/fairly represent the other side. Deep down Krugman is in the “the zero rate doesn’t have to matter, but policy will be such that the zero rate is a constraint” camp. But he acts as if he is in the “at zero monetary policy is useless” camp.