How to Read What We Learned About Government Policy and the Business Cycle from 2013: Monday Focus (January 27, 2014)
Mike Konczal gives his view on the issues I wrestled with during the week of January 5:
Mike Konczal: In 2013, the Fed showed why fiscal policy is still important: “Last spring, I wrote a piece in Wonkblog saying we’d get to see whether or not the expansion of monetary policy by the Federal Reserve would offset fiscal austerity in 2013…. I concluded that it wasn’t looking too good for the Fed… but that QE3 was a smart idea anyway (and should go further)…. Recently, there’s been a wave of posts by Scott Sumner and David Beckworth calling me and others out, saying that the votes are in and it’s a victory for the market monetarists, the team that said monetary policy would offset austerity in 2013 and that fiscal policy wouldn’t matter….
I don’t see it. I’m willing to be convinced, but the two clearest tests I saw the market monetarists put forward in early 2013 have resulted in failure. Let’s go through them:
At the end of 2012, David Beckworth… argued “that nominal GDP (NGDP) growth has been remarkably stable since about mid-2010 despite a contraction in federal government expenditures” and that “the Fed has been doing a remarkable job keeping NGDP growth stable.”… I like this test because it draws a line in the sand and it also fits with my understanding of how the market monetarists view the situation: The Federal Reserve picks the NGDP path it wants…. So how did this line in the sand turn out?… When government spending starts to fall… NGDP growth was lower in the first two quarters of 2013 than it was in 2012…. [And] how did the Fed’s projections for 2013 turn out? Did the economy end up how the Fed said it would when it announced expanded monetary policy? It fell, both in real GDP and especially core inflation….
One way to read 2012’s monetary actions was that the Federal Reserve really wanted to hit a 2 percent inflation target…. Many people considered this an important part of the Fed’s ability to boost the economy…. Regardless of what you think the Fed wanted in late 2012, they certainly weren’t trying to generate lower inflation. If the Fed truly is omnipotent, we shouldn’t see this….
To reiterate, I think the Federal Reserve should be doing more. I’d love to see Yellen enact a genuine regime change at the Fed. But we shouldn’t doubt that fiscal policy, at this moment, is making a difference…
As I have said, I used to think that under a “neutral” policy–neither unusually stimulative or contractionary–the U.S. economy would close 40% of the gap between its current position and full employment each year. I have had to give that up: now I’m down to thinking that, at least at the zero lower bound and under conditions of ultra-low inflation, it looks to be 20%. But we haven’t had that 10% gap-closing in the past year. And monetary policy has certainly not been neutral, or perhaps it would be better to say that the Federal Reserve thinks that monetary policy has been dangerously expansionary. That leaves me concluding that fiscal policy is indeed powerful: that contractionary austerity is contractionary, and austere.
So I really don’t understand why the likes of Beckworth and Sumner are declaring that the absence of a return to formal recession in 2013 increases their confidence that fiscal policy does not matter. It does not increase my confidence.