Notes on Gerald Friedman

Rethinking macro economics Fiscal policy

J. Bradford Delong: Notes on Gerald Friedman: Since 2010 fiscal policy austerity has been a disaster for both Europe and the United States. But how much better could things be? How much good could be done by a restoration of a sensible fiscal policy?

I take a sensible fiscal policy to be one that, in the words of Abba Lerner, recognizes the first principle of functional finance…

to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce… concentrat[ing] on keeping the total rate of spending neither too small nor too great, in this way preventing both unemployment and inflation…

I think a sensible fiscal policy entailing larger deficits and much more aggressive federal spending on investment—and remember that improving public health and the human capital of twelve year olds are just as good “investments” as big pieces of useful infrastructure, and much better than border walls—would do a lot of good. Gerald Friedman thinks that it would do about four times as much good in the long run as I do. Let me try to figure out why….

At first, [Larry Summers’s and my] decision to set [our hysteresis parameter] η = 0.1 as the central case was merely a calculation followed by a belief and then extended by a guess. But the argument was strengthened by… American economic history. It is very difficult see large and permanent depression of the rate of potential output growth following any of the major and at times lengthy recessions of the pre-Great Depression period. And whatever damage had been done to long-run productive potential from the Great Depression and its decade-long output gap appears to have been offset by the boost to productive potential from the extremely high-pressure economy of World War II…. [And] previous post-WWII downturn episodes had been followed by V-shaped recoveries—after 1957, 1960, 1975, 1982, and 1992—seems to leave little space for any hysteresis coefficient η much larger than calculations, beliefs, and guesses had led to….

To me, back in the winter of 2016, projections finding large benefits that made sense only under an assumption of η = 0.4 thus seemed four times as large as was in fact likely to be the case. The world seemed to be telling us that η = 0.1 instead. It seemed—and it seems—to me that overpromising the benefits of even the best policies is not a good business to get in. Somebody like Irving Kristol could unashamedly take the Public Interest he edited and use it as a vehicle to publish things he really did not believe could possibly be true:

My own rather cavalier attitude toward the budget deficit and other monetary or fiscal problems [arose because] the task, as I saw it, was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority—so political effectiveness was the priority, not the accounting deficiencies of government…

But this is not a good game to play. We seek to do better…



Brad DeLong
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