A Suggestion to Readers Who Actually Have PhDs
C’mon, admit it–for a lot of you, reading Free Advice is your guilty pleasure, sort of like listening to Abba. I don’t have the time to do this carefully, because I actually don’t have guaranteed checks every month. (And I certainly don’t get summers off.) So here’s my suggestion. You can feel free to run with this if it turns out to be right, and you don’t even need to say you got it here. Plausible deniability is the name of the game.
OK so the ECB comes out [.pdf] says fiscal austerity not only makes sense according to freshwater theory, but there are at least 3 historical episodes where governments initiated strong reductions in their deficits (primarily through spending cuts) and even in the short run, their economies rebounded.
Paul Krugman goes through and tries to pick apart all the examples, to show why they aren’t relevant now. Specifically, each of the examples relied on either cutting interest rates (which is impossible now) or boosting exports (which the whole world can’t do right now). So that’s why it’s gotta be pump-priming deficits, baby.
In a more recent post, Krugman favorably links to a new paper by Corsetti and Meier [.pdf] that looks at the multiplier conditional on there being a financial crisis. And wow! they find the multiplier in such cases can be two.
But if we turn to their discussion of the case of financial crises, they write:
Our results, shown in Figure 4, suggest that the response of consumption and output to a fiscal expansion is positive and large, once we condition on the occurrence of a financial crisis: consumption
and output rises about twice as much as the rise in spending. Correspondingly, the trade balance deteriorates significantly and persistently. The response of investment is initially muted, but appears to grow over time. In addition, the real exchange rate depreciates strongly.
As I say, I don’t have time to do this justice. But can we dismiss all of these examples the same way Krugman blew up the ECB’s examples of fiscal austerity working? In other words, to get the multiplier of two, is it important that the real exchange rate depreciates strongly? If so, then these cases are inapplicable, per Krugman’s logic: The whole world can’t have a strongly depreciated real exchange rate.
(Incidentally, I know the difference between imports and exports, and how the national income accounting identity treats rising exports as boosting output while imports as reducing it. Even so, if these historical examples for some reason rely on depreciating exchange rates to ‘work,” then Krugman can’t use them.)
Good points. I have been thinking for some time that demand-stimulating policies tend to be zero-sum at least internationally. As you say, not everyone can devalue simultaneously and to the same degree. A kind of beggar thy neighbor effect, it seems.
Mario (or anyone else who knows the answer), am I right in thinking that this paper is saying a short-run Keynesian boost necessarily relies on increasing imports? If you look at the quotation above from the paper, they sound like they are saying something like this:
“In times of financial crisis, government deficits lead to large increases in consumption. Since this isn’t matched by a comparable increase in domestic production, of course the high multiplier is accompanied by a surge in net imports.”
Note that I am putting words into their mouths, but doesn’t it seem like they’re saying something like that?
And if so, isn’t that an important point? In other words, isn’t it rather damning if even the “smoking gun” Keynesian paper says, “Sure you can boost Y by running a deficit, but you’re not actually boosting domestic production?”
I realize I am running around in circles, because if C went up just because net exports fell, then Y would be unchanged. But there is something about that quotation above–which seems to take it for granted that a high multiplier would go hand-in-hand would a collapsing trade balance–that isn’t sitting well with me.
Scott Sumner has posted on this as well.
http://www.themoneyillusion.com/?p=6076