On Sachs on Krugman
I have been pinged
@Noahpinion @sjwrenlewis also pinging @interfluidity @robertwaldmann @Frances_Coppola and anyone else who wants to get involved.
— Michael Harris (@MichaelH_PhD) January 7, 2015
and am so flattered to be pinged in such company that I decided I had to read the Jeff Sachs article on Krugman Austerity and the Obama recovery and comment on it. It isn’t quite as bad as I feared.
My comment is really here. I note that the actual pattern corresponds to Krugman’s descriptio of growth of real GDP speading up exactly when the long decline of government purchases (G) reversed in 2014q2. I fear I will be posted the graph of US real G for the rest of my life.
The graph shows steadily increasing austerity along with consistently disappointing recovery, then an end to the reduction in G and rapid growth. The data perfectly fit both the vulgar Keynesian story and the fancier Krugmanite story that vulgar Keynesianism is valid when the economy is in the liquidity trap.
Krugman’s response is extremely convincing. Brad DeLong is impressively shrill. Simon Wren-Lewis found a new way to illustrate the fact that the recovery was disappointing.
So what was Sachs thinking ? First, in his defence, I am sure the “brisk” growth he had in mind was in 2014q2 and 2014q3. He should note that some is the economy unfreazing after 2014q1, but the word isn’t crazy.
I think he made one polemical choice and one mistake. The mistake is to consider only Federal fiscal policy. This is a natural simplification if one relies on daily newspapers for news of fiscal policy, but Sachs should know how to FRED and should know to FRED. For aggregate demand, it doesn’t matter if government consumption and investment is federal state or local. The graph above is for all together. This mistake is less excusable in a critique of Krugman, as Krugman often discusses the 50 little Hoovers.
Second the polemical choice is to focus on the deficit and not on G. This is totally unreasonable in a critique of Krugman. Krugman has repeatedly stressed the difference between the Government expenditure multiplier and that tax cut multiplier. He denounced Obama for (among many other things) including too large tax cuts as well as too small spending increases in the ARRA (Sachs had the exact same objection).
Krugman has made a proposal for optimal fiscal policy in a liquidity trap. In it he did not mention the timing of taxes at all, because he used a model with Ricardian equivalence in which this timing doesn’t affect aggregate demand. The post is flagged as “ultra-wonkish” but it isn’t too wonkish for Sachs.
Importantly, Keynesians all agree that balanced budget spending increases (as proposed by Sachs) stimulate. Therefore the structural deficit is not an adequate index of the fiscal stance. Some New Keynesians go so far as to use models in which deficits don’t matter (By my rules I must name names, so I name Smets and Wouters). I consider myself an extremely old fashioned Keynesian, who thinks the timing of taxes matters a lot. Krugman and Sachs are somewhere in between, and at almost exactly the same point.
Being (even) less enamored of Ricardian equivalence than Krugman, I have more of an intellectual problem due to the absense of noticeable damage due to the end of the partial payroll tax holiday in 2013q1 (this not being the NYT I can just say that is just one data point and that shit happens). Oddly Sachs and Krugman agree on policy, yet Sachs continues to insist that Krugman disagrees.
When oh when oh when will one of the ping worthy notice that these disagreements flare up all the time because of a methodological failing of economics?
“Textbook” economics generates whatever answer you fools want it to generate. Krugman is telling the truth when he says, “Reality has a well-known liberal bias.” The clear implication is that, if you want to be right, manipulate your models so that they generate a liberal policy recommendation.
But then to come in afterwards and declare the success of Keynesian economics? Please.
http://econospeak.blogspot.com/2014/12/are-keynesians-desperate-about-1921.html?m=1
I found the conversation with Barkley Rosser interesting.
Dr. Waldman,
The discussion in your blog centers on how to respond to a Liquidity Trap and whether austerity is the best approach or whether a Keynesian fiscal stimulus is better. Unasked here is whether there is currently a Liquidity Trap at all.
Dr. Krugman’s explanation seems useful:
“…is basically the same as saying that even a zero short-term interest rate isn’t low enough to produce full employment — is a situation in which increasing the monetary base has no effect on aggregate demand, because you’re substituting one zero (or very low) interest asset — monetary base — for another zero or low interest rate asset, short-term government debt.”[1]
Today, if I were to have one million one dollar Federal Reserve Notes (FRNs), I could put that money into a safety deposit box and earn an effective interest of zero or I could purchase United States Treasury (UST) Bills and earn an effective interest rate of zero (nominal interest rate minus inflation). In 2007 this was not the case, the effective interest rate paid by UST Bills was higher than on holding FRNs. The Federal Reserve Bank (FRB) could influence interest rates through Open Market Operations (OMO) based on the differential between currency and securities, in this case lower interest rates. Today that leverage is lost, the FRB cannot lower interest rates further, if there were in fact a Liquidity Trap.
However is this the case? The UST routinely auctions off securities at very low interest rates and the FRB has purchased them from buyers through auction. People do convert money into debt. In the United States money is not actually equivalent to UST Bills, Bonds, Notes, &c, the latter enjoys a significant legal preference to currency. UST securities are exempt from a number of core provisions of bankruptcy law[2]. These “safe harbour” provisions create a significant preference for UST securities over currency.
[1] http://bit.ly/14dZdBF
[2] http://nyti.ms/1xJt7cx