Hamlet on fiscal space in recessions

January 24th, 2018 at 10:46 am

Over at WaPo, wherein I argue that a) when we hit the next recession, many policy makers will point to our higher-than-average debt/GDP ratio as evidence that we have too little fiscal space to engage in offset fiscal stimulus, and b) those policy makers will be wrong.

I cite an important new paper by Romer/Romer on these points, showing that when you show up to put out a fire, you’d better bring some water. IE, countries with more fiscal and monetary space do more to offset negative shocks than countries with less space.

But the other very important, recent piece in this space is Auerbach/Gorodnichenko’s empirical work on how we have more fiscal space than is typically realized. If you want an excellent summary of their findings, see Furman’s comments on it, e.g.:

The key result in the Auerbach and Gorodnichenko paper is that a fiscal expansion in an economy with a substantial output gap is likely to lower the debt-to-GDP ratio because it raises the numerator (debt) by less than it raises the denominator (GDP). Relatedly, they find that in these circumstances there is more evidence for fiscal expansions resulting in lower real interest rates and Credit Default Swap (CDS) on sovereign debt, market developments that are consistent with the improved fiscal sustainability. Moreover, they find no evidence that fiscal expansion is less effective in a high-debt economy. Critically, all of these results are about economies in downturns—their featured point estimate for the impact of a fiscal expansion in an expanding economy is that it would increase the debt-to-GDP ratio.

Why the Hamlet reference? As the erudite OTE crowd knows, he said, “…there’s nothing either good or bad, but thinking makes it so.” What you didn’t know is that he was talking about fiscal space at high debt/GDP ratios.

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3 comments in reply to "Hamlet on fiscal space in recessions"

  1. Smith says:

    We don’t need new studies by the Romers, or your carefully constructed arguments in the Washington Post. The refusal to use fiscal stimulus is a political decision and not an economic one. For as long as you engage Republicans and conservative economists on their terms, and concede they have a case to make, you lose. You never get to the actual cause of economic stagnation and continued inequality. Why do you need more studies when we already live with the failed results of the natural experiment run in 2009? Krugman cited the history of the Great Depression in 2008, which every child in high school learns about in U.S. history class, depression, deficit spending, recovery.

    Yes but the Larry Summers memo of Dec 2008 shows the same mistake was made with dire results. Summers has never admitted he got it wrong and doomed the economy and country to a slow recovery. Doubtless the poor recovery was a necessary component for ascendancy of Trump. I believe his position is still the same in opposition to the views of Keynes, FDR, but agreeing with Sec Morgenthau who gave us a double dip Depression.


    Here is what the Washington Post reported January 2012:
    “The controversial takeaway from the memo is that Summers suggested that a stimulus in excess of $1 trillion would spark a counter-reaction from the bond markets. This furthers the argument that members of the president’s economic team warned him off of an
    appropriately sized stimulus.”

    “The key thing I took away from the memo is that it does not read at all like the current story the administration gives for the inadequate size of the stimulus, which is that they knew it should be larger but had to face political reality,” writes Paul Krugman. Rather, he says, “Summers et al were afraid of the invisible bond vigilantes.”

    Here was Krugman right after Obama’s election, early Nov 2008, already concerned about the size of a counter cyclical fiscal stimulus package.

    • UserFriendly says:

      The level of employment has always been and always will be a political decision. The fact is that the donor class likes the power and authority they get from being able to threaten their employees with unemployment more than they would like the increased profits they would see from a full employment economy.

      That is why we went from having both parties targeting full employment to both parties targeting low inflation in the 70’s. The oligarchy manipulated the inflation caused by oil shortages (OPEC and Iran) to declare full employment unsound.

      • Smith says:

        Krugman has brought up Kalecki numerous times in the past. The odd thing is that Krugman has trouble understanding the premise, how captains of industry would give up profits or growth under certain conditions.
        Also, I think your understanding of how people pursue policy and in particular give preference to inflation over full employment is mistaken. Both parties do not target full employment, it’s more about what is your definition of full employment.
        Prime example, Jared Bernstein believes upon reaching full employment the Fed will be justified in raising interest rates to control or curb the economy and prevent inflation. Thus the difference in policy between Bernstein and those using inflation to suppress full employment is a matter of degree.