Friday, 4 January 2013

Macroeconomic Theory and the Multiplier


I agree with most of what John Quiggin says in his post on fiscal multipliers, but I started having problems towards the end when he writes:

“To sum up, despite the thousands of papers published every year in the field, macroeconomic theory is incapable of giving even a qualitative answer to the most basic questions about fiscal policy[3]; at least, not one that would not elicit dissent from a substantial, and well-credentialled group of leading experts.”

The footnote reads

“[3] While writing this, I wondered what would happen if you put this question to a group of DSGE theorists as a pop quiz. I suspect most would give some variant of “the question is ill-posed” and the rest would be all over the place. But, if any DSGE theorists are reading, I’d be keen to get their views.”

OK, I have written a fair number of published DSGE papers on fiscal policy over the last decade, so here is my response. New Keynesian theory, and therefore the New Neoclassical synthesis, provides pretty clear answers to the multiplier question. I have talked about this before so I will not repeat these answers here. Macroeconomic theory is ‘all over the place’ on many issues, but this is not one of them. I would go further. If policymakers had paid more attention to theory, and less to a well known piece of empirical work, they would have been less likely to have made the mistakes they have.

The problem is not ambivalent theory, but the fact that a large section of macroeconomists choose to ignore or discount the relevant theory. Now this is actually consistent with the sentence from John Quiggin’s post that I quote above, because of the part that says ‘at least ....’. So in that sense it is a quibble. But I think it is an important quibble. There is a great deal of difference between suggesting that theory is all over the place, and saying that a large body of theory – the theory used by nearly all monetary policymakers – is pretty clear, but that a significant group of economists do not accept it.

The difference comes in the following paragraph, where he says “It really is hard for me to see how the economics profession can recover from its current rotten state, at least as regards macro..” If a large section of the profession (perhaps even a majority) subscribes to the New Neoclassical synthesis framework, and that framework is sound (if far from perfect), then we still have a problem, but one that does have solutions.


5 comments:

  1. Is there any room in the current environment to seriously, theoretically disagree with the theory of the fiscal multiplier?

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    Replies
    1. Jonathan,

      What stops you? To seriously, theoretically disagree, I mean. I'd even dare to say that even half-baked, non-serious disagreements will enjoy a publication and popular support. There is a lot of demand for papers that estimate fiscal multiplier to be less than one, zero or negative...

      Delete
  2. Simplify your understanding. Simplify the math. Unify the concepts.
    This is what my research is doing...
    You can find it here.

    https://docs.google.com/open?id=0BzqyF_-6xLVET1dkQ0VDenRRTjQ

    The equations use simple math yet they are really good. The equations have determined that the natural rate of unemployment has risen, while other models aren't sure. The equations show a deeper view of the Solow growth model. and more... My equations would have seen the problems in the economy 10 years ago. But I only just discovered these equations within the last 2 months.

    This proves there is still room to save economics...

    ReplyDelete
  3. These are the fiscal multiplier projections from Artus at French investment bank Nataxis. If these are correct, then there will simply be no recovery;

    http://cib.natixis.com/flushdoc.aspx?id=66446

    ReplyDelete
  4. The Finance Minister is overawed and not looking forward to his weekly meeting with the boss. How will he be able to explain to his law-educated PM that (a) the velocity of money changed, and (b) the fiscal multiplier was under estimated? He can offer the head of the Chairman of Economic Advisers but the Governor of the Bank is on a fixed term contract....

    ReplyDelete