Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 4 June 2015

Multipliers and evidence

I should be more careful with titles. The title of this post may have misled some (including Paul Krugman) to characterise what I was saying as favouring a priori beliefs over evidence. What I was in fact talking about was different kinds of evidence.

One kind of evidence on multipliers comes from directly relating output to some fiscal variable like government spending. In much the same way we could base monetary policy on attempts to relate output or inflation directly to changes in interest rates. This is sometimes called ‘reduced form’ estimation. As I said in my post, these studies are valuable, and if they repeatedly show something different from other evidence that would be worrying. However in my experience I have found them less reliable than evidence based on looking at the structure of the economy. I discuss a personal example here, but two more recent examples where reduced form evidence has not proved robust concern the impact of debt on growth and evidence supporting expansionary austerity.

As I wrote in the recent post: “My priors come from thinking about models, or perhaps more accurately mechanisms, that have a solid empirical foundation.” Again perhaps I was remiss in not emphasising that last clause, but it is critical. Robert Waldmann did interpret what I wrote correctly, but has a more worrying (for me) charge - that my view of what specific structural empirical evidence says is tempered by modern microfounded modelling.

A good example concerns how consumers might react to a temporary increase in income. I wrote that my prior is that consumers will largely discount temporary income changes. But what exactly do I mean by ‘largely’ here? Is a marginal propensity to consume out of temporary income of, say, 0.3 large or not? As I have noted elsewhere, there is good empirical evidence to support a number of that kind, and it is possible to explain this in terms of consumers optimising in the face of uncertainty. 

But the plain vanilla intertemporal consumption model implies a marginal propensity to consume out of temporary income close to (or identical to) zero. So when I wrote “largely discount”, did I in fact temper my knowledge of the empirical evidence because of this basic (and in macro ubiquitous) theory? Or was I attempting to use a form of words which was ambiguous enough not to upset those who did have a strong attachment to the plain vanilla model, which would have been just as bad.

It would be ironic if I had been. On a number of occasions I have argued that it was unfortunate that the microfoundations revolution has completely killed (in the academic literature, if not in all central banks) the alternative of analysing aggregate models where relationships are partly justified by empirical evidence. One of my reasons for believing this to be unfortunate is that it tends to put too much weight on simple theory relative to evidence. When I wrote ‘largely discount’ was I providing an example of just this kind of thing?

If it was, it may only have been a temporary lapse. Paul thinks a multiplier of around 1.5 is reasonable (I assume at the Zero Lower Bound when there will be little or no monetary policy offset), and when I wrote this I also assumed a multiplier of 1.5. However I think the point that Robert was making is a very important one: in macro we seem generally happier falling back on what standard theory says than on what the majority of empirical evidence suggests.     


12 comments:

  1. If the multiplier is 1.5 in the UK since 2008, how many newspapers telling a person that expansionary austerity is effective could that person have bought with the money they have lost by voting for political parties which have assumed expansionary austerity to be a valid proposition?

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    1. American under Obama has done much better than the UK, and we now have a Republican Congress due to the frustration of the American people with the pace of improvement. You Brits are extremely tolerant of poor economic performance, which your Tory party made the showpiece of their campaign.

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    2. Or more likely : the electorate are right wingers.

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    3. In trying economic times, the electorate likes austerity. If they have to cut back; they think that the government should also?

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    4. Correct.
      Also, the "healthier" the programs, the more counted against the debt ceiling.
      Look up "Modern Monetary Theory" and "Overtones window." We need to change the framing and talk about real resourced not money.

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    5. Sorry should be "Overtone Window."

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  2. This comment has been removed by the author.

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  3. Wow thanks. I am very flattered by this post. Amazing man. I am too flustered to, like, write Oxford quality English. My head is spinning.

    All that praise for saying roughly 1.5 not roughly 1 and suggesting that 70% isn't largely.
    I wonder if I could get a bit more praise for saying the multiplier is marginally more likely to be 1.6 not 1.5, and that even 75% wouldn't be accurately conveyed by "largely".

    (typo corrected)

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    1. Don't push your luck! And if you are implying that I write Oxford quality English, I have plenty of evidence that this is not even 'largely' true.

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    2. Hi Robert, if I were to write a multiplier of roughly 1.5 your skepticism would be well founded (and, I think it's good to retain a degree of skepticism), but when a professor of Economics says, on balance or similar, implies what is meant based on my experience run-through a peer-reviewed intellect (pardon my non-Oxford trained grammar).
      Shaun T

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    3. Hey Simon, what is your view on ZIRP forever? (The government having overdraft at Ways and Means account.)

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  4. http://www.3spoken.co.uk/2013/05/the-misuse-of-fiscal-multiplier.html?m=1
    On multipliers.

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