Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 16 July 2015

Evidence for monetary offset

As Tony Yates among others has observed, antagonism towards using fiscal policy for macroeconomic stabilisation seems to be an essential part of market monetarism. However their argument is not that fiscal policy will have no impact on demand and therefore output, but rather that monetary policy can always offset this impact. This can be called the ‘monetary offset’ argument.

As I have noted before, the idea of monetary offset is actually a key part of Keynesian objections to austerity in a liquidity trap [1]. In a liquidity trap monetary policy’s ability to offset fiscal austerity is severely compromised, but at other times it can be done. It therefore makes much more sense to postpone austerity until a time when monetary offset is clearly possible. So the idea that monetary offset can happen is common ground. What is in dispute is the extent to which a liquidity trap (or almost equivalently the fact that nominal interest rates cannot become too negative) prevents complete monetary offset.

If empirical evidence could be found that complete monetary offset has operated during a liquidity trap that would be powerful support for the market monetarist case. Scott Sumner recently presented (HT Nick Rowe) some analysis by Mark Sadowski which he said did just that. Taking the cyclically adjusted primary balance as a measure of fiscal policy, it showed that there was no correlation between this and growth in nominal GDP in the single period from 2009 to 2014 for those countries with an independent monetary policy.

There are tons of problems with simple correlations of this kind, some of which I discuss here, which is why quite elaborate econometric techniques are nowadays used to assess the impact of fiscal policy. But there is a rather simpler problem with this correlation. As far as I know, no one had expressed a concern about fiscal austerity because of the impact this will have on nominal GDP. The issue is always the impact on real activity, for reasons that are obvious enough.

So what happens if we relate fiscal policy to real GDP growth, using Sadowski’s data set? Here is the answer.

There are two obvious outliers here: at the top Singapore, and to the right Iceland. Exclude those and we get this.

There is a clear negative correlation between the extent of fiscal tightening and the amount of real GDP growth. Strange that Sumner gave no hint of this :)

Do I think this is definitive evidence? No, for two reasons. First, the obvious problems with simple correlations of this kind noted earlier. Second, this sample includes quite a few countries where interest rates over this period have averaged over 2% (Australia, Norway, New Zealand, and Korea) and so are unlikely to be subject to a liquidity trap. Others may only have been in a liquidity trap for a part of this period. What we can say is that these correlations are perfectly consistent with the view that austerity reduces growth in countries with an independent monetary policy. [2]

If you were to conclude that we just do not have enough data to know to what extent monetary offset can operate in a liquidity trap, I think you would be right. If you then went on to say that therefore the data cannot discriminate between the two sides in terms of policy, you would be wrong. What market monetarists want you to believe is that there is no need to worry about fiscal austerity in a liquidity trap, because an independent monetary policy can and will always offset its impact. This is wrong, precisely because the empirical evidence is so limited. We know, both from theory and the great majority of econometric studies, that fiscal contraction has a fairly predictable impact in reducing GDP. We have virtually no idea how much unconventional monetary policy is required to offset this impact. Given lags, that means trying to achieve monetary offset in a liquidity trap is always going to be hit and miss. The moment you think about uncertainty, the market monetarist argument for not worrying about austerity in a liquidity trap falls apart. 

[1] It is not the only reason why fiscal austerity in a severe recession might be a bad idea. There is a lot of empirical evidence that the impact of austerity is greater in recessions than when the economy is stronger, and there are other theoretical reasons besides monetary offset why that may be the case. This is of some importance for individual economies in a monetary union.

[2] If the coefficient on fiscal policy was lower for this sample than for Eurozone countries (I’ve not tried), would that at least be evidence for some monetary policy offset? The trouble here is that some of the countries driving the EZ results were also suffering from an overvalued real exchange rate as a result of earlier excess demand, and so this might bias upwards the coefficient on fiscal policy in those regressions.


  1. I have a very general question .. i know this is off-topic and presumably naive. But i read this blog is written for non-economists as well, so i dare ..

    Why this fetish-like relationship to GDP, its growth and comparing those values for different countries ?

    1. Because GDP is closely related to income per head. and people care a lot about their income.

    2. Well, you need some basis for comparison...

      It would be better to have a way of physically describing economies from the base up - models in which the financial flows were a derived output parameter - but this is in the 'crazy hard' category.

      Even with financial measures, there is distribution, activity outside of the formal economy, conversions.. so yes these measures are imperfect. The trick is to try and find something better.

    3. Anonymous: there are all sorts of theoretical reasons why GDP per head might be a bad measure of human well-being. But if you look at the countries that people want to emigrate to, it correlates surprisingly well with GDP per head.

      But here we are using GDP purely as a proxy for the short run business cycle fluctuations over time within given countries. So none of the results here would be affected if we said that (say) UK welfare is always double what the GDP figures suggest, because the UK has such great music. GDP is still not a perfect proxy for the business cycle, but we don't have a perfect one. Instead we argue about which proxy is least bad.

  2. I certainly agree with your last paragraph, coming basically out of theoretical consideration. Nonetheless, aside from your objection on sample size, correlation & standard deviations look quite poor.

    1. Which is why I said that these correlations do not prove anything either way. But market monetarists seem to think otherwise.

    2. All right. You had argued above likewise; moreover particularly yesterday and at some reference you give here as well. But then you say "there is a CLEAR negative correlation between the extent of fiscal tightening and the amount of real GDP growth". That's all, no further comments of my part about this piece.
      Of course I appreciate your mentioning of stuff like "ommited variables", or more generally speaking, misspecification.
      Spurious relations ("mathiness" I think they say nowadays lol) often bring wrong conclusions.
      That is precisely my controversial point with you (and your good friend Dr. Krugman) on the Greek affair; regarding how come you treat a small more or less open economy, with the same recipe of the large economy's original keynesian approach, mechanical expenditure multipliers, growth log-linear trends, inflexible foreign trade and disfunctional public sector.
      But I don't want to annoy you bringing this up again.
      Please, I am no modern monetarist at all. In fact I'm quite old fashioned, millennial if you will.

    3. "I'm quite old fashioned, millennial if you will."

      I don't know what you are, but it's irrelevant. Your reading comprehension is abysmal if you can't figure out that this:

      "There is a clear negative correlation between the extent of fiscal tightening and the amount of real GDP growth. Strange that Sumner gave no hint of this :)

      Do I think this is definitive evidence? No, for two reasons."

      means that the author doesn't believe that the data shows unimpeachable evidence of his assertion. This is exactly the opposite of what you concluded.

      The overall point made (and that you missed - intentionally or otherwise) is that the data used by Sumner is NOT sufficient to prove Sumner's point, either. Therefore, Sumner has no credible claim to support his position.

    4. I only questioned the adjective CLEAR. I don't know who you are either, and when talking about poor understanding, it seems rather up to you, ever since neither of my 2 comments had endorsed Mr. Sumner's alleged point of view.

  3. «their argument is not that fiscal policy will have no impact on demand and therefore output, but rather that monetary policy can always offset this impact.»

    I think that the argument is that monetary policy *will*/*must* always offset the impact, which is quite different. The "*will*/*must*" comes from the argument that expansionary fiscal policy is always wage-inflationary, and therefore since central banks are or should be committed to fight wage-inflation, they will always use monetary policy to nullify expansionary fiscal policies.

    The argument above begs a couple of important questions even if one were to take it seriously, but they are details in this discussion.

    1. Monetary policy would be more potent if it included helicopter money.

  4. The high priest of market monetarism, Scott Sumner, actually goes a bit further than simply claiming that “monetary policy can always offset” fiscal policy (to quote SW-L). Incidentally I’ve made this point before on this blog, but it’s perhaps worth repeating.

    Sumner actually argues that fiscal policy is defective or useless because it is likely to be or bound to be offset by monetary policy. That argument is pure false logic. The fact that there are two ways of achieving something (imparting stimulus), and the fact that those in charge of implementing one way may counteract those in charge of implementing the second, does not prove the second is useless. That’s like arguing that it’s a waste of time for a pilot to make a plane go faster because the co-pilot might try to slow it down. See:

    On a different point, I’m puzzled by SW-L’s sentence: “It therefore makes much more sense to postpone austerity until a time when monetary offset is clearly possible.” Why does it ever make sense to impose “austerity”, if by that you mean running the economy at less than capacity?

    It may very well prove necessary to cool down an overheating economy at some time in the future, but that should not involve austerity in the latter sense. I suggest that sentence of SW-L’s should read something like, “a dose of deflation either in fiscal or monetary form may be needed at some point”.

  5. Although I am not as convinced as Sumner that monetary easing alone is enough to solve problems at the zero lower bound, he also leans heavily on the argument that fiscal stimulation when we are close to the central bank inflation target will likely be offset downwards canceling government fiscal efforts.

    It might not be worth it for the government to waste money if the central bank doesn't have a proper target and will just undo the benefits and leave the government indebted for little gains.

    Isn't it possible that, as monetary policy becomes ineffective at the ZLB, the effects of fiscal policy also weakens severely at the upper inflation bound set by the central bank?

    When we are close to the ZLB and close to the inflation target, the only solution that may work is to do both at the same time, fiscal stimulation _and_ raising or improving the target.

    Any comments on this perspective?

  6. Thanks for looking at this Simon.

    Two points:

    1. What I found compelling about Mark Sadowski's simple regressions is that he (implicitly) did a sort of "difference in differences" analysis. If we find that fiscal policy works in countries with fixed exchange rates (or sharing a common currency), where there can be no monetary offset, but does not work in countries withe their own central bank and flexible exchange rates, where there can be monetary offset, we can be a little more confident that it is monetary offset that is driving the results, rather than sheer chance or some econometric misspecification. It's a way of holding other things constant (unless those other things are correlated with having a fixed or flexible exchange rate).

    2. I disagree on the NGDP vs RGDP thing. Sure, RGDP is what we care about, but we don't know whether a rightward shift in the AD curve will cause increased RGDP, increased price level, or (more likely) some mixture of the two. Using NGDP instead of RGDP is a crude way of acknowledging our ignorance about the slope of the Short Run Phillips Curve.

    Now, if fiscal loosening (in countries with flexible exchange rates) causes RGDP to increase but does not cause NGDP to increase, which is what your results and Mark's results seem to imply, when taken together, we have a very uncomfortable conclusion for all of us. It tells us that the Short Run Phillips Curve slopes the wrong way. It tells us that an expansionary fiscal policy causes inflation to *fall*. Which is a very strange result indeed, unless you want to talk about the supply-side benefits of bigger deficit spending.

    Now the supply-side argument is not stupid. If you suddenly lay off thousands of government workers, that causes some real supply side issues, because those workers won't be able to reallocate instantly even if aggregate demand does not fall. The search theorists do have some sort of a point. Any sort of change in the composition of demand between private and government sectors, in either direction, will cause some temporary increase in frictional unemployment, shifting the SRPC in the bad direction.

    I don't find my above "explanation" fully convincing. But it's better than assuming the SRPC slopes the wrong way, so that an expansionary fiscal (or monetary) policy *reduces* inflation in the short run.

    1. Is there any research on alternative measurements on public productivity?

      As far as I know all public employees are valued at cost in the GDP statistics. If the same employees get hired by a private company, GDP will change by the sum of employee's wages and marginal company profits. If public hiring was done on the same basis as private hiring, the assumption would seem reasonable (even too pessimistic, since you'd expect private business to hire only if it increased its profits).
      But there is no profit motive in the public sector and we still likely face negative returns to scale anyway. Isn't the assumption that an additional public employees have no marginal effect on the profitability of the public sector somewhat optimistic? I don't really have a good alternative proposal, but it seems to make the analysis much harder.

      At the extremes, the cost approach is somewhat perverse in some situations. Let's say that instead of paying unemployment benefits, the state hires the unemployed to sit at home producing nothing. Wouldn't you get a spike in GDP, with the transfer payments being now considered productive, even if they are not in my example?

      Does this effect have much impact on the kind of analysis we are doing here?

      Wouldn't some kind of adjustment based on the size of the public sector make sense? Certainly the first public employee is likely to produce more value than his own salary, but at some point, that number must turn negative. Given the size of the public sector in many countries, wondering if we are not in the negative territory seems reasonable to me...

      I am not even sure what you should maximize to be honest...

    2. Anonymous: good point. The decomposition of NGDP into RGDP and P is fraught with perils like this. Which is another reason for looking at NGDP instead of RGDP, if we want to measure the macroeconomic effects of fiscal policy. Then we can leave those difficult questions to the microeconomists.

    3. Nick: I do not see the logic in this. We have two theories, about austerity and RGDP and about the Phillips curve. Now if there is no link between austerity and nominal GDP, at least one of these theories may be wrong. But there is a link between austerity and RGDP. So I think that tells us which of the two theories are suspect. You cannot just say ignore the RGDP correlations.

      If NGDP is measured at market prices, then a sales tax increase (or which there have been a number) will reduce real GDP and raise prices.

    4. As an alternative to the "supply side" story to reconcile the conflicting RGDP and NGDP results, maybe it's some sort of real exchange rate story? But my brain can't figure out which way that would go. Fiscal loosening (plus monetary offset) would appreciate the real exchange rate, so imports are cheaper, and since imports have a minus sign in GDP, NGDP rises relative to RGDP? Nope, I think that effect goes the wrong way, unless I'm muddled.

    5. Simon: but I really don't want to assume a Short Run Phillips Curve that slopes the wrong way. If I take the RGDP and NGDP results at face value, I am forced to assume that fiscal policy shifted the SRPC. And we are then left with a semantic dispute about what we mean by "demand-side monetary offset". Does it mean the central bank holds RGDP constant, or NGDP constant, or inflation constant? If we said it means "holds inflation constant", because that's what most central banks are supposed to target, what we actually observed is too much monetary offset.

    6. " I really don't want to assume a Short Run Phillips Curve that slopes the wrong way."

      Certainly we don't want to assume that, but as the discussion on this point seems to suggest, it seems not to be out of the question that we are observing it. It was known back in the 60's and 70's that austerity could, in certain circumstances, increase inflation most obviously through increases in sales taxes and reductions in subsidies but also through falling productivity due to falling output levels and therefore loss of efficiency (the converse of increasing returns to scale). Put these two phenomena together and you have something that looks very like a backward sloping Philips curve. Of course, it may not be a true Philips curve in that the increase in inflation is not directly causing the unemployment, or vice versa. But it is a clear message that the relationship between inflation and employment is not necessarily linear.

    7. «austerity could, in certain circumstances,»

      I have appreciated that "austerity" in our blogger's piece is always properly qualified as "fiscal austerity", as there are many other forms of "austerity".

      «increase inflation most obviously through increases in sales taxes and reductions in subsidies»

      It seems here you are talking too about fiscal austerity, but which inflation? It seems you are talking about "consumer price" inflation, but policy is mainly concerned with wage-inflation. Price increases of goods and assets matter a lot less.

      «but also through falling productivity»

      But which productivity? Dollars out per hour worked? Dollars of output per dollar of wage? Physical production per hours worked? Dollars per workers per year?

      «due to falling output levels and therefore loss of efficiency (the converse of increasing returns to scale)»

      Something like that happened happened in the UK recently, but whether it was caused by fiscal-austerity and whether the UK was really subjected to fiscal-austerity (in absolute terms? in percentage terms? as to cuts in spendings? as to increases in taxes? as to shrinking deficit regardless of which way?) is not so clear.

      All these discussions are better with a bit of precision... Especially if one aims to derive conclusions from scattergrams.

      «may not be a true Philips curve in that the increase in inflation is not directly causing the unemployment, or vice versa»

      And I thought that the Phillips curve was no longer taken seriously, except by central bankers and their political sponsors to justify a policy of pushing down wages with the justification that doing was necessary to avoid the mythical wage-price spiral.

    8. Who says that the Philip's curve is not taken seriously; look at Mankiw's macro book and it is still there.

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  8. If nominal GDP is on target, but real GDP growth is weak, the deficiency is not one of Aggregate Demand. Is that not so?

    If it is so, then the prima facea interpretation of these results would be that offset works, and austerity has been greatest where growth in potential flagged severely. But it is close to zero evidence on the real point of difference, which requires a sample both at the zero lower bound on interest rates and with separate currencies. That would be a sample of about three, which no econometric trick can make strong evidence.

    But I am quite keen to learn if there is, contrary to my perception, some way for austerity to depress real growth through a demand channel and at the same time cause inflation. Maybe if inflation is measured including VAT and it is ex-VAT prices that are sticky? Are there good models that yield this pattern?

    1. Actually, I think the sample would be about 4, but otherwise I think you are correct about the usefulness of these correlations. I only talk about them because other people think they are important.

  9. Speaking personally, and speaking about countries like Canada, that have responsible sustainable long run fiscal policies (at least at the federal level), I would be (and was) very against tightening fiscal policy in the recession. For two reasons: first it would be stupid on microeconomic grounds, second I might be wrong about monetary offset, and don't want to take the risk.

    1. Which is a variation on what I was saying in my last paragraph. It is so obviously reasonable, I really wonder where others that do not appear to share this view are coming from.

    2. They are coming from countries other than Canada, which don't have fiscally responsible hardline Conservative (OK, and Liberal) governments which can afford to loosen up a bit at times, since everyone knows they will tighten again in future ;-)

  10. > antagonism towards using fiscal policy for macroeconomic stabilisation
    > seems to be an essential part of market monetarism.

    I really disagree with this characterization.

    Market monetarists believe that under an NGDP targeting regime with a functioning prediction market and absent political constraints, the central bank would always offset fiscal stimulus, because the central bank is targeting NGDP.

    When the central bank is incompetent, or politically constrained, or targeting the wrong thing (like inflation), or using the wrong policy instrument (like short-term interest rates), then it's very possible (in the market monetarist world view) for fiscal stimulus to increase AD and NGDP.

    I would really like to set this fight to rest. NGDPLT is better monetary policy. It will dramatically improve the world. It will prevent another NGDP collapse like 2008-2009. Keynesians and MMs should be working together to make this happen, not arguing about the exact conditions in which monetary offset would neutralize fiscal stimulus.

    Thank you,

    Kenneth Duda
    Menlo Park, CA

    1. My support for NGDP is a bit more measured, and I do not think NGDP targeting would mean that monetary offset would always apply at the ZLB. But I agree with your final sentiment. I only write these posts in response to claims about fiscal policy made by market monetarists.

  11. I agree there is a correlation there but it is no way significant at r^2 = 1.331 (N=13)* and you were careful to say not to read to much into it. But you are effectively hanging quite a deal of your argument off it certainly footnote [2]. No way this comparison is going to be meaningful if you have this data.

    Clearly any informed sane (or non-malicious) person would agree with you that austerity is clearly the wrong thing to be engaging in but the problem with the lack of evidence cuts both ways.

    * Just a quick check t=rsqrt[(1—r^2)/(N—2)] gives p = 0.27 two tailed (which I think is fair in this case) but as you do have a hypothesis set up even single tailed can't save you p = 0.13.

    1. When I wrote "If you were to conclude that we just do not have enough data to know to what extent monetary offset can operate in a liquidity trap, I think you would be right.", that is part of what I meant. One of the problems I grapple with in writing posts is to try and keep it understandable for the non-economist, or in this case the non-scientist.

    2. You can apply "advanced" statistics to minuscule sample sizes, and lots of Economists do, but it is quite vapid. I think that good econometricians spend their evenings crying over small sample sizes and the suspicion that anywhow the populations the samples come from change significantly over time and location.

      The best approach is what SimonWL does here and it is to show selected scattergrams and derive mostly qualitative impressions from it. The impression that central banks don't actually try or succeed at nullifying fiscal policy in realistic cases seems indeed not contradicted by the tiny sample. *Why* is a rather different question... :-)

      But my impression of the general position from which market monetarism has evolved is that the argument is not so much that fiscal policy *is* or *can be* nullified by central banks, but that it *should be*.

  12. I'll inflict on the readers here a flight of fancy as to why market monetarists and new keynesians disagree as to whether monetary policy *should* nullify fiscal policy.

    To some extent market monetarism is just the "nominal GDP" variants of the RBC or the Ricardian equivalence argument.

    The link is this...

    At its core Keynes was describing a coordination failure and how to remedy it: in his view there is uncertainty, animal spirits, investment decisions that are unrelated to saving decisions, plus liquidity is not the same as money, thus a suboptimal "equilibrium" can happen and persist. The solution is intervention by an agent that has a wider perception of the situation than any individual, and that has the power to improve coordination.

    What the RBC and market monetarists have in common is the rejection of the "absurd" notion that a market based economy can suffer from coordination issues: there is no need for a central agent to improve coordination because all individual agents thanks to rational expectations converge in a distributed "wisdom of crowds" way on the same optimal behaviour. Therefore the only role of a central bank is just run the system (RBC) or have a fixed policy (market monetarists). Indeed the central bank *must* nullify fiscal policy because a non-neutral fiscal policy *creates* a coordination problem, that is governments don't behave according to rational expectations, and thus must be made to do so, by the central bank.

    New Keynesians as they proudly confess are RBCers who admit that there can be small temporary coordination problems caused by the reluctance or ignorance of a category of market agents to use rational expectations to adjust their nominal wages downward, thus creating voluntary unemployment and thus a shortage of effective demand. Thus a central agent should exist that makes small temporary adjustments, and only in that special case, to undo the coordination failure, and because these are coordination improvements, the central banks should let them happen to realize the same outcomes that would happen if wage earners behaved according to rational expectations.

  13. Simon,

    Sumner actually responded to some of this in responding to my post, but overall the key is that Sadowski's analysis just kind of ignores the theory behind a liquidity trap.

  14. What about evidence for fiscal expansion in a liqudity trap? FDR did fiscal expansion in the early 30s and the economy improved. Then in 37 he retrenched and we slid back into recession. Then came the mother of all fiscal expansions, WW2 . The depression ended.

    Many have said financial crisis recessions are unique and at zlb monetary policy is constrained. As a guy who doesn't make much, if there is such a crisis use all you have to fight it , fiscal stimulus plus qe etc. If one can borrow at negative rates why wouldn't esp if you print your own currency.

    And nuts say you'll debase the dollar. That's a feature not a bug. The dollar is way too strong cause of reserve currency . Don't think people will betting on the Titanic that is th Euro and China is bumpy.

    1. Yes..

      When you think about it, the idea that idling factories, putting millions out of work and ceasing to do things that need to be done is good for the economy is absolutely absurd. Yet this is what the promoters of Austerity want.

      I think the problem is psychological - it results from thinking of money as a 'thing' in it's own right. But that's wrong, even gold has no fixed value; money only has value because of real productivity and utility elsewhere. This is a scary thought if you are worried about your long term personal/family security, because it implies that no such security really exists, and that the only real 'value' exists as part of society as a whole. A man on a desert island has no morality and no money..

  15. "What the RBC and market monetarists have in common is the rejection of the "absurd" notion that a market based economy can suffer from coordination issues: there is no need for a central agent to improve coordination because all individual agents thanks to rational expectations converge in a distributed "wisdom of crowds" way on the same optimal behaviour"

    Yet "wisdom of crowds" does not mean that crowds are correct. Sometimes people act like lemmings, following a movement because a lot of others go in a given direction. Subprime crisis in 2008, house bubble in Spain and Ireland, excessive capital inflow in Greece are some of the most patent example of market disfunctions linked to an improper evaluation made by a great numbers of individual.

    Therefore we can ask either for someone stop the music when needed or look at the disastrous results.

    Ludovic Coval

  16. «Yet "wisdom of crowds" does not mean that crowds are correct. Sometimes people act like lemmings, following a movement because a lot of others go in a given direction.»

    That's just the argument that rational expectations are not a sensible hypothesis. In the original framework of Keynes it is pretty obvious that neither businessmen nor their workers can be expected to behave according to "rational expectations".

    But the RBC and "market monetarist" people and to a large extent New Keynesians do seem to believe in "rational expectations". So if you want to discuss with them you have somehow to take "rational expectations" as a respectable concept, not as a fantasy turned into a core assumption in order to reach a predetermined truthiness. And most academic Economists have strong incentives to do so, for various reasons.

  17. Simon, what do you think of Scott Sumner's follow up post on this subject?:

    Also, Sadowski produced a series of further posts on Marcus Nunes' site, such as this one.

    1. I couldn't see anything that addressed the points made here

  18. It seems obvious to me that monetary policy has at least some traction, even at the ZLB, in the way price level growth in the US has been so oddly stable over the last 6 years. We had a once-in-three-generations crash, but no deflation, and an unprecedented monetary base expansion, and no hyperinflation.

    It seems that inflation (core inflation, at least) is clearly anchored by expectations. The Fed has implicitly targeted a somewhere-below-2% rate, and consistently achieved it, despite external shocks and shifting fiscal policy.

    So if the Fed can and does maintain a price growth target, even at the ZLB, it implies there is *some* level of monetary offset. But only the amount that is necessary and sufficient to maintain stable core price growth and expectations thereof.

    What that means is the offset is almost certainly *partial*, in terms of real output (and even nominal output, for that matter).

    Stated another way, even if we believe that competent and motivated central banks can maintain a price target, or even an NGDPLT, that is categorically *not* the same as an RGDPLT. It would only serve to dampen rather than eliminate the effects of shocks on RGDP.

    This all seems so obvious, I'm not sure what there even is to argue here, aside from the specific values of the ratios of effect. The monetary offset is real, and it's dependent on the monetary regime in place, but it's always more than 0.0x and less than 1.0x the size of the direct fiscal policy effect. Of course it is difficult to produce evidence for an effect that is largely based on ephemeral expectations setting, but I don't think that diminishes the certainty of what we should know.

    From my perspective, the market monetarists have an important point about the effectiveness of expectations-based monetary policy even at the ZLB. But then they go and detract from that by forgetting all the caveats (that the offset is regime dependent) overstating their claim ("the appropriate fiscal multiplier is 0" type stuff). It's as though they don't actually care about monetary policy, sometimes, other than as a pretext to reject active fiscal policy. Which is a shame, since their insights could be tremendously valuable right now if they were enacted into real central bank policy.

  19. The REH assumes the economic management authority's policy is governed by the second guessing of the independent agent's response to its policy. What if the independent agent third guesses the authority etc.etc.? Can the result be then determinate? What is rational about the REH other than its a priori premise fixes an outcome by design? What is the point of discussing anything with someone whose world view is fixed and given by their starting premise? I would imagine Keynes would be prepared to have a conversation around the REH seeing expectations are seminal to the GT, but would probably have no truck with its methodology steeped in stochastic mathematics and married to a Neoclassical perspective of the world.


  20. Everyone seems to presume we are in a liquidity trap because interest rates are zero or negative. I’m not sure that this necessarily follows. The liquidity preference function shifts around according to the effects of expectations. This is a complex relationship which is difficult to quantify. Keynes version of the liquidity trap has it that wealth holders prefer to hold cash when interest rates hit a lower bound believing that the price of interest bearing securities can go no higher. So are we at that point or not? The question is moot.

    The reason there is a focus on what is happening in money markets is that economic recovery out of the GFC has been sluggish and tortuous despite massive QE. QE funds have ended up in the hands of wealth owners and have been dissipated in asset market bubbles. Investment has not responded robustly and consumption spending has been slow growing.

    I think the reason the economic response has been muted are all too obvious - businessmen and consumers (those that are still employed) have focussed on cleaning up their balance sheets and are also still gun shy – i.e expectations are still on the cautious side of things.

    The other big factor I believe is that the effects of the GFC and the ensuing austerity measures in some countries have exacerbated income and wealth disparities. Growing inequities feeds into poor consumption performance which feeds into sluggish investment performance.

    Monetary policy is considerably ineffectual in such circumstances. Supply side remedies add to aggregate demand reductions which overwhelm the micro effects – the only remedy is appropriate fiscal easing.


  21. I entirely agree that there are "problems with simple correlations of this kind". However, one thing puzzles me: If a country (successfully) pursues a countercyclical fiscal policy, the underlying budget deficit should increase in years with weak growth (as the budget is used to support economic activity) and decrase in years with strong growth. Do your figures imply that most countries fail to pursue a counter-cyclical fiscal policy? (Apologies for being off-topic. This question should perhaps have been asked under your post on correlations and causations from March.)


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