I have a sense that Paul Krugman wrote this post out of exasperation with those who
cherry pick data to draw incorrect conclusions about the importance of fiscal
policy. I know the feeling. Here is my version of what
Paul did, using OECD data. We take growth in government consumption (G) [x
axis] and GDP [y axis] for a whole bunch of countries for each year from 2010
to 2013, and plot the two variables against each other.
Paul’s point in that post was not that this positive
correlation proves fiscal policy matters, but that there is a lot of variation,
and so it will always be possible to find a case where G fell and GDP rose, or
vice versa, but the general pattern is that the two variables are positively
correlated.
I think that is as far as this should go. As Paul also said, you can
quite legitimately argue that the relationship is not causal. Here is a very
good argument about why it will not be. Imagine an ideal world where growth was
always steady, and everything generally went according to plan, but some
countries grew faster than others. If every country planned to keep the ratio
of G to GDP constant, in the fast growing countries you would be likely to see
high growth in both GDP and G, while in the others you would expect slower
growth in both variables. What you would observe is lots of points close to a
45 degree line. This would tell you nothing about how a shock to G would influence Y.
If you tried to read the 45 degree line as telling you about a G multiplier you would
get implausibly large numbers.
This is not an academic point. Look at the three points
involving 8% or more growth. They are for Estonia and Turkey. Growth in G in
those cases happened to be quite low but positive, but no one would seriously
suggest that this meant there was a huge multiplier in those countries. But
these observations drag any trend line to be closer to 45 degree line. Indeed any trend
line fitted to this data would come close to having that slope.
The other extreme numbers on the negative side are mainly
Greece. Now there this reverse causation argument is less convincing: we know
that negative growth in Greece did not cause the Greeks to reduce government
spending. However the correlation there can still not be taken as causal
because of another elementary econometric problem: omitted variables. Austerity
did not just involve cuts in government consumption, but many other fiscal
variables that will also have had a large impact on GDP.
All this is of course why people do proper econometrics on this
question. Unfortunately the fact that there has been so much econometric work
looking at multipliers itself creates a similar problem. Because difficulties
involving omitted variables, simultaneity and other issues are difficult to
solve, and because of different data sets, not all econometric work is going to
come up with identical answers, and it will be possible to cherry pick among
those as well.
One way of dealing with this problem is for new studies to
start by replicated their predecessors where they can, as Jordà and Taylor do for example. (This is part of what
David Hendry calls encompassing.) An alternative is to look at
meta studies, like this recent example from Sebastian Gechert. To quote from his abstract: “We find that
public spending multipliers are close to one and about 0.3 to 0.4 units larger
than tax and transfer multipliers. Public investment multipliers are found to
be even larger than those of spending in general by approximately 0.5 units.”
Fortunately that is consistent with what theory might suggest. A subsequent meta analysis by Gechert and Rannenberg shows that multipliers are "systematically
higher if the economy suffers a downturn", a result which is also key in Jordà and Taylor.
Despite the number of econometric studies already done, I'm sure there is plenty still to do. Sharp disagreements still exist that remain unresolved, although I suspect a lot will be sorted out when the
monetary regime in place is adequately controlled for.
Of course we have very few recent observations of the ‘Zero Lower Bound/QE’
regime. Leaving QE to one side, what basic New Keynesian models tell us is that multipliers observed under
fixed exchange rates probably act as a lower bound for ZLB multipliers, which
is why what has happened in the Eurozone periphery is of some relevance to the
UK, US, Japan and Eurozone as a whole. We already know enough from both theory and evidence elsewhere to suggest that at the ZLB
multipliers could be large, but just how large remains unclear. However I doubt our knowledge will be improved by drawing more
scatter plots.
