Response to Malcolm Turnbull – part 2

I raised the issue a few weeks ago of what might happen to GDP output and public debt if the discretionary stimulus package were simply cut off in mid-stream. I argued that this would lead to higher numbers on jobless benefits and much lower corporate profits.

Could it also produce a smaller budget deficit over time, as we hear it said, mainly by Republicans in the USA and Coalition members in Australia? In theory, the increase in jobless benefits and investment could actually leave the budget deficit unchanged. Has anyone seen or done such a “counter factual” calculation?

Of course, if we went along with the Coalition that the government money is all wasted, we might end up nowhere. Why not assume a fiscal spending “multiplier” of 1.6 (as suggested by Christina Romer in times like the present)?

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JC
JC(@jc)
12 years ago

Why not assume a fiscal spending multiplier of 1.6 (as suggested by Christina Romer in times like the present)?

Because it contradicts her own research.

Romer argued in a 1994 paper that the most effective way out of economic crisis (recession)is through monetary stimulus.

Here; http://www.nytimes.com/2009/01/10/washington/10stimulus.html?hp=&pagewanted=all

Christina Romer, whom Mr. Obama has designated to be his chief economist, concluded in research she helped write in 1994 that interest-rate policy is the most powerful force in economic recoveries and that fiscal stimulus generally acts too slowly to be of much help in pulling the economy out of recessions, though associates said she now supports a big stimulus package if policy makers roll it out early enough in the recession.

There is also this:

This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.

Why cant Romer refer back to her previous work and simply say that according to her 1994 research the fed is exit door from a burning house. He she forgotten what she wrote and what great work she did?

Frankly I’m puzzled.

JC
JC(@jc)
12 years ago

Thanks Fred:

So who to believe? The Christine Romer of 1994 who incidentally was more than aware of the effects of a banking crisis as she lived through one at the time (S&Ls’) or the Christine Romer that now thinks a fiscal package is more effective than monetary policy?

Incidentally the S&L crisis was actually quite similar, although the size of the problem wasn’t as large. S&L were about 7% of GDP while this one is about double.

It’s a pretty difficult fork in the road to go; from writing a pretty good study suggesting fiscal stimulus is ineffective to reaching the opposite conclusion.