We are still in the process of determining what’s in the Build Back Better (BBB) bill, but it approximates what is currently discussed, it in conjunction with the Infrastructure Investment and Jobs Act (IIJA) will not likely lead to much pressure in credit markets and upward pressure in prices, given it is largely paid for. Here (while we wait for the CBO) are Moody’s Analytics projections (as of 11/4).
Goldman Sachs (Phillips/Briggs/Mericle, 3/13) document some aspects of the American Rescue Plan, signed into law by President Biden.
From the summary of the document, which reviews the literature and current macroeconomic state of play. Some key findings are germane to the current intra-Republican party debate over how to proceed with the current recovery package. I know it is the triump of hope over experience to think they will accede to expertise, but here goes.
I am fine with govt. helping people pay bills. But the idea that the spending will actually increase GDP is the Keynesian argument that I find very misguided.
So, here it is useful to have a model discipline one’s arguments (textbook I’m using this semester, here, includes Classical as well as New Keynesian models). Fiscal stimulus, particularly some that have proposed, involves transfers (SNAP, unemployment insurance payments). Helping people pay bills presumably makes aggregate demand higher (by virtue of enabling greater consumption) than it otherwise would be. If there is slack in the economy (which is likely if lots of people can’t pay their bills), then higher aggregate demand will lead to higher output.
If higher demand results in higher production, that means that income necessarily is higher than it otherwise would be, and likely disposable income. That would then mean consumption should be higher; but that would mean higher aggregate demand, and hence higher output, and higher income, leading to a repeat cycle – albeit at a lower rate.
In other words, we have the Keynesian multiplier process. In the presence of slack in the economy, output will rise. Of course, assume that output falls entirely because of reduced production capacity (not a single person reduces consumption because they aren’t being paid), then increased transfers won’t do anything.
How likely is that condition?
The capacity for some people to engage in internally inconsistent reasoning and writing is breathtaking.
More on multiplier estimates here.
From Mr. Riedl at Manhattan Institute:
I really hope the fiscal stimulus debate doesn’t gain momentum. Not only is it premature…..but I don’t have the writing bandwidth to remind everyone how Keynesian stimulus is an outdated theory (the multiplier is close to zero) with a terrible historical track record.
In my mind, absent a shooting war, the economy is headed for a slowdown, if not a recession. I am confident that, should the administration or anybody else propose countercyclical fiscal policy, a set of the usual suspects will deny the efficacy of discretionary policy. Hence, a prebuttal is called for.
Assume a closed economy, no government spending and no taxes, and no depreciation. National income accounting states unambiguously:
C + I ≡ Y ≡ C + S
Program here. Here are a couple of papers I found of interest.
From the Empirical Macro session:
- “Output response to government spending: Evidence from new international military spending data,” By Viacheslav Sheremirov; Federal Reserve Bank of Boston, Sandra Spirovska; University of Wisconsin, Madison
Using 25 years of military spending data from more than a hundred countries, this paper provides new evidence on the effect of government spending on output. Following a popular assumption that military spending is unlikely to respond to output at business-cycle frequencies—and exploiting variation in military spending of a significantly larger magnitude than in the previous literature based on U.S. data—we find that the pooled government spending multiplier is small: below 0.2. This estimate, however, masks substantial heterogeneity: the debt financed
spending multiplier is larger and can be well above 1 if monetary policy is accommodative. The multiplier is especially large in recessions and when the government purchases durables. e also document substantial heterogeneity across countries with the spending multiplier larger in advanced economies and in countries with a fixed exchange rate. The output response to government spending persists for about two to three years. These findings suggest that the effectiveness of fiscal policy depends largely on the economic environment, policy implementation, and the central bank’s response, and that the small multipliers found in historical or pooled data are a poor guide to evaluating the effectiveness of a specific stimulus program.
From the Monetary Policy session:
- “Has Globalization Changed the Business Cycle and the Monetary Policy Trade-offs?” by Enrique Martinez-Garcia; Federal Reserve Bank of Dallas
No presentation/paper online, but the answer is “yes”.
Tomorrow, there’s the Sovereign Debt session:
- “Optimal Redistributive Policy in Debt Constrained Economies,” by Monica Tran Xuan; University of Minnesota
This paper studies optimal taxation in an open economy subject to redistribution motive and long-run binding debt constraints. The debt constraints arise endogenously from the government’s limited commitment, and become relevant in the long run due to the impatience of the domestic agents. Marginal and lump-sum taxes are allowed to distribute resources across heterogeneous agents. The standard Ramsey results of labor tax smoothing and zero capital tax limit no long hold. The optimal labor tax decreases as the debt constraints bind, and eventually converges to a real limit. The optimal capital tax is positive in the long run. The effcient contract features front-loading redistribution and back-loading efficiency, allowing the economy to accumulate a large external debt position, and increase its borrowing capacity when the debt constraints bind. A numerical exercise of the model demonstrates that a higher redistribution motive leads to a higher labor tax rate during the unconstrained-debt periods, a lower labor tax limit, and a higher external debt accumulation over time.
- “Sovereign Risk Premia and Corporate Balance Sheets,” by Steve Pak Yeung Wu; UW-Madison
- “Real Interest Rates and Productivity in Small Open Economies,” by Tommaso Monacelli; Università Bocconi and IGIER; Luca Sala; Universita’ Bocconi; Daniele Siena; Banque de France
In emerging market economies (EMEs), capital inflows are associated to productivity booms. However, the experience of advanced small open economies (AEs), like the ones of the Euro Area periphery, points to the opposite, i.e., capital inflows lead to lower productivity, possibly due to capital misallocation. We measure capital flow shocks as (exogenous) variations in (world) real interest rates. We show that, in the data, the misallocation narrative fits the evidence only for AEs: lower real interest rates lead to lower productivity in AEs, whereas the opposite holds for EMEs. We build a business cycle model with firms’ heterogeneity, financial imperfections and endogenous productivity. The model combines a misallocation effect, stemming from capital inflows, with an original sin effect, whereby capital inflows, via a real exchange rate appreciation, affect the borrowing ability of the incumbent, marginally more productive firms. The estimation of the model reveals that a low trade elasticity combined with high (low) firms’ productivity disperions in EMEs (AEs) are crucial ingredients to account for the different effects of capital inflows across groups of countries. The relative balance of the misallocation and the original sin effect is able to simultaneously rationalize the evidence in both EMEs and AEs.
Remember when critics wailed about the high cost/per job saved and low multipliers likely under the American Recovery and Reinvestment Act? The same set of people do not seem very bothered at all by the relatively small implied output impact of the TCJA produced by any of the reasonable modelers.