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.
Despite aggressive actions by central banks, many of the world’s economies are still stagnating and facing new shocks, leading to renewed calls for helicopter money as a serious policy prescription for countries like Japan and the U.K.. And, if things go badly, maybe the United States?
What does a conventional (estimated) macroeconometric model imply for a sustained 7.7% increase in government consumption and investment as a share of GDP in terms of output.
There are at least two ways of proceeding. One could repeat the following mantra endlessly:
[T]he government taxes or borrows the resources used to build infrastructure projects. Government spending crowds resources out from the rest of the economy. More federal spending comes at the expense of a smaller private sector.
These factors explain why the 2009 stimulus failed. So did Japan’s decade-long attempt to stimulate its economy through infrastructure projects. The Japanese wound up with massive debt, superhighways in underpopulated rural districts—and an anemic economy.
Professor Tyler Cowen’s anti-Keynesian manifesto has been ably discussed by Professor Simon Wren-Lewis at Mainly Macro. I thought what merited additional attention is Professor Cowen’s first assertion:
1. Keynesians predicted disaster following the American fiscal sequester, and the pace of the recovery accelerated.