The Data Have a Market Monetarist's Bias

It almost seems unfair, as if the evidence is biased toward Market Monetarist's views. First it was the better-than-expected employment report last week and now it is the forecast-beating retail sales report. These developments should not be happening, especially now with sequestration, if the fiscal multiplier were large. But they are happening and underscore the case that the monetary policy can offset the drag of fiscal austerity.

This latest evidence for the Sumner Critique--the understanding that fiscal multiplier will be effectively zero when the central bank is stabilizing aggregate demand--should not be surprising since the Fed has been offsetting structural austerity since 2010, a fact lost on many Keynesian-minded folks. This post-2010 period is one of the great macroeconomic natural experiments now unfolding, pitting U.S. monetary policy against U.S. fiscal policy.¹

This multi-year natural experiment has not be lost on all observers. Jeff Spross of Think Progress takes note of it:

It hasn’t really made the front pages, but the United States recently began carrying out a massive and nearly unprecedented economic experiment, and 2013 looks to be the year when the results come in. The question is straightforward: When the economy is in a deep slump, and the government makes things worse by cutting spending, how much can monetary policy do to help? The answer could reshape the way we argue about economic policy, with profound implications for progressives’ economic priorities — and big opportunities, if they can seize them.

So far, progressives have tended to side with economists like Paul Krugman and bloggers like Mike Konczal. They argue that monetary policy is severely weakened at the zero lower bound...

But economists like David Beckworth and Scott Sumner countered that the economy’s 2.5 percent growth rate stuck around despite blows from multiple rounds of spending cuts, the European crisis, and worries about China. In fact, as Beckworth pointed out, government spending began shrinking by the start of 2010 — yet the economy just kept puttering along at 2.5 percent.

Other points in Beckworth and Sumner’s favor: Before sequestration, the latest round of across-the-board spending cuts, began, the group Macroeconomic Advisors projected growth for the first quarter below 2.5 percent if sequestration didn’t happen. Then the May 3 jobs report, which came out after Konczal’s piece, was so good it was almost shocking. Matt Yglesias and Ryan Avent, two other fans of monetary policy’s salutary effects, pointed to other data sources that suggest the Fed actually has been able to raise long-term inflation expectations. So this looks like at least a preliminary win for team monetary policy.

In my view, the most important insight from this "radical experiment" is not that monetary policy can effectively make the fiscal multiplier zero, but that it could be doing far more to shore up aggregate demand. The fact that the Fed has successfully offset structural fiscal austerity since 2010--as seen by the stable NGDP growth--suggest it could do far more. The Fed has made big strides with QE3, but has yet to unload both barrels of guns. It is time for a NGDP level target.

¹  The other, great macroeconomic experiment now unfolding is Abenomics in Japan.