Friday, December 6, 2013

The Great Macroeconomic Experiment of 2013

In early 2013, Mike Konczal wrote the following:
In late 2011, the economist David Beckworth and the writer Ramesh Ponnuru wrote an editorial in the New Republic on how “both liberals and conservatives are wrong about how to fix the economy.” How were they wrong? Conservatives were wrong because, contrary to common belief on the right, the Federal Reserve wasn’t in fact doing enough to boost the economy. Liberals, however, were wrong in opposing austerity and calling for more fiscal stimulus in the form of stimulus spending or temporary tax cuts.

In Beckworth and Ponnuru’s view, the Federal Reserve still had plenty of room to boost the economy. Not only would fiscal tightening be good over the long haul, but it would force the Fed to act. And they argued that as long as the Fed is working to offset austerity, the country “won’t suffer from spending cuts.

We rarely get to see a major, nationwide economic experiment at work, but so far 2013 has been one of those experiments -- specifically, an experiment to try and do exactly what Beckworth and Ponnuru proposed. If you look at macroeconomic policy since last fall, there have been two big moves. The Federal Reserve has committed to much bolder action in adopting the Evans Rule and QE3. At the same time, the country has entered a period of fiscal austerity. Was the Fed action enough to offset the contraction? It’s still very early, and economists will probably debate this for a generation, but, especially after the stagnating GDP report yesterday, it looks as though fiscal policy is the winner.
So how has this experiment unfolded since then? Has the Fed been able to offset the fiscal drag? Michael Darda, Chief Economist of MKM Partners, has the answer:
Despite a two-year contraction in nominal federal outlays for the first time in more than five decades and a raft of tax hikes starting in early 2013, job gains are running slightly ahead of the 2012 pace. Non-farm payrolls (+203K in November and 200K in October) have averaged 189K during the first 11 months of 2013, ahead of the 179K 11-month average in November 2012 and the 170K average for November 2011. Over the last 12 months, non-farm payrolls have averaged 191K, also above the 12-month averages for the last three years. Indeed, year-to-year gains for overall payrolls and private sector jobs have been very steady despite the most intense fiscal consolidation since the Korean War demobilization. Many observers late last year were of the mindset that the fiscal cliff and/or sequester would either throw the U.S. economy back into recession, or slow it materially. It has done neither because, in our view, the Fed has offset it. Although monetary policy has beenfar from perfect, allowing the financialsystem to crash in 2009 (instead of doing QE1), allowing low inflation to morph into deflation in 2010 (instead of initiating QE2) and allowing the full force of the sequester/tax hikes to hit in 2013 (rather than rolling out QE3) do not seem like particularly desirable outcomes. The Fed has managed much better than the ECB and that is the proper counterfactual.
Several points to note. First, the Fed has been offsetting since 2010 a tightening of the structural budget balance as a percent of potential GDP. In my opinion, that is an even more impressive feat. Second, its ability to do so demonstrates that monetary policy is still effective at the zero lower bound. Third, it is amazing that so many people were predicting a recession in 2013 because of the sequester. They did not take seriously the possibility QE3 could offset the fiscal drag. I am waiting for their mea culpa.


  1. THe market monetarist were bold, patient and intellectually respectful.
    Its nice to see the game advanced with new thinking. A big congratulations to the core team.

  2. David, and all that was obtained with the Fed having 'one arm tied '. Imagine if it had honestly tried to compensate for the level effect of falling into a deep hole in late 2008-09!

  3. Agreed. The Fed has been feeble, and now inflation (PCE) headed below one percent.

    1. Disagree. Inflation is globally effected and the BRIC slowdown is why "inflation" is falling. In otherwords, not a issue. Same thing happened in the late 90's(though that was a BRIC crash).

  4. "job gains are running slightly ahead of the 2012 pace"

    Have to question whether 2012 is the relevant counterfactual.