What is Wrong with This Statement?

According to the AP, Dallas Fed President Richard Fisher believes that the Fed's policies are making it easier for Congress to avoid hard choices:

"The more we offer accommodative monetary policy," said Fisher, president of the Federal Reserve Bank of Dallas, "the less incentive they have to pull their socks up and do what's right for the American people."

What is wrong with this statement?  The answer is that Richard Fisher has the causality backward.  The very reason Congress has been running deficits in the first place that need to be addressed is because the Fed failed to first prevent and then afterwards correct the collapse in nominal spending that took place in 2008-2009.  This failure to return nominal spending to its trend path increased the cyclical budget deficit and opened the door for the structural budget deficit brought about by President Obama's fiscal stimulus.  

If Fisher really wants to create an economic environment conducive to fiscal consolidation, then the Fed must first restore robust nominal spending.  Most studies show that successful fiscal retrenchment requires an accomodating monetary policy that stabilizes nominal spending.  If the Fed were to tighten, as Fisher currently desires, then Congress will be facing an even bigger budget deficit to reign in. There is no way around this reality.

Fiscal Austerity Requires Monetary Liberality

Over at Cafe Hayek, Russ Roberts takes on Paul Krugman's claim that most studies show fiscal policy tightening will stall a recovery rather than help it:

Unfortunately, Krugman doesn’t provide a link to those “many studies” of the historical record. Maybe he was busy or simply didn’t have room to provide them. But I will just mention that in 1946, federal spending fell about 55% when the war ended. The Keynesians predicted a horrible depression. Yet despite the release of 10 million people into the labor market with demobilization private sector employment boomed and the economy thrived. That’s a great natural experiment. I am eager to read any of the alleged many studies of the historical record.

Like Roberts, I am skeptical about the ability of discretionary fiscal policy to stabilize the business cycle.  His critique, however, is too quick to embrace the popular view that fiscal policy consolidation actually improves the economy.  On this point, Krugman is correct that most of the empirical evidence (e.g. here, here, and here) does not support this view.  What the evidence does show is that in most cases where fiscal consolidation was accompanied by a robust recovery it happened because monetary policy was accommodative.  In other words, a loosening of monetary policy made it appear that fiscal policy tightening was the cause of the economic recovery when in fact it was not.  For example, the much celebrated case of Canada's fiscal retrenchment in the later half of the 1990s coincided with the Bank of Canada dropping interest rates about 5% which supported domestic demand and increased exports via currency depreciation.  For fiscal austerity to work then, monetary policy needs to be accommodating. 

Along these lines, a more general point is that the impact of any fiscal policy action--where expansionary or contractionary--depends on the stance of monetary policy.  Thus, from 2008-2009 when monetary policy was effectively tight the easing of fiscal policy didn't quite pack much of a punch.  Conversely, in late 2010, early 2011 when there was not much fiscal stimulus, but some monetary policy easing under QE2 there was some improvement in the pace of recovery.  Another way of saying this is that an independent monetary policy will always dominate fiscal policy.

So if Russ Roberts is like me and wants fiscal policy consolidation that works he should really be clamoring for more monetary stimulus.  Otherwise he may get more than he bargained for.

Update: Awhile back I did a related post criticizing hard money advocates to which Paul Krugman replied.  Here was my response to Krugman.

Hard Money Advocates are Their Own Worst Enemy

Hard money advocates have been taking a beating in the blogosphere over the past few days, complements of Matthew Yglesisas, Paul Krugman,  Mike Konczal, and Ryan Avent.  These critics make some good points about the hard money view.  Here is Avent's critique:

The hard money approach is atrocious economics. I don't think it's outlandish (or even particularly controversial) to say that the biggest difference in the outcome of the Great Recession and the Great Depression was the change in central bank approach to policy. An economic catastrophe was averted. What's more, hard money is a great force for illiberalism. Sour labour market conditions fuel anger at the institutions of capitalism and free markets. And when countries are denied the use of normal countercyclical policies, they quickly reach for illiberal alternatives like tariff barriers.

These points are often overlooked by hard money supporters.  There is, however, an even bigger problem for them.  Most hard money advocates are in the GOP which also happens to be calling for fiscal policy restraint.  The belief is that hard money and sound government finances are necessary for a robust recovery to take hold.  The problem is that the hard money approach--which means tightening monetary policy--makes it next to impossible to stabilize government spending.  It also makes it likely the economy will further weaken. 

How do we know this?  First, in almost all cases where fiscal tightening was associated with a solid  recovery  monetary policy was offsetting fiscal policy.  Last year there was a lot of attention given to a study by Alberto F. Alesina and Silvia Ardagna that showed large deficit reductions were often followed by rapid economic expansion.  Further digging by the IMF and by Mike Konczal and Arjun Jayadev found, however, that this was only true when monetary policy was lowering interest rates.  Fiscal tightening coincided with a recovery only because monetary policy was easing. 

Second, a key lesson of recent years is that monetary policy overwhelms fiscal policy.  Thus, from 2008-2009 when monetary policy was effectively tight the easing of fiscal policy didn't quite pack much of a punch.  Similarly, in late 2010, early 2011 when there was not much fiscal stimulus, but some monetary policy easing under QE2 there was some improvement in the pace of recovery.  

Third, another lesson from the recent crisis and the Great Depression is that if tight monetary policy is dragging down the economy it opens the door for more active fiscal policy.  Imagine if the Fed had been able to stabilize nominal spending more effectively and thus prevented the economic collapse in late 2008, early 2009. It would have been a lot harder to justify the large fiscal stimulus package. The same is true for 1929-1933.  Had the Fed not been passively tightening monetary policy at that time there would have been far less political support for fiscal policy and government intervention in the economy.

All of this indicates that calls for tight monetary and tight fiscal policy simply don't make sense for the GOP.  Such an approach would most likely cause the cyclical budget deficit to increase even if the GOP successfully lowered the structural budget deficit.  More importantly, with tight monetary policy there would probably be no recovery to show for the budget deficit cutting. This would make it politically tough to do further fiscal reforms. If the GOP wants to meaningfully address budget problems it needs to soften its stance on monetary policy.  Otherwise, it risks becoming its own worst enemy.

Update:  Paul Krugman comments on this post.  Here is  my reply to him.

Impeccable Timing

Amidst all the U.S. budget talk last week, the IMF decided to weigh in by noting the U.S. lacked a "credible strategy" to handle its public debt.  Now Standard & Poor's has decided to pile it on by downgrading U.S. public debt from stable to negative.  From the FT:

“We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns..."

Between this and the rumors of a possible Greek debt restructuring, global markets are roiling.  If this turns ugly, then Fed should be ready to accommodate the spike in global demand for dollar-denominated money.

A Natural Experiment in the Making

Martin Wolf makes an interesting point today in his column.  He argues that the divergent policy paths of the United States and the United Kingdom are providing a natural experiment on the efficacy of "expansionary" fiscal austerity:

The US and UK have similarities that go beyond speaking the same language: both had huge expansions in household credit; both had to rescue their financial sectors; both have watched their central banks push interest rates close to zero and adopt “quantitative easing”; and both have experienced massive post-crisis increases in fiscal deficits. Yet a big policy divergence is on the way. The coalition government of the UK will on Wednesday announce details of their cuts in government spending. Nothing comparable is expected in the US...What we do know is that the UK has launched a remarkable policy experiment. The contrast with the US should at least be instructive.

While this will make for an interesting comparison going forward,  it will be difficult to disentangle the effects of monetary policy from that of fiscal policy.  Martin wolf cites an IMF study in his column that speaks to this issue.  This study shows that many of so called "expansionary" fiscal contractions  occurred because monetary policy was providing accommodation via lower interest rates and/or a currency depreciation.  Scott Sumner made a similar point a while back.  He argued it is nearly impossible to estimate the true size of the fiscal multiplier and thus the actual effect of fiscal stimulus because monetary policy will typically offset such actions.  Still, the diverging policy paths of the US and UK  will be interesting to watch. 

Payroll Tax Holiday with a Twist

There is a lot of chatter right now about whether a payroll tax holiday would provide an effective stimulus to the slumbering U.S. economy.  The motivation for this chatter is the news that the White House is considering, among other things, some kind of payroll tax cut.  The discussion so far has been mixed with some folks like Scott Sumner, Tyler Cowen, and Arnold Kling endorsing it while others like Megan Mcardle and Mark Thoma expressing uncertainty as to how much stimulus it would actually provide.  Mark Thoma concludes his discussion of this proposed tax cut with the following:

Thus, the overall effect on employment depends upon the net effect of the AD and AS shifts. If the AD shift dominates, as I suspect it would, it's still possible for this policy to have positive effects on output and employment. But the size of the effect depends upon the strength of the demand side shift, and how strong the shift would be is an open question, particularly given the degree of household balance sheet rebuilding we are seeing which causes the tax cuts to be saved rather than spent.

See the rest of Thoma's post as to why a payroll tax could affect both aggregate supply (AS) and aggregate  demand (AD).  One way to make sure the AD effect dominates would be to do the payroll tax holiday in the manner I suggested a few days ago: have the Federal Reserve (Fed) fund the payroll tax holiday with a "monetary gift" to the Treasury department and at the same time commit the Fed to doing so until a certain nominal target (e.g. a price level target) is hit. As discussed in the comments in my previous post, only part of this funding would truly be a "monetary gift" from the Fed. Still, the announcement of a nominal target to complement the payroll tax holiday would go a long ways in stabilizing the nominal expectations.

With all that said,  I am not advocating this approach as my first-best solution. I would rather go with  more aggressive monetary policy along the lines Scott Sumner discusses here.  If, however, there is going to be a payroll tax holiday, why not make it more effective by bringing in the Fed's money helicopter?  The biggest impediment to this proposal is a legal one, it would require Congressional approval.

Update:  I overstated Tyler Cowen support for the payroll tax cut.

More Dependent Than Ever

Paul Krugman recently claimed we should not be concerned about whether China will continue to finance U.S. budget deficits since they are being funded by U.S. private savings:

The US private sector has gone from being a huge net borrower to being a net lender; meanwhile, government borrowing has surged, but not enough to offset the private plunge. As a nation, our dependence on foreign loans is way down; the surging deficit is, in effect, being domestically financed.

When I read this claim back in March my reaction was that it makes sense but I also wondered if it were supported by the data. The evidence Krugman showed at the time was that private sector borrowing had declined and was being offset by increased public sector borrowing. While this evidence was consistent with his view, it did not directly show the actual saving rate from each sector or the national saving rate. Consequently, I had some lingering doubts as to whether the U.S. budget deficit was being entirely financed by increased U.S. private savings.

Yesterday I had the chance to reexamine this question while I was putting together some graphs on U.S. saving rates for my class. Below is one of the graphs I created. It shows the net saving rates for the private sector (households and firms) and the public sector (state and local government and federal government) and is based off of data from the BEA's National Income and Product Account Table 5.1. (Click on figure to enlarge.)

Consistent with Krugman's claims, the figure does show that the private sector saving rate has increased with most of the gains coming from households. However, the figure also indicates the public sector dissaving is far larger than the saving gains in the private sector. If we sum up the sectors we get the net national saving rate which is graphed below over a longer period:

Here we see the net U.S. net saving rate is negative in 2009 with an average rate of about -2.5%. This net saving shortfall amounts to about $356 billion dollars that had to be financed by foreigners last year. Now to be fair to Krugman, the figures above show U.S. net savings which is equal to U.S. gross savings minus savings allocated to maintaining the existing U.S. capital stock. If one looks at U.S. gross savings in 2009 it is positive. This means the actual budget deficit was financed domestically. Note, however, that the $356 billion dollar shortfall in net savings means the U.S. economy is currently not saving enough to replace its existing capital stock let alone create new capital. The last time that happened was in early 1930s. Luckily for us, though, foreigners are still willing to invest in the United States and make up the difference. So while Krugman is correct that the concerns about China threatening not to finance our budget deficit are misplaced, it also true that the U.S. economy is now more than ever dependent on China to maintain and grow its capital stock.

P.S. Here is the net saving rate per year going back to 1929. The source, again, is Table 5.1 from the BEA:

A Quick History of Foreign-Held U.S. Public Debt

Bruce Bartlett has an interesting article that traces the history of the U.S. public debt that is foreign held. Here is an excerpt:

Until the 1970s foreigners owned less than 5% of the national debt. This began to change after the big run-up in oil prices. As oil exporters suddenly acquired vast financial resources they found it convenient to park them in Treasury securities, which provided liquidity and safety. By 1975 the foreign share of the national debt rose to 17%, where it stayed through the 1990s, when China began buying large amounts of Treasury bills. At the end of last year foreigners owned close to half of the publicly held national debt.

Here is the table from his column:

A Fat-Tail Event for U.S. Government Financing?

I recently argued that those observers who only see long-term structural budgetary problems, fail to consider the potential for a fat-tail event adversely affecting U.S. government financing in the near term. Clive Crook considers this possibility by asking whether the U.S. government might soon face a crisis of confidence like that of Greece:

It depends on what you mean by "soon." At the moment, the United States is borrowing with no great sign of stress. Far from coming under pressure, the dollar is still strong, and the cost of U.S. government borrowing (the interest rate on Treasury bonds) shows no sign of spiking. Greece, to be sure, has some problems all its own. Where it leads, the United States need not follow. Yet one should not dismiss the parallel too blithely. Sentiment in financial markets can change abruptly, and the differences between Greece's financial condition and America's are not as vast as one would wish.

Read the rest here.

The Fate of the National Debt

Bruce Bartlett has an interesting article in Forbes where he tackles the question of how much national debt is too much for the United States. He notes that even with the help of history and theory the answer to this question is not straightforward:

The latest budget projections show the national debt rising from $5.8 trillion last year to $7.6 trillion this year and $14.3 trillion in 2019. According to the Congressional Budget Office (CBO), the debt will rise from 40.8% of the gross domestic product in 2008 to 53.8% in 2009 and 67.8% in 2019.

This raises the question of how much debt is too much...This is a surprisingly difficult question to answer. The only time in American history that the debt has been as large as projected was during World War II and the decade following it. The Civil War caused the debt to rise from 1.4% of GDP in 1860 to 31% of GDP in 1867. During World War I, the debt rose from less than 3% of GDP in 1915 to about a third of GDP in 1919. On the eve of World War II, the debt was a little more than 50% of GDP, rising to 122% of GDP by 1946.

[...]

Insofar as we can isolate the impact of the national debt on the economy, it is hard to find it. One reason might be that in the past, people understood that the debt was only temporarily high and would decline sharply as soon as the wars ended. Indeed, the debt did decline after every war in American history. Arguably, the budget surpluses of the Clinton years, which saw the debt/GDP ratio fall from 49% to 33%, resulted largely from the end of the Cold War, which permitted a large cut in defense spending... [O]ne problem we have going forward is that we are not in a war of the magnitude that led to sharp rises in debt in the past. Therefore, we cannot anticipate that the debt will fall with the end of hostilities...

Okay, but if push came to shove at least the United States has the option to inflate its debt away... right?

Although it is thought that inflation is an effective way of reducing the burden of debt, this is no longer true. For one thing, a declining portion of the debt is financed with long-term securities. Today, just 3% of the debt consists of bonds with maturities of 20 years or more; 10 years ago, the proportion was four times greater. To the extent that the debt consists of short-term securities that must constantly be rolled over, inflation does nothing to erode its value because interest rates just rise to compensate, raising interest payments and borrowing, thus maintaining the real value of the debt... Inflation will also cause the dollar to fall on international markets, which will cause foreigners to dump their bonds. With foreigners now owning more than 50% of the privately held debt, this may force the Treasury to issue foreign currency denominated bonds. At this point, our finances will effectively be controlled by foreigners and the International Monetary Fund (IMF)

Barlett, himself a Republican, goes on to discuss his fear that the current Republican leadership is so averse to any tax increase (and presumably they would be politically incapable of scaling back spending) that they would rather default than raise taxes. They would also make life difficult for any Democrat that tried to do so. Given these political realities, he concludes that possibility of a U.S. default is not out of the question.

Niall Ferguson Says "Bring It On!"

... and refuses to back down.

Clive Crook on Long-Term U.S. Fiscal Costs

While supportive of the short-term fiscal stimulus, Clive Crook cautions that we should be thinking seriously about the long-term fiscal health of the United States. He is glad, therefore, that President Obama is spending so much time this week discussing this issue, but wonders if the conversation will be frank on the tough fiscal choices the nation faces over the long-haul:

This year’s budget deficit will be about $1,400bn (€1,090bn, £977bn) or roughly 10 per cent of gross domestic product. This comprises $1,200bn, as recently estimated by the independent Congressional Budget Office, plus another $200bn from the first year of the fiscal stimulus. What happens after that? A new analysis for the Brookings Institution by Alan Auerbach and William Gale estimates that the deficit will average at least $1,000bn a year over the next decade – and this on the basis of some pretty optimistic assumptions.

It assumes an orderly recovery, much as from previous recessions: no lost decade of slow growth. It assumes that the provisions in the stimulus law expire when the act says, even though the administration and Congress hope to make many of them permanent. It takes no account of new outlays under the housing plan or the forthcoming financial stability plan. And it assumes the administration does not embark on comprehensive healthcare reform, even though the White House insists it will.

Even under these favourable assumptions, an annual deficit of $1,000bn or more persists. The Auerbach-Gale study also looks further ahead and estimates a “long-term fiscal gap” – “the immediate and permanent increase in taxes” that would be needed to keep the ratio of government debt to GDP constant at its current level. Under those same favourable assumptions, the necessary tax increase is between 7 per cent and 9 per cent of GDP, about equal to the take of the present federal income tax.

Fiscal Policy Stimulus Smackdown

The usually reserved Tyler Cowen comes out swinging in this rebuttal to Paul Krugman and other fiscal policy stimulus proponents. He provides a number of good critiques, but this one I think is key:

Note that under standard theory neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts. That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I've never seen a stimulus proponent deny this point about real shocks but I don't see them emphasizing it either. It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.

Josh Hendrickson makes a similar point here in his discussion of what macroeconomic theory has to say about this crisis. My belief is that macroeconomic policy should aim to stabilize nominal spending while these negative real shocks are being worked out. This can be most easily accomplished through the existing policies of (1) shoring up the financial sector and (2) quantitative easing by the Fed. Note that it was the equivalent of these two policies in the 1930s the ended the Great Depression, not fiscal policy stimulus.

Fiscal Transfers to the States and the U.S. OCA Status

In a previous post on the givers and takers among the states, I mentioned that it seemed odd that states in the Rustbelt--those states undergoing significant economic hardships--were on average paying more in federal taxes than they were receiving in federal expenditures over the period 1981-2005. I wanted to be more precise about my observations so I plotted the two figures below showing the relationship between federal dollar expenditures per dollar of federal taxes per state and the economic performance of each state. The first measure comes from The Tax Foundation while the second measure is the year-on-year growth rate of the Philadelphia Fed's coincident indicator series. My thinking--influenced by the optimum currency framework--was that federal fiscal transfers should on balance go more toward those states lagging economically. In short, I expected a negative relationship between the two plotted measures. Here is what I found for the period 1981-2005 (click on figures to enlarge):

The above graph does shows the negative relationship that I expected and it is significant at 6%. However, it has a R-squared of only 0.07--only 7% of variation in federal dollar expenditures per tax dollar can be explained by variation in the states economic performance! I redid the graph for years 2000-2005 and found the following:

Here there is no significant relationship and yet the Rustbelt states are really suffering. So at best, there is a significant relationship that explains next to nothing. My priors did not hold up.

These results were interesting to me because they are important in thinking about whether the United States is truly an optimum currency area (OCA). For the United States to be an OCA--and thus be best served by a single currency and monetary policy--states should either (1) share similar business cycles or (2) have the economic shock absorbers of wage and price flexibility, factor mobility, diversified economies, and federal fiscal transfers. In the former case, similar business cycles among the states mean that a national monetary policy, which targets the aggregate business cycle, will be stabilizing for all states. In the latter case, on the other hand, dissimilar business cycles among the states will result in a national monetary policy that is destabilizing—it will be either too simulative or too tight—for some of the states unless the economic shock absorbers listed above are in place. There is ample evidence that there is significant variation among the states' business cycles. So for the United States to be an OCA it is important for the economic shock absorbers to be in place. The evidence above suggest one of the shock absorbers is missing.

The Givers and Takers Among the States

The Wall Street Journal reports on another casualty from that the weakening U.S. economy: state finances. According to the article "states are being slammed by tax shortfalls" and observers "expect it to get worse before it gets better." Amidst this gloomy news--especially for tenure track professors at a state university like me--some states should take solace in the fact that there are federal fiscal transfers from the U.S. government that can serve to offset cyclical economic pressures. Note, though, that I say some states since one state's gain is another state's loss in the form of federal taxes. Where the states fall is tracked by The Tax Foundation in Washington, D.C. They have a series called "deficit neutral federal expenditures per dollar of federal taxes" that I have listed in the figure below (click to enlarge).
The numbers for the District of Columbia are striking, but not really surprising. What is surprising is that the heart of the Rustbelt states--Michigan, Indiana, and Ohio--were net givers. Michigan, for example, got 80 cents back for every dollar it paid in federal taxes. One would think those states suffering the most economically would be getting the most federal support.

Why Monetary Policy Has Already Used Up its Ammunition

The reality of a new fiscal stimulus package has led to much discussion about the proper type of fiscal stimulus during a recession (See here, here, and here). A key concern raised in this debate by some observers is that the past budget deficits under the Bush administration have used up of much of the ammunition fiscal policy would otherwise have had during a recession. Now The Economist makes a similar argument for why monetary policy stimulus may not be as effective this time around: it has used up much of its ammunition (i.e. monetary policy transmission channels) from being too loose and accommodative over the same time period.

"Faith in the Federal Reserve is not what it used to be. Since September the Fed has cut its policy rate by 1.75 percentage points, to 3.5%. It still has plenty of firepower left—rates are some way above the 1% level reached in 2003—but few seem willing to rely on monetary policy alone to save the day...

What lies behind this loss of faith? One cause is the feeling that overly loose monetary policy got the economy into this mess. Repeated cuts in interest rates during the last downturn, in 2001-03, fuelled the housing and credit bubbles that are now bursting to such damaging effect. The legacies of that boom—falling asset prices, high consumer debt and bank losses—may now hamper the ability of central banks to prop up spending."

Nicely put. Read the whole thing.

Cyclically-Adjusted Tax Revenues Under Different U.S. Presidents

Paul Krugman is attempting to provide "straight talk on taxes" at his blog. He shows real federal revenue per capita from the early 1990s to the present. While his approach is insightful, I like to look at the cyclically-adjusted federal revenues as a percent of GDP. This approach makes similar adjustments as does Paul's measure--it accounts for the size of the economy and inflation--but it also adjusts for the influence the business cycle has on federal revenues. This latter adjustment is important because both the Reagan and Bush tax cuts were during economic downturns. (The data is also easily available from the Congressional Budget Office at this site; look for the "standardized budget revenue".)

I downloaded down the data and created the following graph (click here for larger picutre), where the dashed lines mark off each presidency:

This graph is not what I expected. I will let it speak for itself. Mabye Paul Krugman will have a word to say on it.

To be clear, and repeating what I stated when I discussed cyclically-adjusted budget balances, I still find the nuanced Laffer curve view--if I can call it that--of Justin Fox, Brad DeLong, and Greg Mankiw a reasonable position to hold.

Update
My above post did not make clear why it is important to correct for cyclical influences on tax revenues. Both the Reagan and Bush II tax cuts occurred during economic downturns. This timing means that even if there had been no tax cuts tax revenues probably still would have declined during the recessions. Similarly, even if Clinton had not increased taxes there probably still would been higher tax revenues given the booming economy of the mid-to-late 1990s. Consequently, one needs to also account for these business cycle influences when assessing the tax revenue evidence. The data I use above makes this adjustment.

Should Fiscal Policy be Used as a Stabilization Tool?

We already know Greg Mankiw's answer to this question. We now know Alex Tabarrok's answer as well: no. His reasons--which are similar to some of the points I raised earlier--are as follows:

"First, the money for any new spending or tax cuts has got to come from somewhere, right? Thus there is usually substantial crowding out of any stimulus.

Second, by the time the new spending or tax cut gets through the political process the economy has moved on and the stimulus is no longer relevant except by accident.

Third, there just isn't that much discretionary spending to play with and even a large increase in spending, say tens of billions, is too small to make much of a difference in a 13 trillion dollar economy.

Fourth, in their desperation to "do something" politicians will often do something foolish. If a spending increase or tax cut isn't worthwhile on its own merits then it's highly unlikely to be worthwhile once we add in the benefits of "stimulus." Thus, it's one thing to argue for extending unemployment benefits as a matter of welfare it's quite another to think that an increase in unemployment benefits will so increase spending as to reduce unemployment! (The implicit view of Larry Summers.)"

Since Greg Mankiw is crafty at naming new clubs (e.g. Pigou Club), maybe he should find a clever name for the "no fiscal policy" club he and Alex are forming. I suspect Larry Summers will not be joining anytime soon.

Update

See this relevant post by Mark Thoma

Fair Tax Links and a Question

Here is a compilation of links to individuals and their writings on the Fair Tax. It appears to me many economists are skeptical of the plan (though more supportive in general of consumption taxes relative to income taxes for efficiency reasons). I have been able to find a few prominent economist, though, supportive of the plan.

One question I have not seen answered is this: what would happen to fiscal policy as a tool for macroeconomic stabilization under this plan in its purest form? Given all the recent talk about using fiscal policy (here, here) to fight off the almost certain recession now facing the U.S. economy, I would think someone out there would have explored this question.

Skeptical/Against
Arnold Kling
Bruce Bartlett (abbreviated version)
Tyler Cowen
Megan McArdle
Brad DeLong
William Gale

Supportive/For
Laurence Kotlikoff
Vernon Smith
Others

Other Sources
Justin Fox
Fair Tax Official Page
NY Times Piece
Fair Tax Wikipedia
FactCheck.Org
Fair Tax Blog
Tax Foundation (Article Round Up)

More on Stabilization Policy

Mark Thoma had an interesting post on stabilization policy in the form of changes in tax rates. He makes the following points:

(1) Changes in tax rates to 'lean against the wind' during the business cycle should be temporary.

(2) Changes in tax rates to 'lean against the wind' should be consistently applied. Cut taxes when output falls below its potential, but also increase taxes when output exceeds its potential.

(3) As a result of (1) and (2), the budget should balanced over the business cycle. There should be no sustained budget deficits.

(4) Political realities make (1) - (3) difficult to implement in practice. Always count on a politician to cut taxes when the economy weakens, but never expect one to increases taxes during an unsustainable economic boom. Throw in the upward spending bias of most politicians and sustained budget deficits become an almost certainty.

(5) The number of steps in implementing even a thoughtful countercyclical fiscal policy makes this form of stabilization policy almost intractable. If anything, the implied lag in implementing fiscal policy could make it destabilizing rather than stabilizing. (However, automatic stabilizers do provide timely but limited countercyclical aggregate demand management. See related post on structural versus cyclical budget balances here.)

For all these reasons fiscal policy typically plays second fiddle to monetary policy when it come to stabilization policy. However, given the challenges the Fed the ECB have had with credit markets some observers like Martin Feldstein and Lawrence Summers are suggesting fiscal policy supplement monetary policy. Over at the WSJ, David Weasel provides a good overview of this view. Meanwhile, Greg Mankiw tells us that monetary policy is up to the task now at hand and that Congress and the White House (i.e. fiscal policy) should do "absolutely nothing."