Yoga with Brad and Larry

In a timely and somewhat interesting paper, economists Brad DeLong and Larry Summers argue that fiscal policy has an important role to play when monetary policy is constrained by the zero bound on interest rates. From the abstract:

“This paper examines logic and evidence bearing on the efficacy of fiscal policy in severely depressed economies. In normal times central banks offset the effects of fiscal policy. This keeps the policy-relevant multiplier near zero. It leaves no space for expansionary fiscal policy as a stabilization policy tool. But when interest rates are constrained by the zero nominal lower bound, discretionary fiscal policy can be highly efficacious as a stabilization policy tool. Indeed, under what we defend as plausible assumptions of temporary expansionary fiscal policies may well reduce long-run debt-financing burdens. These conclusions derive from even modest assumptions about impact multiplier, hysteresis effects, the negative impact of expansionary fiscal policy on real interest rates, and from recognition of the impact of interest rates below growth rates on the evolution of debt-GDP ratios. While our analysis underscores the importance of governments pursuing sustainable long run fiscal policies, it suggests the need for considerable caution regarding the pace of fiscal consolidation in depressed economies where interest rates are constrained by a zero lower bound.”

Of course, it’s too large of a paradigm shift for them to admit, for example, that (1) fiscal and monetary approaches are largely interchangeable insofar as additions to and subtractions from the stock of net financial assets go, or (2) that Clinton-era Rubinomics “succeeded” thanks to ongoing and demographically supported credit expansion in the private sector (and was an utter disaster for U.S. dollar-dependent entities such as Argentina, Mexico, Russia, and Asian Flu countries).

Their paper extends earlier work done by sympathetic economists on fiscal policy in low interest-rate environments. While it offers the right policy prescription, it’s also an effort to preserve and protect some prevailing but defective macro models.

One particular point of interest is that DeLong and Summers cite MMT stalwart Randy Wray on page three, however briefly. Fortunately, fellow MMT economist Bill Mitchell posted a critique of the zero-bound or ‘liquidity trap’ argument just yesterday, concluding:

The reason the mainstream promoted monetary policy to the fore was because they were really advocating smaller government and more free market space. Hence they had to undermine the case for fiscal policy. In doing so, they have created three or more decades of persistent underutilisation of labour resources in most nations; virtually zero growth in per capita incomes in the poorest nations; and set the World up for the current crisis.

By continuing to see quantitative easing as the solution, the more progressive mainstream economists have also caused the current crisis to be extended.

Fiscal policy expansion is always indicated when there is a spending gap. It is a direct policy tool ($s enter the economy immediately) and can be calibrated and targetted with more certain time lags. Liquidity trap or not, fiscal policy is the best counter-stabilisation tool available to any government.