Monday, 23 December 2013

Scott Sumner’s strange claim that the fiscal multiplier is zero.

He has made that claim in numerous blog posts, but this one is typical, and it’s entitled  “For the 247th time, the fiscal multiplier is roughly zero.” The 247 is presumably there to patronise dimwits like me and others who don’t agree with him. Anyway, let’s examine Sumner’s argument.
His reason for saying that the fiscal multiplier is zero is set out in the first two sentences of his post: “Keynesian economists have never been able to accept my assertion that the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy.  There’s a mental block on their part…”
Well now a very good analogy to the latter argument can be made with those cars with two steering wheels and designed for learner drivers. The learner controls the car most of the time, but the instructor can take over by using the other wheel (e.g. in an emergency). Now you could say that the learner is not in control in that the instructor has the power to negate what the learner does. But does that mean that what the learner does is pointless or has no effect? Does it mean that really it’s the instructor who is “steering the nominal path” of the car (to use Sumner’s phraseology)?
Well in the case of a learner who is clued up, the instructor wouldn’t interfere. And in that case it’s the learner that is driving the car. It’s amazing that I need to spell this stuff out, isn’t it?
Same applies to monetary and fiscal policy. If fiscal stimulus is implemented, and the central bank thinks that stimulus is desirable, then the central bank won’t negate it. So in that case that particular bout of fiscal stimulus will work. Indeed, during the recent crisis, central banks (much to the surprise of Sumner, perhaps) AUGMENTED fiscal stimulus by cutting interest rates.

Which is better: monetary or fiscal stimulus?
That of course all leaves the question as to which is better: monetary or fiscal stimulus. My answer to that is that PURE monetary policy (i.e. relying just on interest rate adjustments or QE) is not a good idea. My reasons are here, here and here.


  1. "If fiscal stimulus is implemented, and the central bank thinks that stimulus is desirable, then the central bank won’t negate it. "

    It doesn't matter if the central bank thinks it is desirable or not. It will not act against the democratic elected government.

    Because to do so would cause a constitutional crisis.

    You cannot have an unelected entity countermanding the elected body.

    Here in the UK the House of Lords will not stand in the way of the government's Finance Bill, so the Bank of England certainly isn't going to either.

    This is what the monetarists can't get their thick head around - that the central bank is merely a servant of the government and it is their job to do as they damn well told.

    In monetarist land there is no government. Just them running the central bank and ignoring reality.

  2. I of course agree with Neil about which entity has ultimate authority over, well everything.

    Ralph, technically reducing interest rates counteracts fiscal policy, it does not augment it. My claim here needs to stipulate that the elected govt understands the nature of fiat monetary systems.

    In this scenario, when the Fed drops interest rates to zero, the amount of spending the Govt adds to economy decreases as well. With T-bonds held by the public (Fed interest is remitted back to Tsy) plus the T-bonds held by the SS trust fund, valued at ~$12T. Every 100 basis points increase in the FFR is worth $120B in new spending each year.

    The Fed could technically implement the largest possible stimulus. If the FFR went up to Volcker levels of 15%, Govt spending would grow by around $2T per year.

    1. Auburn, Whether monetary policy augments or counteracts fiscal policy depends on your starting assumptions, which is what I think you’re saying. E.g. assuming government delegates to the central bank the right to adjust the stimulatory stance taken by government, the central bank will augment the latter stance if the CB thinks that stance is inadequate. And it will counteract it if it thinks that stance (i.e. fiscal policy) is too stimulatory. Hope I got that right!!!!


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