An Unnecessary “Stimulus”

In two Defining Ideas articles in 2009, “Who’s Afraid of Budget Deficits? I Am” and “Furman, Summers, and Taxes,” I criticized Lawrence Summers and Jason Furman, two prominent economists who worked in the Obama administration, for their dovish views on federal debt and deficits. They had argued that we shouldn’t worry much about high federal budget deficits and growing federal debt. Of course, that was before the record budget deficit of 2020. Now even Summers is worried. In two February op-eds in the Washington Post, Summers argues against the size and composition of the Biden “stimulus” bill.

Summers makes a solid argument, on Keynesian grounds alone, that the proposed $1.9 trillion spending bill is much too large. He also, to his credit, digs into some of the details of the bill, pointing out how absurd they are. Had Summers looked at more details, he could have made an even stronger case against the measure. For instance, one major provision of the bill, the added unemployment benefits through August, will actually slow the recovery. And other provisions of the bill, like the bailout of state and local governments, are bad on other grounds. The fact is that this is not your father’s or your grandmother’s run-of-the-mill recession. It was brought about by two things: (1) people’s individual reactions to the threat of Covid-19 and (2) politicians’ reactions, in the form of lockdowns, to the same threat.

These are the opening two paragraphs of my latest article for Defining Ideas, “An Unnecessary ‘Stimulus’“, Defining Ideas, March 5, 2021.

And the ending:

First, the economy is recovering. In January, the International Monetary Fund predicted that real GDP will grow by 5.1 percent in 2021. Possibly that’s because the IMF understands that this is not a typical recession. The slump we’re in was due initially to people’s fear of the virus, a fear whipped up by Dr. Anthony Fauci and others. But now it’s due mainly to lockdowns. As the percent of the US population that has had COVID-19 rises and the number of people vaccinated rises, we are getting closer to herd immunity. Then people will feel even safer going out and governments will have fewer excuses to keep their economies locked down. We can all become Florida or Florida-Plus. That will all happen without any stimulus bill.

Second, the $1.9 trillion bill represents government taxing us or our children in the future to spend money in places where we the people have chosen not to spend it now. The bill is, in essence, a huge instance of central planning with government officials’ preferences overriding ours. The bill, for example, contains $28 billion for transit agencies, $11 billion in grants to airports and airplane manufacturers, and $2 billion in grants to Amtrak and other transportation. How does the government know that those are the right amounts? What if, as I predict, when the pandemic and lockdowns end we will still have fewer people wanting to ride transit because they and their employers will opt for a hybrid model of some at-home work and some in-office work? The effect of this misallocation of resources won’t necessarily show up in GDP because GDP measures government spending at cost rather than at value. But this spending will make us somewhat worse off. It’s far better to rely on people having the freedom to make their own allocations.

If the government gets out of the way, the economy will recover. Maybe it takes an outsider to see that and to say that. I just did.

Read the whole thing.


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When is fiscal stimulus appropriate?

Greg Mankiw recently presented a graph showing that the US is doing much more fiscal stimulus than other big economies during the Covid crisis, even as a share of GDP:

I was struck by the big difference between the US and major European economies such as Germany, France and Italy.  According to mainstream macroeconomic theory, the Eurozone economies should have been doing far more fiscal stimulus than the US.

The standard model suggests that monetary policy should steer demand during normal times.  According to this view, there might be two situations where fiscal stimulus is appropriate:

1. If a country lacks an independent monetary policy.

2. If a country is stuck at the zero bound, and monetary policy is ineffective.

Both the US and the Eurozone have near-zero short-term rates.  In contrast to the Eurozone, however, longer-term rates are well above zero in the US.  So the case for monetary policy ineffectiveness is stronger in the Eurozone.

The US has an independent monetary authority that can provide stimulus when needed.  Individual Eurozone countries lack such an authority, and thus might benefit more from fiscal stimulus.

This is not to suggest that I believe Eurozone countries should have done more fiscal stimulus.  I’m skeptical of the efficacy of fiscal stimulus, and countries without an independent bank have less margin for error in terms of avoiding a debt crisis.  Rather my point is that for whatever reason, developed countries are not following the playbook suggested by the standard model of fiscal policy.  The US would be expected to do far less fiscal stimulus than the Eurozone countries.

PS.  For those interesting in long run debt sustainability issues, I strong recommend David Beckworth’s podcast with Ricardo Reis.  It’s a bit technical, but highly informative.



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Mitt Romney’s Expensive and Unfair Child Allowance

Co-blogger Scott Sumner argues for, without quite endorsing, Senator Mitt Romney’s proposal for a large child allowance. I won’t lay out the specifics of Romney’s proposal in detail because Scott has already done it and the Tax Foundation has provided even more details.

I will point out that the budget cost of the plan, all else equal, is estimated to be about $229.5 billion annually. While that might not sound like a lot in this time of trillion-dollar spending programs, it is a lot.

Of course, not all else is equal. If Romney got his way, the child care tax credit would be eliminated, which would save $117 billion annually, leaving $112.5 billion as the net cost. He would also reform the Earned Income Tax Credit, saving $46.5 billion annually, driving the net expenditure for his plan down to $66 billion.

He would come up with the $66 billion by increasing taxes in three ways and cutting two other spending programs.

While the Tax Foundation did an excellent job of analyzing the provisions of the Romney plan, it did make one error. The analysts, Erica York and Garrett Watson, state:

Romney estimates eliminating the SALT deduction would result in $25.2 billion in annual savings through 2025.

But eliminating the SALT deduction doesn’t save money: it costs money. It costs taxpayers who will lose the deduction. Of course, York and Watson may be quoting Romney and so it may be Romney’s mistake. But it is a mistake.

Note also that the child allowance starts phasing out for single taxpayers with income about $200,000 and for married, filing jointly taxpayers with income above $400,000, at a rate of $50 per $1,000 in income. That implies that very high-income people, virtually all of whom are already in a fairly high federal tax bracket, will see their marginal tax rates increase by 5 percentage points. That’s if they have 1 child. And if they have 2 children, their marginal tax rates will be 5 percentage points higher over an even larger range of income than the Tax Foundation’s graph shows.

Most of these high-income people will be in a 35 percent tax bracket. This phase-out increases their marginal tax rate by 14.3 percent (5 is 14.3 percent of 35). The efficiency loss, also called deadweight loss (DWL), from taxes is proportional to the square of the tax rate. So the 14.3 percent increase in the marginal tax rate doesn’t increase DWL by 14.3 percent. It increases it by 30.6 percent. (Take 0.4 squared divided by 0.35 squared and you get 1.306.) That’s a large increase.

And why all this? Why does it make sense to subsidize people having children?

Two other points.

First, although Scott Sumner says that the proposal will increase equity, he doesn’t define equity. But implicit in his discussion is the idea that equity is synonymous with income equality or, at least, reduced income inequality. That’s not my view. My view is that people are treated equitably when other people don’t take their stuff. Romney would tax people more when they live in high-tax states and thus lose their deduction of state and local taxes. That’s not fair. (I think, along with Scott, that the SALT deduction should be zero, but in return, marginal tax rates for high-income people should be cut.)

Second, what happened to Romney’s fear, which he once had, of the deficit. The budget deficit is huge this year and, although it will likely be lower next year, it is set to be at least $1 trillion annually for a long, long time. We should be looking at paring down “entitlements” such as Social Security, Medicare, and Medicaid, not adding new ones.


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Olivier Blanchard on monetary offset

This tweet identified the real issue:

People often talk about the risk of economic overheating, but that seems unlikely.  TIPS market participants seem to agree, as that market also forecasts close to 2% inflation going forward.

The actual risk is that a very large fiscal stimulus package will not stimulate the economy (at the margin), as the Fed will offset the effect. (Just as the Fed offset fiscal austerity in 2013).  Instead, we will merely add to the national debt.

Given low interest rates, there’s a respectable economic argument for a slightly higher steady-state budget deficit, and some of the fiscal package may be useful.  But quickly dumping $1.9 trillion into the the economy is almost certainly not a policy that minimizes the long run deadweight cost of taxes.  I’d encourage policy makers to take a deep breath and think about their long run objectives.  What are they actually trying to accomplish, and what’s the most cost effective way of getting there?

And think at the margin.

PS.  I began blogging on monetary offset back in 2009.  Expect to see a lot more discussion of this issue in the years ahead.


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Government Support Is Vital as Countries Race to Vaccinate

By Vitor Gaspar, Raphael Lam, Paolo Mauro, and Mehdi Raissi The COVID-19 pandemic is accelerating in many countries and uncertainty is unusually high. Decisive government actions are necessary to ensure swift and extensive vaccine rollouts, protect the most vulnerable households and otherwise viable firms, and foster a durable and inclusive recovery. Most countries will need […]

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Top 10 Blogs of 2020

By IMFBlog Welcome to 2021. Before we step too far into the new year, the editors at IMFBlog invite you to reflect on what the world went through in 2020. As much as we would like to turn the page on 2020, navigating a course forward through still uncertain times entails using all we’ve learned […]

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Newt Gingrich’s Numeracy Problem

And Trump’s and the Dems’ arithmetic problem.

$2,000 * 200 million does not = $2,000.

$2,000 – $600 does not equal $2,000.

Newt Gingrich tweets:

If Senate Republicans fail to bring up the $2000 payment as a clean vote they run a real risk of losing the two seats in Georgia. This is an 80% issue. People get it. Billions for the banks, billions for big companies, but we can’t find $2000 for everyday Americans.

If the proposal before the Senate really were to give $2,000 to everyday Americans, no one would be raising an objection because $2,000 divided by, say, 200 million everyday eligible Americans is way, way below 1 penny each.

Everyone understands that it’s $2,000 per “everyday American.” With about 200 million Americans qualifying, that’s $400 billion.

So if we were to rewrite Newt’s tweet honestly and accurately, it would read something like:

If Senate Republicans fail to bring up the $2,000 payment as a clean vote they run a real risk of losing the two seats in Georgia. This is an 80% issue. People get it. Billions for the banks, billions for big companies, but we can’t find $400 billion for everyday Americans.

Sounds a little different, doesn’t it?

And remember how Trump objected that $600 was way too low an amount to have the government give eligible people and $2,000 was the right amount? Well, they got the $600. So if Trump really believed what he said, and if the Democrats believed what they said they believed, he and they should have pushed for an extra $1,400, not an extra $2,000.

Newt’s tweet also shows the difference between those of us who want to have gridlock and divided government in order to restrain government and people who want divided government simply because they want the Republicans to be the majority party in the Senate.

Many of us want gridlock because we fear what a Democratic House of Representatives, a Democratic Senate, and a Democratic president will do. One of the main things many of us fear is that they will spend hundreds of billions of dollars more than if the Republicans won the Senate and restrained the Democrats’ spending. But if Mitch McConnell caves so that the feds spend an extra $400 billion and the Republicans win in Georgia, they will have nullified a huge part of the reason for having the Republicans win in Georgia.


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No free lunch for government debt

Matt Yglesias has a post advocating fiscal stimulus in the form of checks sent to all Americans. While discussing the bonds that would be issued to finance the increased deficit, Yglesias makes this claim:

The federal government needs to pay interest on the bonds, but that interest becomes Fed profits which are rebated to the Treasury so there’s no actual cost.

Of course, the total federal debt will go up, but the more important “debt held by the public” will not since the extra debt will, by law, be perpetually held by the Fed rather than by the public.

That would be true if the bonds were bought with zero interest currency notes, and the currency notes stayed in circulation forever.  Most of the debt, however, will be purchased with interest-bearing bank reserves.  This is because a large permanent increase in the stock of zero interest currency would likely cause the Fed to overshoot its 2% inflation target.  Maybe not right away, but certainly after the economy recovered and interest rates rose above zero.

So let’s assume that the deficit is financed by issuing Treasury debt, and the Fed buys the debt with interest-bearing bank reserves.  In that case, there is not likely to be much Fed profit to offset the interest burden on the Treasury.  Yes, the Fed will earn interest on the bonds it purchases, but it will pay interest on the bank reserves that it injects into the economy.

In general, the interest rate on bank reserves is roughly equal to the interest rate on T-bills.  While it is usually (but not always) the case that interest rate on bank reserves is below the interest rate on longer-term bonds, that sort of “profit” could be earned simply by shortening the maturity of the Treasury’s outstanding debt.  For various reasons, the Treasury prefers to borrow by issuing bonds of a wide range of maturities.  If the Fed bought longer-term bonds with bank reserves they would probably earn a profit, but there is risk involved.

It’s also possible that interest rates will stay at zero forever.  But in that case there would be no cost in financing the deficit even if the debt were not purchased by the Fed.  So money creation does not perform any fiscal miracles.

On the other hand, because the demand for currency rises over time, the Fed earns a certain amount of seignorage from adding to the stock of currency.  But that profit (sometimes referred to as the “inflation tax”), occurs regardless of what fiscal policy is doing.  And it’s a very small share of GDP, relative to the entire federal budget.

PS.  Some might argue that the US should copy Japan’s “zero interest rates forever” policy.  But Japan did not achieve that outcome with easy money; they did so by producing ultra-slow NGDP growth, which drove the Japanese natural rate of interest down to zero.  People who favor proposals to monetize debt and/or permanently hold interest rates at zero, are generally people who favor expansionary policies regarding aggregate demand.  Anyone in that camp should NOT be citing Japan, which among the major economies has the worst performing aggregate demand growth in modern history.  That’s why Japanese interest rates are stuck at zero.  Nonetheless, I recall seeing a few MMTers cite Japan as an example of a zero interest rate policy.


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That doesn’t mean what you think it means

Over the past month, I’ve been trying to pin down exactly what’s wrong with Modern Monetary Theory. Or perhaps a less presumptuous way of putting it is that I’ve been trying to figure out what mainstream economists believe is wrong with MMT.

Here I’ll list 6 MMT ideas. I’ll first explain the kernel of truth in each claim.  Then I’ll explain the mistaken way that MMTers interpret these claims.  Finally, I’ll explain how and why these claims don’t mean what MMTers think they mean. I’ve taken this approach because I believe that MMT is based on a series of basic misunderstandings:

1.  Banks don’t loan out reserves.

2. There is no money multiplier.

3. Money is endogenous.

4. Interest rates are an exogenous monetary policy instrument.

5. Investment is not very responsive to interest rates.

6. In a closed economy, net saving equals the budget deficit.

1. Banks don’t loan out reserves.

It’s true that most bank loans are executed by crediting the borrower with a new bank account, and thus the reserves usually don’t immediately leave the banking system.  BTW, for any given monetary base, the only way that reserves can leave the banking system is as currency notes.

From this mostly valid claim, MMTers wrongly conclude that an injection of new reserves into the banking system does not boost bank lending.

As I explain in this post, the injection of new base money by the Fed (initially as bank reserves) sets in motion a series of price and quantity changes that has the effect of boosting bank lending.

2.  There is no money multiplier.

It’s true that the money multiplier is not a constant, a point well understood by mainstream economists.

From this valid claim, MMTers wrongly conclude that a permanent and exogenous injection of new base money by the Fed does not have an expansionary effect on the monetary aggregates.

As I explained in this recent post, the injection of new base money has a multiplier effect on all nominal variables in the economy.

3.  Money is endogenous.

When there is no interest paid on bank reserves, it’s true that pegging rates makes the money supply is endogenous, which means it cannot be changed at the discretion of a central bank.

From this valid claim, MMTers wrongly conclude that under an interest rate targeting regime the central bank cannot adjust the money supply to control inflation.

In fact, even under interest rate targeting, central banks can and do adjust the money supply to target inflation, as during the period from 1983 to 2007.  To adjust the money supply appropriately they must frequently adjust the interest rate target, but they are quite willing to do so as required to stabilize inflation.  They didn’t target the money supply during 1983-2007, but they used OMOs to adjust the monetary base as required to control inflation.

4. Interest rates are an exogenous monetary policy instrument.

On a day-to-day basis, it’s true that central banks can and do target short-term interest rates.

From this valid claim, MMTers wrongly conclude that changes in short-term interest rates reflect changes in monetary policy.

In fact, over any meaningful period of time, short-term interest rates are mostly endogenous, determined by factors such as the income and Fisher effects.  The Fed merely follows along to prevent an economic disaster.  As an analogy, at any given moment in time the path of a bus going over a mountain range is determined by the driver’s handling of the steering wheel, but over any meaningful span of time the path of the bus is determined by the layout of the road, combined with the bus driver’s desire not to go over the edge of a cliff.  In this analogy, the twisting road is like the fluctuating natural rate of interest.  As I pointed out in this recent post, MMTers don’t understand that if the central bank targets inflation then interest rates become endogenous, and positive IS shocks cause higher interest rates.

5. Investment is not very responsive to interest rates.

It is true that a decline in interest rates does not usually do much to boost investment, and vice versa.

From this valid claim, MMTers wrongly conclude that a decline in interest rates induced by an expansionary monetary policy does little to boost investment.  I.e. they conclude that monetary policy has little impact on aggregate demand.

This is reasoning from a price change.  Most declines in interest rates are due to the income and/or Fisher effects, not easy money.  Those sorts of declines are not expansionary.  A fall in output or inflation reduces the natural rate of interest, in which case the central bank must cut the target interest rate even faster to stimulate investment.  Because MMTers mostly ignore the income and Fisher effects, and view the natural interest rate as being zero, they miss the fact that most changes in interest rates do not reflect shifts in monetary policy.

6. In a closed economy, net saving equals the budget deficit.

The MMTers define private net saving as the budget deficit plus the current account surplus.  Thus it’s true (by definition) that net saving equals the budget deficit in a closed economy.

From this valid claim, MMTers wrong conclude that if the public wishes to engage in more net saving, the government needs to run a larger budget deficit.

Actually, the central bank should respond to this scenario with a more expansionary monetary policy, which will push the public’s desire to net save back into equilibrium with the budget deficit at full employment.  Conversely, when there is an exogenous change in the budget deficit, the Fed needs to adjust policy so that net savings moves appropriately, without impacting the Fed’s targets.  The Fed did this fairly well in response to the sharp reduction in the budget deficit during 2013, and again in response to the sharp increase in the deficit during 2016-18.

These MMT errors are all interrelated.  Because MMTers misinterpret the supposed “endogeneity” of money and the supposed “exogeniety” of interest rates, they get monetary policy wrong, greatly underestimating its potency (at least when interest rates are positive).  This leads them to miss the importance of monetary offset, and that leads them to greatly overrate the importance of fiscal policy.

At a deeper level, MMTers seem to draw invalid causal implications from a series of accounting relationships.  Those accounting identities don’t mean what MMTers think they mean.


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Relief, not stimulus

In a rare bit of good news out of DC, it seems as though the “stimulus” part of the new fiscal package may be dropped:

Direct cash payments to most American households were one of the most popular and efficient measures Congress enacted as part of its response to the coronavirus pandemic earlier this year, but lawmakers seem to have lost interest in another round of checks.

Legislators this week resuscitated talks over a new coronavirus relief package, which includes new unemployment assistance, money for vaccine distribution and more aid for businesses and state governments. But none of the potential compromise proposals includes another round of stimulus checks.

“We’re sending money out as a relief for people in distress, as opposed to a stimulus. This is not a stimulus bill,” Sen. Mitt Romney (R-Utah) told HuffPost about bipartisan $900 billion legislation he is crafting with other moderate senators.

The main factor holding back the economy is not a lack of disposable income; indeed areas where people are free to spend (retail sales, housing, etc.) are booming.  Rather the recession is heavily concentrated in services where social distancing is a problem.  Once the vaccines are widely available in the early spring, those sectors will bounce back strongly.  Many people who skipped summer vacation this year will be anxious to take a vacation next summer.  As an analogy, consumption rebounded strongly after the WWII-era rationing came to an end.  The postwar depression predicted by Keynesian economists never happened.

I have not examined the proposed legislation in detail and thus don’t have a position on the overall bill.  But right now the economy does not need fiscal stimulus.  If any fiscal package is going to be enacted, it makes sense to focus on those who are negatively affected by the crisis, especially the unemployed and small businesses adversely affected by Covid-19.  There is no obvious reason to send $1200 checks to Americans with good jobs.

I wouldn’t be opposed to a bit more monetary stimulus, although I suspect the Fed will hit its 2% average inflation target sooner than most economists expect.  The Fed did not actually do very much monetary stimulus in 2020.  They have plenty of ammo.


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