Last April I had a piece in Wonkblog saying we’d get to see whether or not the expansion of monetary policy in fall 2012 would offset 2013 fiscal austerity. I concluded that it wasn’t looking too good at the start, that QE3 was a smart idea anyway (and should go further), and, most importantly, that a fiscal multiplier would be in effect, and we should run a larger deficit and cancel out things like the payroll tax cut while the economy is still fragile. It received a lot of responses at the time (see the endnotes here for a list).
Recently, there’s been a wave of posts by Scott Sumner and David Beckworth calling me and others out, saying that the votes are in and it's a victory for the market monetarists, the team that said monetary policy would offset austerity in 2013 and fiscal policy wouldn't matter. (There have also been responses from Brad DeLong and Noah Smith.)
I don’t see it. I’m willing to be convinced, but the two clearest tests I saw the market monetarists put forward in early 2013 have resulted in failure. Let’s go through them:
1. “Paul Krugman Will Not Like These Figures,” David Beckworth, December 2, 2012, Macro and Other Market Musings
At the end of 2012, David Beckworth told the Keynesians they were wrong. In a provocative post, he argued “that nominal GDP (NGDP) growth has been remarkably stable since about mid-2010 despite a contraction in federal government expenditures" and that "the Fed has been doing a remarkable job keeping NGDP growth stable.” He posted a graph showing year-over-year NGDP growth at a steady clip.
My Wonkblog column was addressed to Beckworth specifically, and he reiterated the same exact data graphic in his response, arguing, “The U.S. series shows a stable NGDP growth rate.”
Even though the approach of examining year-over-year NGDP growth drew criticism, I like this test because it draws a line in the sand and it also fits with my understanding of how the market monetarists view the situation. The Federal Reserve picks the NGDP path it wants, as if it was off a menu, no matter what is going on with the rest of the economy.
So how did this line in the sand turn out? Here’s the data updated through 2013, with year-over-year (Beckworth’s line) and two quarters showing:
It was stable, until it wasn’t. You can see the year-over-year stable at 4-5 percent from 2011 through part of 2012, but when government spending starts to fall in late 2012 and through 2013, this falls as well. NGDP growth was lower in the first two quarters of 2013 than it was in 2012.
The third quarter did spike, but it was mostly the result of inventories, which, as Yglesias says, is probably bad news. Even more interesting, there wasn’t any additional government austerity in this quarter. Government spending actually increased slightly as state and local spending increased, which more than canceled out declining federal spending. (If continued, this would be an excellent trend, like the opposite of the downturn in which state and local austerity canceled out additional federal spending. I was hoping we'd have more data before we started this conversation.)
I’d note Beckworth didn’t mention this data or his old approach at all in his victory lap. Scott Sumner used this graph and data for his "Most Important Graphic of 2013," but didn’t include any of the 2013 data.
1.a Another related way of judging how the economy evolved in 2013 is to compare it to the Federal Reserve’s projections of it. As some market monetarists believe (e.g. Ryan Avent), these projections are an engine, not a camera -- they aren’t neutral projections of inflation and growth but also a communication of what the Fed thinks about what it can accomplish, which in turn will have an impact and determine what happens in the economy.
How did the Fed's projections for 2013 turn out? Did the economy end up how the Fed said it would when it announced expanded monetary policy?
It fell, both in real GDP and especially core inflation. Which leads me to the second test…
2: “The Federal Reserve's New Yield Curve,” Matt Yglesias, January 21, 2013, Slate
One way to read 2012’s monetary actions was that the Federal Reserve really wanted to hit a 2 percent inflation target. First they announced said target, then they announced open-ended purchases, then they announced that 2 percent wasn’t a ceiling and that they’d tolerate inflation above 2 percent.
Many people considered this an important part of the Fed’s ability to boost the economy (e.g. “the commitment to allow higher inflation in the future is one of the key methods through which the central bank can have a positive effect on an economy stuck at the zero lower bound”). I had written a lot about the Evans Rule, and why it would be a good idea for people to support, so I was watching this closely.
Yglesias, in the linked post, pointed to higher inflation projections in the short- and medium-term as of January as a success story. But, as you can see above, we then went on to have inflation rates collapse, leading to some of the lowest inflation rates in decades.
Regardless of what you think the Fed wanted in late 2012, they certainly weren't trying to generate lower inflation. If the Fed truly is omnipotent, we shouldn't see this. You can say that the bickering over the taper caused these problems, but this is precisely, as Michael Woodford has pointed out, one of advantages of fiscal stimulus in these situations (as I said in last year’s piece, “Using fiscal policy also avoids the expectations problems that plague monetary policy”).
To reiterate, I think the Federal Reserve should be doing more. I’d love to see Yellen enact a genuine regime change at the Fed. But we shouldn’t doubt that fiscal policy, at this moment, is making a difference in the giant slack that still smothers our economy and is collapsing our labor force.
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