Ask Not What Your Government can do for You: Macro Policy in

the Current EnvironmentRik Hafer

Distinguished Research ProfessorSouthern Illinois University Edwardsville

February 3,2012

Prologue What are your objectives in

classroom?

What is the “take away”?

Plug-and-chug vs. Policy debate

February 3, 2012

A story about fiscal policy… How has the conventional wisdom of

fiscal policy changed?

Does reality match what we teach?

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Conventional wisdom, pre-1970“But quibbles about exact timing aside, the potency of fiscal policy…has been demonstrated time and again in the past couple of decades.”

Walter Heller (1969) A caricature Fiscal policy as a stabilization tool

Change G, change T and change Y

February 3, 2012

The Monetary vs. fiscal policy debate

St. Louis position Fiscal policy affects economy

Transitory Monetary policy affects economy

Lasting effects on nominal GDP and inflation

Fiscal policy without monetary support?

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Fiscal policy fails: New conventional wisdom

“Dubious Keynesian Proposition #4:Fiscal policy is a powerful tool for economic stabilization, and monetary policy is not very important.”

Mankiw (1992)Political barriers

Inability to deal with deficits Lack consensus on countercyclical policy

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“New” role for fiscal policy?

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Spending/tax programs affect current behavior Deficits signal higher future taxes Fiscal policy is complicated (Woodford,

2011) Tax structure, spending, debt within

dynamic time dimension

Set policy for medium and longer term

Success of new conventional wisdom?

Tax policy Predictable tax structure?

Federal income tax code: > 45,000 pages Mid-1980-2001: 7,000 federal tax code

changes Debate over marginal rates in election

February 3, 2012

Success of new conventional wisdom?

Spending policy Unpredictability of deficits

Politics? Economics? CBO January 2011 projections (billions)

2015 2020Low $429 $429High $969 $1,422

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Great Recession derails new conventional wisdom

Spending (Bullard, 2012)

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Unpredictability of debt

(Leeper, 2010)

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Back to old conventional wisdom (pre-GR)?

Is debt sustainable? Bullard’s (2012) two worlds

Increased deficits/debt signal expectation of stronger future growth Business react and growth occurs

Increased deficits/debt signal expectation of weaker future growth

Probably in world #2

February 3, 2012

Stories we tell students

Government spending multiplier Concept or algebraic exercise? Wide range of estimates

IMF (2009) review of studies One-year spending multiplier

Range: -0.1 to 1.4

February 3, 2012

Stories we tell students

Crowding out

February 3, 2012

Should we ignore deficits/debt? Deficit has not crowded out private investment

doesn’t meant it could not happen Bond downgrades?

Gov’s taxing and spending choices affect us personally

Size of government debate What is government’s role Economic freedom

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If not fiscal policy, what?

Monetary policy re dux Zero Lower Bound (ZLB) issues

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Monetary policy at ZLB

Bullard (2012)“In reality, the Committee has been able to run an

effective countercyclical monetary policy during the last three years via “unconventional” policy. In the theory, this makes fiscal stabilization policy ineffective.”

QE policies Not limited to financial assets Section 13.3 of Federal Reserve Act

February 3, 2012