What is the best kind of fiscal policy shock?

by on December 16, 2008 at 6:49 am in Economics | Permalink

Hot off the presses from the NBER, from Andrew Mountford and Harald Uhlig, the evidence is mounting:

We propose and apply a new approach for analyzing the effects of fiscal
policy using vector autoregressions. Specifically, we use sign
restrictions to identify a government revenue shock as well as a
government spending shock, while controlling for a generic business
cycle shock and a monetary policy shock. We explicitly allow for the
possibility of announcement effects, i.e., that a current fiscal policy
shock changes fiscal policy variables in the future, but not at
present. We construct the impulse responses to three linear
combinations of these fiscal shocks, corresponding to the three
scenarios of deficit-spending, deficit-financed tax cuts and a balanced
budget spending expansion. We apply the method to US quarterly data
from 1955-2000. We find that deficit-financed tax cuts work best among
these three scenarios to improve GDP
, with a maximal present value
multiplier of five dollars of total additional GDP per each dollar of
the total cut in government revenue five years after the shock.

The emphasis is mine.  I’m not saying you have to believe this paper in all its details (I don’t), but over the next year you will continue to hear talk about the wonders of government spending as fiscal policy.  The science isn’t there.  Here are ungated versions of the paper.

kxf_in_dc December 16, 2008 at 8:06 am

Ugh. Why didn’t they include the years before/just after the Great Depression?
Why not include 2001-2004? Oddly enough, I’m just not convinced that a tax cut today
that gives us benefits five years from now is the right idea. Agreed that the science
isn’t there, but this is right up the alley of the global warming deniers.

Bob Murphy December 16, 2008 at 9:03 am

I’m not saying you have to believe this paper in all its details (I don’t), but over the next year you will continue to hear talk about the wonders of government spending as fiscal policy. The science isn’t there.

Hang on a second, Tyler. In the NYT symposium of economists that ran about a week (?) ago, they asked you what the best form of fiscal stimulus would be. If I recall correctly, you didn’t say anything about tax cuts; you said they should spend money on airports and to prop up state & local spending. (In contrast, Casey Mulligan, bless his heart, thought wage earners should get $300 billion back, if we’re handing out free money in DC.)

So what’s going on here? Were you being unscientific in your answer to the NYT, or is there some subtlety I’m missing? Like, “Oh, the spending on airports and state & local wouldn’t ‘boost’ GDP, it would prevent it from collapsing further.” ?

Bob Murphy December 16, 2008 at 9:15 am

So far as I can tell, Tyler Today is saying Tyler on Dec. 15 is being unscientific.

Oops should have been Tyler on Dec. 12 was being unscientific. (There was an UPDATED DEC 15 on the NYT article that threw me.)

Tyler Cowen December 16, 2008 at 9:37 am

Bob, “stop state and local spending from falling” is not symmetric with “boosts to federal spending will bring recovery.” There isn’t any contradiction. And another runway at LaGuardia would do wonders for productivity.

Sydney December 16, 2008 at 10:01 am

Tyelr is only quoting a portion of what Mountford finds. He really throws Keynes under the bus. As Robert Wenzel points out http://tinyurl.com/5w6zhh, the new love affair with tax cuts as a stimulus by Mankiw, and now Tyler, seems to coincide with Obama’s naming of Cristina Roemer to head CEA.

Bob Murphy December 16, 2008 at 10:32 am

Tyler wrote:

Bob, “stop state and local spending from falling” is not symmetric with “boosts to federal spending will bring recovery.” There isn’t any contradiction. And another runway at LaGuardia would do wonders for productivity.

Tyler, OK, that’s in the ballpark of what I thought you would say–well actually, I’m flattered that you said anything!–but still, I think this sentence in the NYT article was misleading:

Tyler: “There are many good ideas, such as electronic medical records, that will not benefit the economy as macroeconomic stimulus. And so they do not make the list as you have phrased the question.”

If I understand your latest clarification, you could have easily added, “Of course, nothing would make the list as you have phrased the question, so don’t misconstrue the first things I listed as part of the empty list. Supporting state and local spending are also good ideas that would not benefit the economy as macroeconomic stimulus, but I decided to distinguish those items from electronic medical records because…[I don't know why--Bob.]”

Anyway, just pointing out something that confused me so you will know you have literal people like me reading your future columns. :)

Anonymous December 16, 2008 at 12:26 pm

Haven’t we learned that the best course of action is to do the opposite of whatever Mankiw thinks best?

indiana jim December 16, 2008 at 12:54 pm

From the post: “We find that deficit-financed tax cuts work best among these three scenarios to improve GDP with a maximal present value multiplier of five dollars of total additional GDP per each dollar of the total cut in government revenue five years after the shock.”

If this were the case, then shouldn’t we cut all taxes to zero and deficit-finance all government?

This suggests a number of difficulties: one is that there is no generic T for taxes. All kinds of things are taxed. And also the cost of deficit financing depends on the amount of the deficit and debt, doesn’t it?

Anonymous December 16, 2008 at 3:51 pm

this guy’s a complete joke. He finds one NBER paper, and decides to use it as something that sounds atleast somewhat conclusive. He qualifies it by saying he doesn’t believe in the DETAILS of the paper, but decides to use it as evidence against the wonders of fiscal spending.

jorod December 16, 2008 at 4:34 pm

Cut government spending, cut tax rates 50% and it will be cheaper than all those bailouts and to much better effect.

HT: Brian Wesbury

Brian December 16, 2008 at 4:54 pm

Does this paper assume that all output is created equal? I’d rather have another runway at LaGuardia than $50 billion in “output” from some ponzi scheme hedge fund populated via tax giveaways.

Alan Brown December 17, 2008 at 6:31 am

We can end the deflation by having the Fed create new dollars and using them to purchase some of our $10 trillion in existing US debt.

To avoid inflating again, the Fed set the value of the dollar to some amount of a stable commodity like gold and just buy enough US debt to maintain that price. The Fed can always resell that debt later if the dollar’s value begins to decline. We should have a target price and a range around that price that triggers the appropriate action if exceeded.

And we should avoid re-inflating. The housing bubble was caused by Fed-created inflation.

This approach would, unfortunately, not require any wasteful new spending or bailing out any doofusses.

Tim December 17, 2008 at 11:53 am

//And we should avoid re-inflating. The housing bubble was caused by Fed-created inflation.//

//having the Fed create new dollars//

??

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