Sunday, January 01, 2012

Actually, I don't think David Romer is batty at all...

Scott Sumner thinks I am too quick to bash other people's blog posts without first doing my due diligence:
Noah Smith is a very smart guy, but he has a bad habit of jumping into disputes without first discovering what the other side is actually saying.  Indeed he recently admitted this after DeLong pointed out that his criticism of Robert Lucas was inaccurate.
Guilty as charged (though readers should note that said mistake was more of an attempt to defend Lucas than criticize him). The blogosphere is a place where we discuss very high-level ideas in very glib sentences, and whenever high-level ideas are discussed in very glib sentences, there will be a tendency to misinterpret people's claims. So a lot of these arguments are really just people talking past each other, which is kind of a waste of time. Like most econ bloggers, I engage in that sort of thing more than I should.

Sumner, who is an even smarter guy than I am, believes I have made another such error in this post of mine. He writes:
In his long post he spends a lot of time setting up foolish arguments that he imagines I might make, and then shoots them down.  Unfortunately for him, I don’t actually make those foolish arguments.
Well, perhaps I did. Let's see what I said in my earlier post. I was responding to this quote of Sumner's:
Keynesian economists have never been able to accept my assertion that the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy.
Now, I do admit that this sentence could mean several things! Let's consider three claims that could be represented by this statement:

Possible Claim 1: Because monetary policy can act in opposition to fiscal policy, the effect of fiscal stimulus depends crucially on how the Fed reacts to a stimulus.

Possible Claim 2: The data show that, in practice, the Fed does act to negate the effects of fiscal stimulus.

Possible Claim 3: Because the Fed can, in theory, counteract any fiscal stimulus, the effect of any fiscal policy on output should be considered to be zero.

So, let's look at these possible claims. Possible Claim 1 is a theoretical claim. It basically just says that monetary policy is always capable of counteracting fiscal policy. That claim is not logically inconsistent ("batty") at all. Arguable, maybe - since it depends on how effective you think monetary policy can be - but certainly not batty.

Possible Claim 2 is an empirical claim. Therefore, it can't be logically inconsistent or "batty"; only the data will tell us if it's true or not. Andy Harless and David Beckworth argued in the comment thread of my earlier post that this claim is true, and I'm certainly willing to entertain the possibility that it is true (though I must say I am skeptical).

Possible Claim 3 has two parts - a definitional part, and a theoretical part. First, it says that (3a) when we talk about the "multiplier" associated with fiscal stimulus, we should include the Fed's reaction function in the model that we use to estimate the multiplier. This is the argument made by David Romer in some remarks cited by Sumner:
As Robert Solow stresses in his remarks in this session, we should not be trying to find “the” multiplier: the effects of fiscal policy are highly regime dependent.  One critical issue is the monetary regime...if [central banks are] successful [at offsetting the effects of fiscal policy], one would expect the estimated effects of fiscal policy to be close to zero.
This is just saying that there are several ways to define "the multiplier" - you can talk about the multiplier while holding monetary policy constant, or you can talk about the multiplier in the context of a model that includes the Fed's reaction function. If we look in the data and see that a fiscal stimulus was followed by an increase in nominal output, we could say that "The stimulus increased output," or we could say that "The Fed increased output by choosing not to counteract the stimulus." To borrow an old NRA slogan, it's a question of whether guns kill people or people kill people.

BUT, aha! Possible Claim 3 also involves a theoretical claim. This is the claim that (3b) the Fed's reaction function is invariant to fiscal policy! To see why, consider a world in which the Fed targets a 3% growth rate for NGDP if there is no stimulus, but raises the growth rate target in the event of a stimulus. In this case, it would make perfect sense to say "fiscal stimulus increased NGDP growth," in the sense that we normally think of causality. It would make no sense to attribute the growth increase to the Fed. That would be like saying "You think you put butter on that piece of toast, but actually it was I who put butter on that piece of toast, since I could have clobbered you on the head and stopped you from putting butter on the toast, and I chose not to. Thus, you are incapable of buttering toast; only I can butter your toast." That would be a truly batty claim!

And it was this claim, Possible Claim 3, that I believed Sumner to be making. Which is why I said it was "batty."

Now, maybe I was wrong. Maybe I misunderstood what Sumner was trying to say when he said "the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy." When I go back and read that sentence again, it still sounds like Claim 3b, but that could be my minsinterpretation. Perhaps Sumner was only making a combination of Possible Claims 1, 2, and 3a. Perhaps he was saying that in the past, the Fed has counteracted fiscal policy, and can therefore be expected to do so again in the future, and that we should include that behavior in our definition of the "mutiplier." And if this was the totality of what he was saying, then I was indeed mistaken in bringing out Bat Boy.

But what kind of research would have allowed me to know that Sumner was not going on to assert Possible Claim 3b? I know Sumner has made Claim 2 in the past, but does that mean that that was all he was saying this time? When I read the phrase "the fiscal multiplier IS zero because the Fed STEERS the nominal economy," it sounds to me like a claim that the fiscal multiplier theoretically MUST be zero. Which would just not be true, since the Fed's reaction function might not be policy invariant.

So perhaps I was too quick to say that Sumner's claim was batty. It was simply the case that the claim I thought Sumner was making would, in fact, be batty (i.e. not logical). Perhaps I should have first asked Sumner "What exactly did that statement mean?" before assuming it meant what it sounded to me like it meant. Perhaps I was too quick to jump to conclusions, and ended up knocking down a straw man. And if so, I hereby revoke the Bat Boy from Scott Sumner and award it instead to anyone out there who does believe that the potential effectiveness of monetary policy means that fiscal policy is ineffective by definition...


  1. You omitted possible claim 4, which is how I read Sumner's statement, and adheres closely to the text without making any assumptions that I am aware of.

    Possible claim 4: The Fed is the a relevant "controlling" factor, meanwhile, fiscal stimulus is impotent.

    In fact, it strikes me that "a relevant" could be replaced by "the one and only relevant," but I lack that level of boldness.

    You approach this idea in the last sentence of the post, but seem to lack boldness as well.

    I suspect Possible claim 4 really is his intent, and he still deserves the bat.

    This suspicion does not arise in a vacuum. The words "fiscal stimulus" seem to seldom or never occur in the writings of certain economists, Sumner included, unless it is deny that it has any relevance or effectiveness.


  2. The quality of debate among economists is appalling. You all make lawyers look like paragons of principled discussion.

  3. If you read Scott's responses to my comments on his blog post, I think it's pretty clear he's not making Possible Claim 3. I rebut his claims based on arguments about the Fed's actual reaction function, and he accepts these as valid counterarguments (and then he has counterarguments of his own, which are also about the Fed's actual reaction function).

  4. @Andy:

    Well, then that's cool (and non-batty). I would just urge that people take into account the possibility that the Fed's reaction function actually depends on fiscal policy. Lucas critique, right? Papers I've read that estimate the reaction function all seem to assume that the parameters in the function are structural.

  5. @Absalon:

    True! Lamentably true. I try to be part of the solution, but that doesn't always turn out... ;)

  6. Anonymous7:32 PM

    "The blogosphere is a place where we discuss very high-level ideas in very glib sentences."

    As opposed to academic literature, where we discuss glib ideas in very high-level mathematics. Zing!

  7. Noah

    It appears to me (a lapsed physicist like yourself) that this Ricardian Equivalence debate goes to the heart of economic understanding of macro issues.

    The big boys are turning this into a contest of wills with trash talk all around. For a graduate student willing to avoid the trash talk this debate is pure opportunity. What you need to do is to be very careful with assumptions and definitions.

    Personally I suspect that Krugman is mostly right and that Cochrane and Lucas are either falling into a fallacy of composition or are so constructing their model that it has no relevance for the real world.

    As a physicist you will know that funny things happen when you go from simple systems to more complex systems - even if it is just the move from an idealized two body celestial mechanics problem to the idealized three body problem.

  8. Roger9:37 PM

    I'm simply stunned by what I can only conclude is the uselessness of the economics profession in toto. If, in a field worked in by countless scholars over centuries, it actually remains an open question whether fiscal stimulus is nullified by monetary policy (I mean this is pretty basic stuff, people), then really, what good is the economics profession?

    I hate to be so depressing about it, but the whole thing really does depress me.

    So you're a physicist, I think I read somewhere. Well these debates don't happen about KE=.5mv^2, right? Sure, they happen about what gives mass to the weak bosons, say. But not about the simple stuff! If you drop a ball, you can calculate to a dozen decimal points where and when it will fall.

    But economics still has to debate the existence of a multiplier on fiscal stimulus at such a polarized and divided level??

    Yes, yes, I know economics isn't a science (nor does it claim to be one), but if y'all can't even work out this very basic stuff, what good is the whole damn enterprise?

    It's just embarrassing.

    And the 'evidence' is all around us, in the decrepit, foreclosure wastelands that rot in our cities. We had Greenspan - the "Maestro" - lecturing us that derivatives INCREASE systemic stability, for God's sake. In what universe can a guy like that STILL be taken seriously and get to write NYT op-eds after being 100% wrong and destroying the world?

    Or, in just about any other profession, if someone were going around spouting the nonsense John Cochrane is lately (tantamount to "gravity has no effect world view says it shouldn't"), he'd be drummed out of the profession. Yet in economics, he retains his named tenured professorship.

    It really is a bad joke. The world depends on you people and this is what you give us?

    No wonder Krugman's depressed. I'm starting to understand why.

    (needless to say, none of this is directed at you, Noah. Your venue just happened to be the one I was reading when I lost it.)

  9. You're a smart guy, Noah. If Sumner can't write clearly enough to be impossible to for you misunderstand, he deserves to be slapped for it as often as possible.

    The main problem with the economics debate is that the non-Keynesians seem to be writing in some kind of weird metaphorical language: their words, they claim when challenged, don't mean what they say. And the meanings shift and evaporate when the words are placed under the limelight.

    By contrast, the Keynesians seem to use words in a more prosaic way, to convey understanding.

    So: continue to take Sumner et al. at face value. Continue to show how wrong they are. And when they complain that you have misunderstood them, respond "that's your problem. Write more clearly."

  10. I hear what you guys are saying.

    Roger I especially feel your pain...You should check out "Models Behaving Badly", by Emmanuel Derman. It's about finance, not macro, but similar complaints.

    Then again, Derman found happiness in the finance industry that he never found as a physics professor... ;)

  11. anon/portly2:14 AM

    I could be wrong, but I think the key is this:

    "[The Fed] doesn't (in its own perception or by the conventional definition) deliberately tighten to offset intentional fiscal stimulus; it merely fails to ease as aggressively as it otherwise would, so that fiscal policy is ineffective because it substitutes for monetary policy actions that would otherwise have happened."

    That is from Andy Harless's 10th comment to your last post. This is what I would interpret to be the gist of the nub of the essence of Sumner's "the fiscal multiplier is roughly zero because the Fed steers the (nominal) economy."

    And I'm really not sure about this, but isn't this idea incorporated into (or addressed by) various types of Macro models? Especially attempts to model the Fed's "reaction function?"

  12. anon/portly2:29 AM

    "To see why, consider a world in which the Fed targets a 3% growth rate for NGDP if there is no stimulus, but raises the growth rate target in the event of a stimulus. In this case, it would make perfect sense to say "fiscal stimulus increased NGDP growth," in the sense that we normally think of causality. It would make no sense to attribute the growth increase to the Fed."

    What if the Fed target was 3%, and there was fiscal stimulus that caused the NGDP growth rate to increase by 1%, and also some other positive shock that caused the NGDP growth rate to increase by 1%, and the Fed increased its target to 4%. (Not 5%, so the Fed only partially accomodates). How do you divide the responsibility now?

    Or what if the Fed targeted NGDP growth of 3%, except if there was a fiscal anti-stimulus that caused NGDP growth to decrease by 1%, the Fed raised its target to 4%. Who gets responsibility for the increase here?

    I'm not sure if I really have a point, but it seems at first glance odd to me to think that if the Fed raises its target in response to some positive shocks, but not all positive shocks, that the positive shock is the key to the increase in NGDP growth, not the change in the Fed's target. I mean, aren't there various positive and negative shocks happening all the time?

  13. There are I think both technical and political issues with Fed reaction function estimates. One is how effectively the Fed can offset fiscal policy, this gets into liquidity traps, output gaps and the like. For example Sumner consistently claims that both fiscal policy and monetary policy are equally nominal. I don't know if this is the standard economically accepted claim, but it doesn't seem necessarily right to me. If the government borrows to build a bridge in a environment with an output gap the evidence seems to be that inflation is pretty sluggish in its response in a low inflation environment. On the other hand monetary policy necessarily acts through inflation expectations.

    But the political questions are even more important, MMer's like to claim that monetary policy "acts last." Though, of course, that's a contingent claim based on congress and executive allowing them to act, and the Fed knows this and gives every evidence of knowing this in their speeches and comments. The congress is the real Chuck Norris.

  14. I'm definitely not claiming it's true by definition. By the way, there is no such thing as holding monetary policy constant. There is holding M2 constant, or holding inflation expectations constant, or holding the fed funds rate constant, or holding the monetary base constant. But there is no such thing as holding monetary policy constant, because know one knows what the hell "monetary policy" is.

  15. Noah,
    I think Scott has inadvertently just made the argument for why monetary policy can't be the right solution.

  16. Anonymous2:31 PM

    If I gave you a highly prestigious job, with good pay, the essence of which was that you must keep butter and toast separate in my house -- you would be humiliated if they came together -- and you were heavily armed and exempt from criminal penalty, while I am a wee wimp; then I don't think the claim that you are powerless to butter toast in my presence would be batty at all.

    Of course, that would be a batty set-up. Maybe so is inflation targeting.