The always-energetic, pessimistic, and--unfortunately--nearly always correct Paul Krugman:
Times Like This Are Different: As Portes emphasizes, back in 2010, as advanced economies “pivoted” to austerity despite protests from yours truly and others, there were really not two but three positions…. It wasn’t just a contrast between the wishful thinking of the expansionary austerity types and those who didn’t buy it. There was also a distinction between those who… concluded that fiscal contraction would have only modest contractionary effects, and those… who argued that historical experience from countries that were not up against the zero lower bound, had flexible exchange rates, and were pursuing austerity amidst a strong global economy was likely to greatly understate the effects of austerity in the current environment. Our position was, if you like, that times like this are different….
Wren-Lewis points out this was… giving theory priority over evidence… some form of IS-LM… was consistent with the evidence. I don’t think any of us would have gone with the theory if budget deficits had in fact caused interest rates to soar in 2009-2010, or if expansion of the monetary base had caused an inflationary explosion. But the analytical framework was essential to the conclusion that the experience of countries not in a liquidity trap was a poor guide to what would happen under current conditions….
[T]he vindication of this position is also a vindication for… Keynes/Hicks… which… yield[s] crucial insights that naive empiricism would miss…
The elephant-memoried Jonathan Portes, who has been waiting for this:
More on multipliers: why does it matter?: [I]n mid-2010 the international economic policymaking community, led by the IMF, and very much influenced by the new Coalition governnment in the UK, executed what became known as the "pivot" to fiscal consolidation…. [T]he question was how quickly, and what the damage, if any, to growth would be…. On this question, broadly, there were three camps…. [A] small group… argued… that fiscal consolidation wouldn't reduce growth… "expansionary fiscal contraction"… Alesina and Ardagna… quickly picked up on by those politicians who wanted aggressive deficit cuts, in both the UK and EU…. [W]hile this view was never very credible economically, it certainly influenced policy.
The second view… was that the negative impact of fiscal consolidation on growth would be significant, but not disastrous…. estimates were based on historical experience over the last three decades….
There was, however, a third view… that the experience of the last three decades (except, perhaps, in Japan) was not relevant to that of a world where monetary policy was limited by the zero lower bound…. In such a world, multipliers would be significantly higher, and almost certainly greater than one….
So what then is the significance of the IMF analysis published this week? For reference, I will repeat the key paragraph:
In line with these assumptions, earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009. If the multipliers underlying the growth forecasts were about 0.5, as this informal evidence suggests, our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession. This finding is consistent with research suggesting that in today’s environment of substantial economic slack, monetary policy constrained by the zero lower bound, and synchronized fiscal adjustment across numerous economies, multipliers may be well above 1…
large enough to have a very substantial, and negative, impact on growth….
[T]he Fund has now accepted that the balance of the argument, both theoretical and empirical, has tilted decisively in favour of the third group…. [H]ow should this affect policy? In the UK… [i]f… multipliers were in fact much higher, then fiscal consolidation is indeed the main reason for weak growth…. [T]he second… the OBR's position is no longer tenable. If it wants to retain its credibility as an economic forecaster independent of government, it needs to examine its assumptions and methodology….
[F]ar more important… are the implication for the eurozone…. [I]n Spain and Italy, trying to hit arbitrary short-run deficit targets, as proposed by the European Commission, is likely if anything to be counterproductive to the objective of long-run sustainability….
The IMF clearly now agrees with this, as Christine Lagarde has made clear in the case of Greece. They need now to point out to the European Commission and the German government as forcefully as possible that if they do not belatedly come to their senses, they will run the economies of Southern Europe - and possibly the euro itself - into the ground on the basis of an economic analysis that has now been discredited both theoretically and empirically…
And the theory-knowing Simon Wren-Lewis:
Multipliers: using theory and evidence in macroeconomics: [I]t was not because we had undertaken a superior analysis of the empirical evidence. Instead we were thinking about basic macroeconomic theory… a world where nominal interest rates were… [at] the Zero Lower Bound (ZLB)… is very different to a world where monetary policy is unconstrained…. With fixed real interest rates the starting point for the government spending multiplier in New Keynesian theory is one, and most elaborations make it larger than one…. It would be overstating things to say that the IMF's analysis proves this theory is correct. It is just not detailed enough to be a very good test…. However New Keynesian theory does suggest that multipliers can be large, and the IMF analysis suggests they have been large.
Those of us who got it right may therefore have simply had the insight to use standard theory. Those that used multipliers of around a half… discount[ed] this theory, and… [used] evidence that was not applicable at fixed nominal interest rates….
[This is] an occasion where thinking about macroeconomic theory can be rather more useful than naively following the evidence of the past.