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links for 2009-08-13

Fiscal Stimulus: Not the "Keynesian" View--the Evidence-Based View

I hear--too often these days--people saying: "well, but fiscal policy only works if you take the Keynesian view." But it's not the Keynesian view: it's the evidence-based view. And it's the monetarist view too--although in the monetarist view the explanation is a little roundabout: fiscal policy by increasing the amount of government debt outstanding raises interest rates which increases the money multiplier and thus the money stock (as banks take advantage of higher yields by stretching their reserves further to cover more deposits) and further increases the velocity of money (as households and businesses find it more expensive in foregone interest to keep their wealth in cash, and so try to spend their cash more rapidly). Nevertheless, when you do the math the effects of expansionary fiscal policy through the monetarist bond-supplies-and-interest-rates-and-money-multiplier-and-money-velocity channel is exactly the same as the effects of expansionary monetary policy through the national-income-accounting-income-expenditure channel. (Walras's law, you know: that in fact was one of the major points of Hicks (1937).)

Here's Christina Romer http://www.whitehouse.gov/assets/documents/DCEconClub.pdf with evidence on the current episode:

The Argument from the Consensus of Other Countries:

Virtually every major country has enacted fiscal expansions during the current crisis. They have done so... because it works:

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The Argument from the Second Derivative of Production and Employment:

The rise in GDP growth from the first quarter to the second was the largest in almost a decade, and the second largest in the past quarter century:

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The Argument from Forecasters' Models:

analysts estimate that fiscal stimulus added between 2 and 3 percentage points to real GDP growth in the second quarter:

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The Argument from Cross-Country Comparisons:

[W]e started with a set of forecasts of growth in the second quarter of this year that were made last November – after the crisis had hit, but before countries had formulated their policy response. We then collected analysts’ recent best guesses for what second-quarter growth will be in those countries. This figure shows the relationship between how countries’ second-quarter growth prospects have changed from what was expected back in November, and the countries’ discretionary fiscal stimulus in 2009:

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The Argument from Looking Across States:

States that received more funds lost fewer jobs:

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On the theoretical side, it is very hard to build a model in which fiscal expansion has no effect on nominal income. You need (a) infinite-horizon rational households without liquidity constraints, (b) no distributional effects, and (c) government purchases providing utility in a manner that is a perfect substitute for private consumption spending. Otherwise it just doesn't go through.

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