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Worst-of-Both-Worlds Fiscal Policy

Fiscal Policy: Tyler Cowen Has Five Strange Propositions

I'm not sure what he is getting at here. But I do have answers:

TC: The monetary authority moves last anyway.

Yes, the central bank can neutralize any additional fiscal stimulus by raising interest rates. (It is not clear that it can undo any fiscal contraction by some combination of lowering interest rates and quantitative easing: it may be able to.) What is clear is that the U.S. Federal Reserve and the Bank of England are right now definitely not in a place where they would neutralize any additional fiscal stimulus by raising interest rates. And my bet is that the ECB is also not in such a place--although it is much harder to figure out what they think and what they will do. That the central bank moves last is important and relevant, but not determinative when you are in the neighborhood of the zero lower bound on interest rates.

TC: We don't need exotic "quantitative easing," we can simply print up more money and hand it out to consumers through a simple vouchers program, at basically zero budgetary cost.  If consumers save all that money, fiscal stimulus also won't have much of a kick.

That's why having the government hire unemployed people to do useful things and paying for it by printing up money at basically zero budgetary cost (right now) is an even better policy. Even if consumers do save all that money, fiscal stimulus on the spending side still has an impact: useful stuff gets done.

TC: The real fiscal problem is spending contraction at the state level (expanding and contracting spending are not symmetric in their effects; contracting spend hurts more than expanding spending helps).  The correct fiscal policy move would have been, and still is, to take Medicaid away from the states and make it fully federal.  This would give state budgets a huge break, and help employment, yet as a one-time change it reduces the moral hazard problems from ongoing outright grants.  Furthermore federalizing Medicaid is a good idea in its own right and it also could be a spur to make other improvements in the program.

Yes, yes, yes, yes, yes, yes, yes, yes. But I would like to attach a maintenance-of-effort requirement of some sort: states would need to raise taxes less or cut other spending less than they would have had they been kept on the hook for Medicare.

TC: Rather than just arguing about the most likely scenario, we should apply the same worst case scenario thinking that is recommended for climate change.

I don't know who this is addressed to, or even what the point is. I think that it is prudent to plan for a 20th percentile outcome--to act as if the outcome is going to be that point in the probability distribution where 20% of outcomes are even worse. After all, we can always start pumping and burning the oil again and raising interest rates if we turn out not to need so much emissions reduction or stimulative macroeconomic policy.

TC: Macroeconomics really is just a theory.  Politicians are reluctant to spend more money, in tough times, on the basis of a mere theory.  Advocates of fiscal stimulus make it sound as simple as solving an undergraduate homework problem and I think they sometimes genuinely do not realize how much the rest of the world, including politicians, views them as simply being very convinced by their own theory.  There are plenty of historical examples with confounding factors and I've linked to some of them lately.  One default hypothesis is that the ranges of fiscal policy being discussed, whether looser or tighter, aren't going to matter much one way or the other.

Marginal costs of further stimulative macro policy in the G-5 economies are very low in every model anybody has written down or spoken out to me. Marginal benefits are uncertain but might well be quite high. And Tyler says that this is an argument against more stimulative macroeconomic policies? I just don't understand. And the import of the kicker--that marginal changes in policies produce marginal changes in outcomes--I just don't understand either.