Gavyn Davies today:
Assessing the risk of a fiscal crisis | Gavyn Davies: The debate on the correct setting for fiscal policy at a time of recession is probably the oldest debate in macro-economics. One key element in the debate is the trade off between supporting output growth in the short term, versus the need to control the growth of public debt in the long term.
There are some economists who do not recognise that this trade off exists at all, because they claim that an increase in the fiscal deficit cannot impact aggregate demand, even in the short run. But this is not a view which I believe to be supported either by empirical research or by economic theory (except on some very restrictive assumptions about Ricardian Equivalence or Says Law).
I recognise that this last statement is very contentious, but it is not my subject today…
As I have said before: The models say and always have said that a debt-financed expansion of government purchases has no effect on production, income, and employment if:
bottlenecks in resource and labor markets are so severe that increases in nominal spending show up entirely as increases in prices and not at all as increases in production; or
the central bank has a nominal GDP target and takes steps to hit it, and so offsets any impact of fiscal policy on nominal spending; or
what the government buys is exactly the same as what the private sector would have bought; or
the government's debt is sufficiently risky that issuing more government debt does not reduce the average riskiness of the pool of outstanding savings vehicles; or
perhaps there are a few other edge cases we could think of if we were sufficiently ingenious, but nobody has focused on them.
If you are arguing that fiscal policy has no effect on production, employment, and income, and you are arguing within economics, you are making one of those five arguments. (2) applies to the U.S. in normal times (for example, to the U.S. under the Clinton Administration in 1993-2000). (4) applies to Greece today. (1) can apply to economies with rapidly-rising inflation rates that are in a thorough-going inflationary boom. (5) might apply anywhere--but if you make that argument, you have to specify what it is. (3) has never applied anywhere at anytime.
I think that every fair-minded person admits that (1), (2), (3), and (4) do not apply to the U.S., to Britain, or to Germany today. I think that every fair-minded person admits that the arguments for (5), whatever they might be, have not been made in a way that applies to the U.S., to Britain, or to Germany today.
Yet Gavyn Davies claims that today his view--that neither empirical research nor economic theory supports the proposition an increase in the fiscal deficit cannot impact aggregate demand--is "very contentious".
So I have a question for Gavyn Davies: what fair-minded person contends? Name one fair-minded person who contends that either economic theory or empirical research supports the proposition an increase in the fiscal deficit cannot impact aggregate demand?