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David Romer: Short-Run Fluctuations

I Debated Alan Reynolds on Fiscal Policy at K-State in Manhattan Last Night...

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Three things struck me of especial note last night:

  • First, Reynolds's willingness to throw George W. Bush completely over the side--not even any of Nooners's "he was incompetent, and flawed, and a failure, but he was a regular guy--not somebody who thought he was smarter than you--and in a way we miss him". None of that.

  • Second, Reynolds's praise for Bill Clinton--twelve years after Clinton left office. I now look forward to hearing Alan Reynolds praise Barack Obama for his attempts to start reining-in Medicare spending via the ACA and the IPAB come... 2029. But it would be nice if we could during that forward in time to the present--it would be really nice if we could have brung his praise of Clinton forward in time to 1993 when we really could have used it...

  • Third, the extent to which those who don't know IS-LM are blind persons in the country of the one-eyed. Reynolds said: "In fiscal policy the government prints bonds, in monetary policy the government--the central bank--buys bonds, if one of these is stimulative, how can the other be?" And he was genuinely puzzled.

The answer is that in expansionary fiscal policy the government prints bonds and uses them to buy stuff, and that in expansionary monetary policy the government prints money and uses it to buy bonds. If you do both together they don't cancel each other out, but rather the economy is left with (i) the government buying more stuff (and no tendency for private agents to buy less stuff out of fear of extra future taxes because there are no extra future taxes coming because there are no extra bonds left to pay off) and (ii) private agents having more money which they will tend to spend (and no tendency for spending to stay constant as people take their extra cash and hide it under the mattress because the government has already spent the money once). Expansionary fiscal policy makes it a sure thing that expansionary monetary policy is effective. Expansionary monetary policy makes it a sure thing that expansionary fiscal policy is effective by removing the channels for interest-rate and tax crowding out.

It's not possible to get confused if you have the IS-LM diagram in front of you…


Slides (which we did not use):

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