I’d meant to draw your attention to this yesterday. Greg Mankiw and Matthew Weinzierl have written an article (PDF) on the optimal monetary and fiscal policy responses to a decline in aggregate demand. It’s not for the casual reader or the math-phobic although the introduction and conclusion are reasonably accessible to a moderately well-informed reader. Let’s jump straight to the conclusion.
Drs. Mankiw and Weinzierl propose the following hierarchy of policy responses:
- When you can utilize conventional monetary policy, do that first. You can no longer utilize conventional monetary policy once short term interest rates are at or near zero.
- When you can no longer utilize convention monetary policy, utilize non-conventional monetary policy. In this context “non-conventional monetary policy” means cutting long term interest rates which the authors assert is effectively targeting a higher rate of nominal GDP growth.
- When monetary policy is constrained, i.e. by short term interest rates already being at or near zero and the central bank being unable for whatever reason to commit to future monetary policy actions, apply fiscal policy to incentivize investment and other components that are sensitive to interest rates.
- Conventional pump-priming fiscal stimulus, e.g. targeted tax cuts, government spending.
In this context “optimal” means that any other strategy will realize poorer results.
It’s an interesting paper. The question that comes to mind for me is just how sub-optimal has policy been to date?
Scary thought…we have been using the optimal policies and this is what we’ve got.
That thought occurred to me, too, Steve.
At this point there aren’t any really good policy options left. The downside risk for just about anything outweighs the upside gain.
I don’t suppose we could take an obvious policy stance: get the government the hell out of the way. Nah. Not sexy enough, and no control, and at odds with 70 years of Democrat orthodoxy.
I honestly don’t see our problems as being solvable within the constraints of party politics. Democrats have taken a stand that entitlements won’t be cut and we’ll continue an interventionist foreign policy, Republicans have taken a stand that taxes should be cut further, we’ll continue an interventionist foreign policy, the DoD shouldn’t be touched, and they’ve stood up in support of Social Security and Medicare as well.
If we were to cut everything but the DoD and interest on the debt, we’d still be spending more than we’re taking in. If we were to cut everything but Social Security, Medicare, and interest on the debt, we’d still be spending more than we’re taking in. It’s not a pretty picture.
I don’t know if Dave’s last remark was directed at me or not. But I would observe: I’m certainly no Party Politics guy. I get b-slapped for being to libertarian. B-slapped for being too conservative Republican.
My philosophy is actually pretty simple: government has certain roles and functions in a modern society that cannot be denied. Defense on behalf of the whole. Perhaps – selectively – as a suerpower to nudge or intervene in world events. Projects (like roads and the water works) that are too big for private enterprise. (But that assumption is being constantly eroded; private enterprise can do much more than in 1935) And some sort of safety net for those who are visited by catastrophic loss, mental or other catastrophic health issues (code for they go crazy), temporary job dislocation, and such. Debatable, but perhaps in the same vein, a universal pension system.
But that’s it. And the notion that its legitimate functions should consume more than 15% of GDP I find ludicrous on their face. Yet we are far above that, with many whining for more.
As I noted a day or two ago, I don’t know many pols who run on a platform of “I’m going to Washington to sit on my arse.” So the inherent gravitational potential if you will is for growth in government for every little gd grievance any ninny has.
Alas. You have to finance it. And so they exhausted the tax avenue. And they are about to exhaust the borrowing avenue. Now what?
“But that’s it. And the notion that its legitimate functions should consume more than 15% of GDP I find ludicrous on their face. ”
Find me a livable first world country that devotes that amount of GDP to govt.
Steve
Drew,
OK, we’re the best of a bad bunch, but with interest rates where they are, what’s the hard evidence that we’re about to exhaust the borrowing avenue? Can you cite a bond auction that didn’t have a solid cover?
In reading the shortened version of the policy responses above, my mind wondered to this List of Demands as proposed for by the ‘Occupy Wall Street Movement’.
Is it just me or does this list seem juvenile? While serious people may be mulling over serious ways of addressing our ebbing economy, this is what the ‘street’ is calling for in a temper tantrum type of way….
Dave,
Having looked at the paper, I have to ask whether you believe the equations, or are they mental masturbation?
From the way I asked the question, you can tell what my answer is.
Anyone who’s worked in the markets knows the importance of consumer and business psychology (=confidence). When the equations can deal with “is it half full or half empty” I’ll start to pay attention to them.
Marc, I think that there are two distinct questions in considering the use of mathematical notation in economics papers. First, does the notation accurately express what the author is trying to say? Second, does what the author is trying to say comport with reality?
I’m pretty confident that in this case the answer to the first question is yes but I’m not really sure about the answer to the second question. IMO putting assertions about the economy into mathematical notation is an exercise a lot like sudoku or decoding a rebus. The truth of the propositions can only be determined empirically and it appears to me that many economists are like Greek philosophers, disdaining data collection and analysis as beneath their dignity.
It does impress the natives, though.
There is a policy option that isn’t even on the list, does not cost any serious money to implement, and continually astonishes me that we haven’t turned to it, deregulation. In its simplest form, there is a store owner who has a demand for a larger sign. He has the money, the desire, and supply is available. The demand does not express itself in the local economy because the local sign ordnance does not permit the sign. It is too large, the wrong shape, too gaudy, whatever. Remove the ordnance, or suspend its function until unemployment drops below 5% and the demand will express itself in the economy. Multiply this by volumes of regulations limiting demand expression across several layers of government and you have a fairly strong policy tool that is just sitting there waiting to be used. One is never too broke to be deregulated and the US is certainly not out of deregulatory bullets.
So why wasn’t this policy included as an option?
TMLutas,
Most of the regulation you describe happens at the state and local level. Therefore, there isn’t any way to centralize deregulation.
steve,
Costa Rica and Singapore come to mind.
Are you including the forced savings for retirement in Singapore? Not sure that a country which is really just one big city can be extrapolated to the rest of the world. Will look at Costa Rica.
Steve
steve,
I just looked at countries with Gov Spending/GDP ratios close to what the 15% mark and looked at the one’s I’d be ok living in. Those two popped out. Singapore is a bit draconian, to say the least, on the civil liberties side, so I’d probably go with Costa Rica.
As for the math in the paper its baby stuff, IMO. First year micro level stuff. As for incorporating beliefs that can be done via probabilities and expectations and using Bayesian methods. It would complicate the math, but might add something interesting in that you could try different beliefs and see how they impact the outcomes.