PAUL KRUGMAN: Fiscal Policy Works

December 24, 2011, 9:15 AM
Via Brad DeLong, there’s a paper by David Romer (pdf) summarizing recent research on fiscal policy, inspired by the crisis and aftermath. And his conclusion is not at all what you hear on the talk shows; it is that there is now overwhelming evidence that fiscal policy does in fact work when it’s not offset by monetary policy. And since we’re now in a liquidity trap in which conventional monetary policy has no traction, that’s the world we’re in.
I like this footnote, which gives you a sense of what has been going on:
3 For within-country evidence, see Chodorow-Reich, Feiveson, Liscow, and Woolston (2010); Suárez Serrato and Wingender (2010); Shoag (2010); Fishback and Kachanovskaya (2010); and Nakamura and Steinsson (2011). For cross-country evidence, see International Monetary Fund (2010); Council of Economic Advisers (2009); and Kraay (2010). For time-series evidence (as well as simulation-based evidence), see Hall (2009); Barro and Redlick (2010); Fisher and Peters (2009); Coenen et al. (2010); and Christiano, Eichenbaum, and Rebelo (2010). On this list, all but Kraay, Barro and Redlick, and Fisher and Peters implicitly or explicitly try to provide evidence about the case where monetary policy does not act to offset the effects of fiscal policy. With the exception of two of these three (Kraay and Barro and Redlick), the papers all suggest substantial effects of fiscal policy. As I describe below, this brief tour omits all work that predates the crisis.
Of course, all you’ll hear on TV is nyah-nyah-nyah the Obama stimulus didn’t work.


Share your thoughts.
    • Alexander
    • California
    Intentionally OT:

    Paul, I just want to give you a big THANK YOU for everything you do, especially this blog, and wish you a great holiday season!

    99% of your readers are bound to concur.
      • Ron
      • New York, NY
      I'm sure for every article cited there is an article that is a complete refutation of your thesis. But why bother showing at least a tiny modicum of balance in your analysis.
        • Greg Esres
        • Memphis, TN
        "Of course, all you’ll hear on TV is nyah-nyah-nyah the Obama stimulus didn’t work."

        This is a problem with how human beings interpret cause and effect; when we take action and produce what we think is a cause, the baseline we use to judge an effect is the the status quo at the time we generate the cause. In reality, we need to judge the effect with respect to what the status quo *would have been* had we not taken action. This projection into the future often requires a fair amount of intellectual discipline that most people don't have, or at least don't intuitively use.
          • beezer8
          • New Hampshire
          When credit growth stops and goes into reverse, no amount of liquidity is going to make a great deal of difference.

          It's then that hiring directly becomes the most effective tool in the government bag. This provides income growth, given that the government pays libable wages and benefits, which first repairs debtor balance sheets, which next repairs Main Street businesses and professionals who depend upon the initial income growth. Which finally, and in the longterm critically important, repairs long neglected, economic enhancing, infrastructure.

          And somwhere along the way, just like magic, credit growth resumes albeit at more sane levels than those which built the bubble. And that growth, my friends, is where wealth is produced.
            • sl
            • florida
            Yes, it worked, in the sense that we borrowed money to stimulate the economy now, in exchange for having it contract in the near future.
              • h4x354x0r
              • Columbia MO
              The liquidity trap, which is partly a facet of income inequality (or vice versa), DOES render stimulus less effective. By the numbers, stimulus is only 1/3rd as effective today as it was 30 years ago, simply because the wealthiest capture the stimulus money and take it back out of the economy so quickly, it doesn't get a chance to be effective.
                • Stephen
                • Long Branch, NJ
                I'm kind of appalled to think that such a view-from-space level review as D. Romer's was given to a specialist audience. It suggests a field where practitioners fear that everything they've ever done is irrelevant.

                In partial support: "The workhorse new Keynesian dynamic stochastic general equilibrium (DSGE) models on which macroeconomists were concentrating so much of their attention have been of minimal value..."
                1. Romer: "the culture of central banking makes it much easier to take unusual steps when the financial system is at risk than when the threat is “merely” one of years of exceptionally high unemployment."

                  Yes. And financial incentives matter.

                  Especially when they run to, say, a quarter of a trillion dollars a year:

                  250 Billion Reasons Why the Fed Hates Inflation (and Doesn't Care About Employment)
                    • Adam Smith
                    • NY
                    Dr. Krugman

                    As I wrote here 18 months ago, this is not about economic nor is about policy, it is rather about politics that the GOP want to make sure that President Obama fails no matter the cost....

                    They fought the mid-term election on Jobs and a year later they have not made even one Jobs bill in the Congress....

                    Now that the economy seems to be dragging itself from the GOP sponsored blackhole and their candidates show why none of them is fit to hold Office, the flood of sabotage will hit the US policy in all fronts in 2012 now that the President's approval rating is on the mend.....

                    Get ready for more nonesensical political trashing/bashing in the New Year.
                    1. Well, of course - that's because academics are a bunch of liberals who are part of a grand conspiracy to take away our Christianity and our freedoms. At least, that's how a Glenn Beck aficionado would read this kind of thing.
                        • taopraxis
                        • nyc
                        There is much talk around these parts about forgotten economics. Unfortunately, such talk often reveals a basic lack of understanding of human nature.
                        Words do not persuade. Evidence does not persuade. Data does not persuade. Logic does not persuade. Science does not persuade.
                        People interact with their environment, gravitating toward positions based upon a complex chain of interactions or series of associative learning experiences that create a visceral or *emotional* attachment to this or that group or position such that a particular viewpoint comes to *feel* right.
                        Then, so-called higher reasoning capabilities are employed in order to find evidence for these preconceptions and inculcated preferences. People are seekers and what they seek,, for the most part, is self-justification, i.e., to validate their own world view/identity.
                        For most people, any level of evidence will do. If such evidence is not available, they will ignore all of the contradictions, seek others who are sympathetic to their views and join them.
                        Almost all people do this, not just the ones who disagree with you.
                        Words are like pebbles tossed into a still pool.
                        Little splashes...then, nothing.
                          • supplydemander
                          • Denver, CO
                          The "nyah, nyah" argument, is pithy. So is "moar stimulus = moar debt = bad!" So a simpler version of 'within-country cross-country time-series evidence shows fiscal policy works' would be useful. I was thinking maybe a health analogy... when a patient is bleeding inside, doctors cut 'em open to stop the bleeding. Sure the cutting causes pain and bleeding, but it is good treatment. So aggressive fiscal policy = "sewing up a bleeding economy".
                          1. to Nile & dwb: Why not bother to read and comment on the evidence Krugman sets before you? Instead of only popping off. Even I can do that; watch: "Depends on what you mean by 'poor execution.' Surprising plentiful world supply that derives down prices (as we want) of a product that American oil/gas-bludgeoned companies/investors still dumbly take to be unwanted anywhere doesn't mean 'poor execution'." As has been noted, Solyndra's executed product is in fact superior. At least deb remarks more intelligently. But, he neither comments on the evidence Krugman has only written to cadge one to go read. So, guys, do ALL these people need calculators? (That's a lot of dumb folks!) I think the overwhelmingly important phrase in Krugman's invitation to read is rather: 'overwhelming evidence'. Both of you brush it all aside as if it were small hill of packaging "peanuts."
                              • RM
                              • Ohio
                              It's hard to imagine that anyone would believe that a targeted fiscal policy doesn't work, but, as we know, these people exist. I would like to take this opportunity to wish you and your family the Happiest of Holidays and to thank you for your insight and your ability to communicate it so well during the past year.
                                • Robert Fox
                                • NJ
                                My ignorant question is: Isn't there at least ONE organized Society of economists that has enough consensus and insight to make an eye-catching public statement to the point you are making Dr. Krugman? ?????????????????
                                  • Rob
                                  • Las Vegas
                                  Of course fiscal policy works in the short term to boost economic growth. But to ask if fiscal policy works is not asking the right question. The question is whether the government can continue to run these record deficits without collapsing under the weight they induce. Krugman and his ilk never want to mention what happens when the music stops and there are not enough chairs to go around.

                                  A recent example would be the payroll tax extension, which is a good idea in this economy to help out middle income workers. But every dollar paid out now in cuts must be made up in future years. There really is no free lunch. It would be refreshing if these self-anointed Keynesians would present full solutions showing how we regain prosperity AND get rid of the deficit ($15,150,000,000,000 and rocketing higher).
                                    • SW
                                    • CO, USA
                                    Maybe it would be a good idea to read them?
                                      • samos2
                                      • Portland, OR
                                      The difference between your efforts and your correct-minded colleagues, vs. Keynes, is that the Classical economists actually believed their point of view. It seems that in this current environment, the political element--the Right (What a misnomer!!!)--is the driving force. It is their ideology that drives those who support them to fabricate facts, deceptively cherry-pick the data to reinforce their point, . . . , that makes rational discourse useless. The only hope is to sweep these politicians from office in order to give Obama an opportunity to actually help the 99.5% (Yes even the top 5%. I haven't performed calculations but it seems that if the economy gets back on its feet everyone is better off--more people buying more goods and services should lead to better profits, more investment, more employment, . . . )

                                      By the way, wishing you and Robin Wells a Merry Christmas and a most prosperous 2012!!! (Thank you for being an on-going voice of reason in this world of deceptive political maneuvering by the Right.)
                                        • SW
                                        • CO, USA
                                        Take a step back and look at the big picture. We had a major economic crisis caused in large measure by the implementation of the ideology of one of the major political parties in this country. The only real solution to this crisis is major government intervention which just like the last time a similar thing happened would almost certainly lead to the sense on the part of a large fraction of the population that the government, had actually helped them. In a desperate attempt to salvage their ideology, the primary goal of one of the major political parties became not finding a way to help the country recover but doing everything they could to prevent these policies from being enacted or if enacted from being effective. The preservation of this ideology being to these people far more important than the well being of the country. Now perhaps they have convinced themselves that their ideology is so important, that it is so fundamental to the country that its demise would constitute something worse than the suffering caused by economic collapse. You can rationalize pretty much anything when your world view is on the line. But the most charitable case you can make is that they have decided to use lies and disinformation in order to prevent policies from being enacted that they must understand would lead to at least short and mid term benefits. It is hard to avoid the conclusion that it is these benefits that they fear the most.
                                          • R. Law
                                          • Florida
                                          All those people are probably using models based on data and empirics, Dr. K. - the radical rightists have no use for reality-based policy driven by results, because the facts are always so darn liberal.

                                          Therefore, they opt to re-create the convenient Richistan bubble and pretend it is reality - this is the reason talking points are necessary (to keep up the illusion as well as continue the self-deceptions) and it all becomes manifest most clearly when their pretend reality bubble policies take us to war(s) we should not be in, allow Wall Street finagling to drag the global finance system over a cliff, produce the array of Romney and the 7 dwarfs to be GOP candidates for POTUS, and even go so far that the GOP'ers want to vote against a payroll tax-cut for 160 million voters at Christmas-time 10 days before the first presidential primary.

                                          The GOP'ers (self) deception apparently knows no limits and they are blinded to its effects, so we have to be doubly vigilant in calling out the cornucopia of stupidities.

                                          Other than that, Merry Christmas, Happy Hannukah and Happy Festivus to us all; each and every one !
                                          1. It's interesting to me that with all the historical evidence, so many talking heads are willing to ignore the fact that fiscal policy does in fact work. Doesn't anyone read history any more? It's probably simpler to spout off on one's beliefs without bothering to study the issue. It's definitely easier to reach a conclusion without doing the background work. You know, "This is what I think is true, so why bother to do the research?"
                                            1. Everyone knows the stimulus had an impact, but not as much as the Administration thought it would. The job of the irresponsible members of the opposition is to oppose.

                                              The job of Limbaugh is to mobilize the Republican low-income, middle income red base who are being totally neglected by this Administration when Limbaugh doesn't want to say that the Administration is headed by, in the words of Krugman, Herbert Hoover. Naturally base mobilizers distort the opposition.

                                              An effective political argument uses Republican heroes. Eisenhower had a road stimulus as we cut down military spending after the Korean War. Reagan had the best Keynesian policy in this century in first ending inflation and then using both taxes and a job (naval construction) program to stimulate after he created a recession. He then raised taxes and lowered defense expenditures in his second term. Bush II had a great Keynesian program until around 2003 or 2004.

                                              Sometimes this blog deteriorates into a Krugman-Limbaugh "debate" with both dedicated to mobilizing the base with emotion and distortions. If the economy is growing at 4 percent in October, the base doesn't need to be mobilized. If Europe, China, and our economy are half as bad as Krugman (and me) expect, nothing will save Obama. A Nobel Prize winner should be talking in a more non-partisan manner to the more responsible figures who will be in charge of economic policy for what is likely to be eight years.
                                                • h4x354x0r
                                                • Columbia MO
                                                The liquidity trap, which is partly a facet of income inequality (or vice versa), DOES render stimulus less effective. By the numbers, stimulus is only 1/3rd as effective today as it was 30 years ago, simply because the wealthiest capture the stimulus money and take it back out of the economy so quickly, it doesn't get a chance to be effective.
                                                  • David
                                                  • Oklahoma
                                                  I think you will be proven the long run. :)
                                                    • drhagus
                                                    • Brooklyn, NY
                                                    It would be great to see some sort of intelligent conservative response on this blog, or elsewhere in the media universe. However, that breed of Republican seems to have been driven to extinction in recent years, and all that is left is the "common sense" types who believe what they believe and expect the rest of us to accept their point of view without question.

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