What should fiscal policy look like?
Jeffrey Sachs, a liberal developmental economist wrote a post a few days ago lambasting Krugman for favoring:
“(1) The belief that multipliers on tax cuts and transfers are stable, predictable and large;
(2) The belief that America’s employment and growth problems are overwhelmingly cyclical, not structural, and therefore remediable by short-term aggregate demand management;
(3) The belief that a growing debt burden is a minor nuisance as long as the economy is in recession;
(4) The belief that for practical purposes, the most urgent need is to raise aggregate demand rather than to focus on the quality and type of public spending.”
Mark Thoma responded, writing that Krugman does think that deficits matter, his views are more subtle, and asserting that the multiplier is fairly large. But none of these things are relevant to whether Congress should engage in fiscal stimulus. Saying the multiplier is positive is saying that the central bank will not only systematically undershoot their target, but will also fail to account for the impact of federal spending in determining the supply of money. Maybe a better explanation is to point out that just like Congress, the Fed is pushed in various directions by political forces and does not have one target at a given time, and furthermore the target is not stable. So suppose the Fed is divided and incompetant, but perhaps Congress is united and has the skill to anticipate macroeconomic shocks and respond in real time.
The ideal fiscal policy would look much like the ideal monetary policy, because the goal hasn’t changed – stabilization of some nominal variable. Policy would be rule based, automatic, forward looking, have an explicit target, and automatically adjust the policy lever until it hit that target. It would be a mistake specify the size of the fiscal stimulus package, which could in retrospect be too small or too large, as we saw in 2008. Instead, fiscal stimulus would be targeted toward some specific objective, such as stabilizing NGDP or inflation.
Area specific spending takes time to haggle on and allocate, but perhaps a tax rate or a transfer could be adjusted until the variable reached its target. The policy lever would have to be forward looking and automatic to stabilize expectations. Perhaps Congress’ budget could be set by a Constitutional amendment to be determined by an NGDP futures market. If the market was too low, the deficit would be allowed to increase. If NGDP futures were too high, Congress would have to run a surplus. Presumably the entire time, the Fed would be randomly adjusting the money supply around without rhyme or reason, because any systematic action on their part would undermine Congress. If the Fed had an explicit target which was different than Congress, it would be like having a heater and an air conditioner with two seperate thermostats, each set to different temperatures. There have been historical examples of a legislature wrestling with a central bank, each having very different targets for NGDP, but it’s never a pretty outcome.
I don’t think any of the advocates of more fiscal stimulus have come within a hundred miles of this proposal (maybe some MMTers). They don’t even consider the possibility of the central bank working against Congress, let alone come up with a plan for having them work together. When fiscal stimulus is proposed, it’s inevitably linked to spending a specific amount of money on some particular project, without any connection to a macroeconomic goal. No one even considers that it could over or undershoot, or what anyone should do if that happens. Theoretically, either fiscal or monetary policy could be used to hit an NGDP target, but the monetary side is light years away in terms of thinking systematically about the problem.