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Ask Not What Your Government can do for You: Macro Policy in the Current Environment. Rik Hafer Distinguished Research Professor Southern Illinois University Edwardsville February 3,2012. Prologue. What are your objectives in classroom? What is the “take away”?

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ask not what your government can do for you macro policy in the current environment

Ask Not What Your Government can do for You: Macro Policy in the Current Environment

Rik Hafer

Distinguished Research Professor

Southern Illinois University Edwardsville

February 3,2012

prologue
Prologue
  • What are your objectives in classroom?
  • What is the “take away”?
  • Plug-and-chug vs. Policy debate
a story about fiscal policy
A story about fiscal policy…
  • How has the conventional wisdom of fiscal policy changed?
  • Does reality match what we teach?
conventional wisdom pre 1970
Conventional wisdom, pre-1970

“But quibbles about exact timing aside, the potency of fiscal policy…has been demonstrated time and again in the past couple of decades.”

Walter Heller (1969)

  • A caricature
  • Fiscal policy as a stabilization tool
    • Change G, change T and change Y
the monetary vs fiscal policy debate
The Monetary vs. fiscal policy debate
  • St. Louis position
    • Fiscal policy affects economy
      • Transitory
    • Monetary policy affects economy
      • Lasting effects on nominal GDP and inflation
  • Fiscal policy without monetary support?
fiscal policy fails new conventional wisdom
Fiscal policy fails: New conventional wisdom

“Dubious Keynesian Proposition #4:

Fiscal policy is a powerful tool for economic stabilization, and monetary policy is not very important.”

Mankiw (1992)

  • Political barriers
    • Inability to deal with deficits
    • Lack consensus on countercyclical policy
new role for fiscal policy
“New” role for fiscal policy?
  • Spending/tax programs affect current behavior
    • Deficits signal higher future taxes
    • Fiscal policy is complicated (Woodford, 2011)
      • Tax structure, spending, debt within dynamic time dimension
  • Set policy for medium and longer term
success of new conventional wisdom
Success of new conventional wisdom?
  • Tax policy
    • Predictable tax structure?
      • Federal income tax code: > 45,000 pages
      • Mid-1980-2001: 7,000 federal tax code changes
      • Debate over marginal rates in election
success of new conventional wisdom1
Success of new conventional wisdom?
  • Spending policy
  • Unpredictability of deficits
    • Politics?
    • Economics?
    • CBO January 2011 projections (billions)

20152020

Low $429 $429

High $969 $1,422

back to old conventional wisdom pre gr
Back to old conventional wisdom (pre-GR)?
  • Is debt sustainable?
  • Bullard’s (2012) two worlds
      • Increased deficits/debt signal expectation of stronger future growth
        • Business react and growth occurs
      • Increased deficits/debt signal expectation of weaker future growth
      • Probably in world #2
stories we tell students
Stories we tell students
  • Government spending multiplier
    • Concept or algebraic exercise?
    • Wide range of estimates
      • IMF (2009) review of studies
        • One-year spending multiplier
          • Range: -0.1 to 1.4
should we ignore deficits debt
Should we ignore deficits/debt?
  • Deficit has not crowded out private investment doesn’t meant it could not happen
    • Bond downgrades?
  • Gov’s taxing and spending choices affect us personally
  • Size of government debate
    • What is government’s role
    • Economic freedom
if not fiscal policy what
If not fiscal policy, what?
  • Monetary policy re dux
    • Zero Lower Bound (ZLB) issues
monetary policy at zlb
Monetary policy at ZLB
  • Bullard (2012)

“In reality, the Committee has been able to run an effective countercyclical monetary policy during the last three years via “unconventional” policy. In the theory, this makes fiscal stabilization policy ineffective.”

  • QE policies
    • Not limited to financial assets
    • Section 13.3 of Federal Reserve Act