Blogging Billiards: A Fiscal Policy Trick Shot?
By Bryan Caplan
Two weeks ago I emailed Mankiw a question about fiscal policy, referencing one of my previous posts.
Mankiw replied (June 7).
Then Brad DeLong responded to Mankiw (on June 15, updated June 17).
DeLong’s post in turn apparently provoked a note from Paul Krugman, which DeLong posted (June 17).
Email from me provokes a response from Krugman via DeLong via Mankiw… that’s what I call a blogging trick shot!
DeLong/Krugman interestingly agree with my conclusion that fiscal policy has no effect on nominal GDP, but our suggested mechanisms are very different.
My guess is that fiscal expansions have roughly zero effect as long as the Fed raises interest rates enough to keep the money supply from expanding.
The DeLong/Krugman view is that, at least these days, fiscal expansions have roughly zero effect because the Fed raises interest rates MORE than enough to keep the money supply from expanding in response. In other words, fiscal expansions now provoke monetary contractions.
Who’s right? Most of the evidence that DeLong/Krugman could marshall for their view also fits mine. If the Fed wants to make inflation 2%, then DeLong/Krugman predict that the Fed will respond to fiscal expansions with higher interest rates. Given an inflation target, that’s my prediction, too. Admittedly, DeLong/Krugman predict that the Fed has to contract the money supply relative to its previously intended path, while I just predict that the Fed has to keep the money supply from increasing relative to its previously intended path. But it’s hard to know what the Fed’s intended path for the money supply was. We never see what the Fed would have done if fiscal policy had been different.
The simplest way I can think of to race these two theories of fiscal impotence is to look at the impact of fiscal policy on nominal GDP when the central bank is run by dogmatic monetarists. I say fiscal policy won’t matter; DeLong/Krugman say it will. But alas, dogmatic monetatists in positions of power have always been very scarce, and as far as I’ve heard are now virtually non-existent.
Other ideas for how to settle this dispute?