The Keynesian information bubble
By Scott Sumner
Paul Krugman likes to brag that he doesn’t read conservative bloggers, as they have nothing useful to say. And certainly the world is full of conservatives making sloppy arguments. But the downside of that strategy is that when he makes silly mistakes, he never finds out about them. So Krugman keeps repeating them over and over again. His friends certainly aren’t going to tell him; they often get their ideas from him, and make the same mistakes.
Over the past few years he has repeatedly cited a cross sectional study using eurozone countries as evidence for a positive fiscal multiplier. Here he goes again:
Second, while there have been a number of studies using various approaches to estimate the impact of fiscal policy in a depressed economy, I think the really decisive evidence comes from differential austerity in Europe. Here’s a crude picture, simply comparing the change in IMF estimates of the cyclically adjusted budget balance with growth from 2009 to 2013:
You can try to explain this correlation away — but it’s a steep climb. The prima facie evidence is that austerity is contractionary, with a multiplier more than 1.
This is nonsense, as all 11 of the countries are within the eurozone. It would be like arguing that fiscal stimulus works by looking at the effects of government spending in individual states in the US—in other words it completely ignores the issue of monetary offset. I’ve pointed this out every time he cites this meaningless regression, as have numerous other bloggers that he doesn’t read.
Commenter Mark Sadowski did the correct regression and discussed the results in the comment section of an earlier post:
In this particular case Krugman uses the change in the cyclically adjusted balance (CAB) from the IMF World Economic Outlook as his measure of fiscal policy stance, and the change in RGDP between calendar years 2009 and 2013. There are 11 countries in his graph, and every single one of them is from the Euro Area. . . .
There are 35 countries in the IMF Advanced Country group of which there are CAB estimates for 33. Sixteen of those are Euro Area members. Of the remaining 17, all have monetary policies independent from each other except Hong Kong which is pegged to the US dollar. Removing Hong Kong leaves 16 nations in the non-Euro Area group.
Yes, regressing RGDP growth on CAB change for the Euro Area we find that the R-squared value is 74.1% and the slope coefficient (essentially the fiscal multiplier) is 1.49 and it is statistically significant at the 1% level. So spending less in Fargo, North Dakota lowers GDP in Fargo, North Dakota.
But, regressing RGDP growth on CAB change for the non-Euro Area countries, we find the R-squared value is 0.0% (you can’t make this stuff up) with a slope coefficient of 0.05 and a p-value of 94.0%. The p-value means that if the null hypothesis of a zero slope coefficient is true, there is a 94.0% probability of the test statistic being further away from zero than it is.
Or, in plain English, when countries each have a unique monetary policy, THE FISCAL MULTIPLIER IS ZERO!
And it’s even worse. Krugman claims the fiscal multiplier model applies when a country is at the zero bound. But the eurozone was not even at the zero bound for the vast majority of the period being studied. Indeed the ECB tightened monetary policy sharply in 2011, driving the eurozone into a double-dip recession. The US did as much fiscal austerity, or more, and avoided a double-dip recession because it had a less contractionary monetary policy.
The Keynesian information bubble is becoming increasingly obvious over time. Driving home from work the other day I heard NPR declare that GDP growth had slowed in 2013 as compared to 2012, due to fiscal austerity. Actually GDP increased faster in 2013 than 2012. But if you take it as a matter of faith that fiscal stimulus works, I guess the next step is to start rewriting history.