The Secret Stimulus: Another fiscal failure?
By Scott Sumner
I don’t follow fiscal policy closely, because I don’t think it impacts the business cycle. But most economists disagree with me, and many are recommending fiscal stimulus. I argue that fiscal stimulus has no demand-side effects when the Fed is targeting inflation (as it is right now) and most fiscal packages actually worsen the economy’s supply side.
Since the debacle of 2013, Keynesians are reluctant to trumpet “experiments” in fiscal stimulus. But if they’ve become bashful, that’s no reason for us to avoid holding them to account. Between 2012 and 2013, the deficit declined rapidly, and then more slowly in 2014 and 2015 (as it typical of a recovery period.)
But this year something very strange has happened. The budget deficit has begun rising rapidly. Here is Politico:
The White House said Friday the federal budget deficit is expected to be $600 billion in 2016, an increase of $162 billion from last year.
This is quite bizarre. There is no cyclical explanation for this change, nor has there been any discussion in the news media of a major fiscal stimulus. Rather the media keeps talking about what’s wrong with our current “austerity”, and the need for more stimulus. The GOP Congress doesn’t want its voters to know that it is caving in to Obama. The Democrats don’t want voters to know what’s happening or else they might get nervous about calls for still bigger deficits. Keynesian economists don’t want this publicized, as their failed predictions in 2013 made them gun shy about actually putting their theories to a highly public test. So let’s call it the “secret stimulus”.
The Politico piece referred to the current fiscal year, which began in October 2015. (This Treasury report suggests the deficit was already increasing in the final three months of last year.) If someone has any more information on when the deficit began ballooning, please let me know.
Now let’s look at how all this fiscal stimulus has impacted growth:
Notice that growth in the first three quarters of fiscal 2016 has slowed sharply, averaging about 1% at an annual rate.
Back in 2013, growth actually sped up after an austerity package was introduced on January 1st. This time, growth has slowed down as fiscal stimulus has picked up steam. In both cases the explanation is the same. In 2013, growth sped up because monetary stimulus more than offset fiscal austerity. Over the past 9 months, growth has slowed because monetary tightening has more than offset fiscal stimulus. Note that growth has not slowed in the eurozone, because the ECB is not currently trying to tighten policy.
PS. Of course NGDP is a better test of demand-side policies, but NGDP growth has also slowed in recent quarters.
PPS. Tyler Cowen has a post on a related topic. Tyler also has a post on Brexit, which indirectly addresses a point I keep making, the cyclical economic effect of “Brexit uncertainty” is very different from (and probably less than) the impact of Brexit itself.
PPPS. You might wonder why these failed experiments have no impact on economists’ confidence in the effectiveness of fiscal stimulus. So do I.