Monetary offset: Reply to my critics
By Scott Sumner
Not surprisingly, there has been lots of criticism of my claim that the Keynesian test of 2013 failed. Let me respond to some of the points:
1. I was accused of cherry picking dates, as I compared growth in the 4 quarters before and after the onset of austerity on January 1st, 2013 (when all the tax increases kicked in–the sequester came a few months later.) Growth rose from 1.60% in 2012 to 3.13% in 2013 (Q4 to Q4.) But my critics are correct that 2012 was an unusually slow year, so maybe a longer time period would be better. Here are growth rates over:
The previous 2 years: 1.65%
The previous 3 years: 2.04%
The previous 4 years: 1.47%
The previous 5 years: 0.59%
The previous 6 years: 0.81%
The previous 7 years: 1.05%
The previous 8 years: 1.33%
The previous 10 years: 1.91%
The previous 15 years: 2.51%
All lower than in 2013. (I ignored compounding to save computational time; the actual growth rates were slightly less, strengthening my point.)
So cherry-picking data isn’t the issue. What if you go forward more than 4 quarters, say 2 years? The winter 2014 quarter was slow because of unusually bad winter; however both the spring and summer of 2014 were red hot. It looks like 2014 will also show decent growth when Q4 data comes in.
Another complaint is that the increase in growth in 2013 was not significant. There are actually two issues here, measurement error, and the problem of ceteris paribus. As far as measurement error, I’ve always acknowledged that the government probably overestimated the speed up in 2013, as other data like job creation shows a much smaller acceleration. But the point is that even the other data shows faster growth, which refutes the Keynesian prediction that growth would slow.
A better argument is that the speed up was within the normal year-to-year fluctuations reflecting all sorts of factors. To see the problem with this argument, we have to go back and look at the “test,” and consider what the Keynesians were trying to show. It might be helpful to first look at a case where the RGDP data went as the Keynesians expected, Britain after the election of the Conservatives in 2010.
The Conservatives were accused of slowing the British recovery with a policy of “austerity.” I use the scare quotes because Britain continued to run just about the largest budget deficits in the world during the early years of Cameron. But let’s accept the Keynesian method of estimating changes in cyclically-adjusted deficits. One thing I noticed is that Britain had a very odd growth slump:
1. Britain continued to generate more jobs than many other developed countries.
2. Britain experienced relatively high and rising inflation.
Now I’m not arguing that Britain had no AD problem, I think it did have one. But given the jobs growth, surely some of the British slowdown in RGDP growth was due to productivity factors unrelated to low AD. Some have pointed to less North Sea oil output and less earnings from big banks in the City. Perhaps the “big government” policies of the previous Brown government slowed trend productivity growth a little bit. I don’t claim to know all the reasons, but Britain would be a textbook case where you might want to question whether it was austerity, or some other factor that explained the RGDP growth slowdown. The ceteris paribus problem.
Nonetheless, the impression I got reading people like Paul Krugman and Simon Wren-Lewis was simply; Austerity —> RGDP slowdown, case closed.
Suppose that if instead of increasing from 1.60% to 3.13% in 2013, growth in the US had slowed by an equal amount (to near zero). Let’s be serious for a moment, and please answer this honestly. Does anyone think the Keynesians would have been saying, “Gee, that pause in the recovery can’t be attributed to austerity, because the drop in RGDP growth is not statistically significant?” If any reader answered “yes,” I hereby accuse you of intellectual dishonesty.
Now some want to argue that even if Krugman, et al, got this wrong, and also used sloppy techniques for considering UK and eurozone austerity, this doesn’t definitively prove market monetarism is correct or Keynesianism is false. Sure, I’d agree with that. Personally, I prefer market tests. I like to look at how market prices respond to new information about monetary policy. And of course this is one reason why the Fed needs to subsidize trading in NGDP (and RGDP) futures markets. And I’d prefer looking at NGDP growth, whereas the Keynesians use RGDP growth.
My point is different; market monetarism passed the test as set up by Keynesians, using the Keynesian ground rules. Their own model failed their own test.
PS. Sometimes Keynesians refer to more systematic studies, but these generally involve lots of observations for regions lacking an independent monetary policy. Numerous researchers have found the correlation goes away if you exclude observations lacking an independent monetary policy. (Mark Sadowski, Kevin Erdmann, Benn Steil & Dinah Walker.)
PPS. I am certainly not dogmatic on this issue:
1. Fiscal stimulus that lowers inflation can be expansionary, even with monetary offset (VAT cuts and employer-side payroll tax cuts are two examples of fiscal stimulus that might work by encouraging monetary stimulus to raise inflation up to target.)
2. Supply-side cuts in capital taxation can boost real GDP growth.
3. Spending on wasteful things like military output can boost RGDP (at the expense of lower living standards) by encouraging people to work harder to try to maintain living standards.
4. If central banks are incompetent in a very specific way then fiscal stimulus might help. But not incompetent in the way the ECB was incompetent when they tightened in 2011 by raising their target rates. More (demand-side) eurozone fiscal stimulus in 2011 would not have helped.