Janet Yellen confirms much of what I've been saying about fiscal stimulus
By Scott Sumner
I’ve been frequently arguing that fiscal stimulus makes no sense, especially at a time when the unemployment rate is 4.9% and the Fed is raising interest rates. Any impact on aggregate demand will be offset by tighter monetary policy.
In contrast, prior to 2007, no one (AFAIK) was suggesting that infrastructure spending is a sensible countercyclical tool when unemployment is 4.9%. And if someone did recommend it, they almost certainly recommended LOWER than usual spending at 4.9% unemployment.
Now Janet Yellen is saying much the same thing; now’s not the time for fiscal stimulus:
President-elect Donald Trump has pledged a $1 trillion infrastructure spending program to help jump-start an economy that he said during the campaign was in terrible shape.
Speaking on Capitol Hill Thursday, Federal Reserve Board Chair Janet Yellen warned lawmakers that as they consider such spending, they should keep an eye on the national debt. Yellen also said that while the economy needed a big boost with fiscal stimulus after the financial crisis, that’s not the case now.
“The economy is operating relatively close to full employment at this point,” she said, “so in contrast to where the economy was after the financial crisis when a large demand boost was needed to lower unemployment, we’re no longer in that state.”
In my recent Lake Wobegon post I pointed out that fiscal policy can’t always be above average. Thus if you do fiscal stimulus when unemployment is relatively low, then in the next recession fiscal policy will have to be tighter than otherwise:
The key point to understand about fiscal stimulus is that more fiscal stimulus today implies less fiscal stimulus during the next recession. That’s because the expansionary impact of fiscal stimulus (in the Keynesian model) occurs because the full employment budget deficit gets larger than before, not because it is large in absolute value.
For the moment, let’s assume that the full employment deficit during the next recession is $X. In that case, the larger the fiscal stimulus between now and the onset of the next recession, the smaller the increase in the deficit during the next recession, and thus the smaller the fiscal stimulus during the next recession.
And now Janet Yellen is saying the same thing:
Yellen cautioned lawmakers that if they spend a lot on infrastructure and run up the debt, and then down the road the economy gets into trouble, “there is not a lot of fiscal space should a shock to the economy occur, an adverse shock, that should require fiscal stimulus.”
In other words, lawmakers should consider keeping their powder dry so they have more options whenever the next economic downturn comes along.
For weeks and months we’ve been bombarded with nonstop commentary from media “pundits” about how monetary policy is out of ammo, and fiscal stimulus is the shiny new thing that everyone favors. I’ve been standing in the middle of the road yelling, “stop”.
My opponents claimed that the Fed does not agree with me. So how does it feel to achieve a dramatic come from behind fourth quarter victory?
Pretty darn good!