Home' Policy Magazine : Policy Vol 30 - No 2 Contents WHY THE FISCAL MULTIPLIER IS ROUGHLY ZERO
6 POLICY • Vol. 30 No. 2 • Winter 2014
accelerating. That policy stance almost inevitably
leads to monetary offset and largely explains why
the recovery continues at a modest pace, despite
an increase in fiscal austerity during 2013.
What role does this leave for fiscal policy? What
would an effective fiscal stimulus look like? It
turns out that fiscal policy could play a role, but
only through supply-side channels. Return to the
AS/AD diagram discussed above. If policymakers
were able to increase aggregate supply, then the
Fed would be under no pressure to offset the
effects with tighter monetary policy. That’s because
supply-side tax cuts actually tend to lower the
inflation rates and raise growth. A good example
is a cut in the employer side of the payroll tax,
which would encourage hiring but would not boost
wages or prices. Indeed, the cost of labour from the
firm’s perspective would decline, whereas workers
would see no change in take-home pay. Some
economists believe that cuts in taxes on investment
income might also boost aggregate supply.
Policy is most effective if each part of the
government focuses on what it does best. That
means the Fed should focus on stable monetary
conditions. Elsewhere, I’ve argued that this can
best be achieved by targeting a stable growth path
for nominal GDP.
14 By committing to a policy
of stable spending growth, the Fed can shape
market expectations in a way that would lessen the
volatility created by its current policies. This would
result in less aggressive policies from the Fed in the
long run. Meanwhile, the fiscal authorities should
focus on the supply side of the economy, creating
an environment where the private sector can
flourish. Attempts to jumpstart the economy
with demand-side fiscal stimulus merely cause the
government to pile up more debt, with any growth
effects being offset by the Fed.
1 Note that taxes rose sharply in 2013, whereas government
spending is more ambiguous, with declines in military
and discretionary spending offset by increases in transfers.
The May 2013 CBO Report made the following estimates
of government spending: ‘Outlays for the first eight
months of fiscal year 2013 were slightly greater than what
the federal government spent during the same period
last year. That increase stemmed in part from shifts in the
timing of certain payments, mostly because scheduled
payment dates fell on a weekend. (Some spending for
defense, Medicare, and veterans’ programs was affected.)
Without those timing shifts, CBO estimates, total spending
would have declined by $46 billion (or 2 percent).’
Congressional Budget Office (CBO), Monthly Budget
Review for May 2013 (Washington, DC: 7 June 2013),
www.cbo.gov/publication/44320. Also note that the
sequester took effect in the spring of 2013, so it didn’t have
much impact on spending for the period from October
2012 through May 2013.
2 John Maynard Keynes, The General Theory of Employment,
Interest, and Money (New York: Harcourt, Brace & World,
3 John H. Cochrane, ‘Fiscal Stimulus, Fiscal Inflation, or
Fiscal Fallacies?’ working paper (Chicago: University of
Chicago, 27 February 2009).
4 See Sylvain Leduc, Fighting Downturns with Fiscal Policy,
Federal Reserve Bank of San Francisco Economic Letter
(San Francisco: 19 June 2009).
5 For example, see Lawrence Christiano, Martin
Eichenbaum, and Sergio Rebelo, ‘When is the Government
Spending Multiplier Large?’ Journal of Political Economy
119:1 (2011); Eric Leeper, Nora Traum, and Todd B.
Walker, ‘Clearing Up the Fiscal Multiplier Morass,’
NBER Working Paper 17444 (Cambridge, Massachusetts:
National Bureau of Economic Research, 2011); David
Romer, ‘What Have We Learned About Fiscal Policy
from the Crisis?’ paper delivered at the IMF Conference
on Macro and Growth Policies in the Wake of the Crisis
(March 2011); Michael Woodford, ‘Simple Analytics
of the Government Expenditure Multiplier,’ American
Economic Journal: Macroeconomics 3:1 (2011).
6 John B. Taylor, ‘Discretion versus Policy Rules in
Practice,’ Carnegie-Rochester Conference Series on Public
Policy 39 (1993), www.stanford.edu/~johntayl/Papers/
7 For example, see Brad DeLong, ‘Only Four Ways Out,’
The Economists’ Voice 6:2 (2009).
8 Matt Berman and Niraj Chokshi, ‘Ben Bernanke Has
Some Gentle Suggestions for Congress,’ National Journal
(17 July 2013).
9 For example, see James Bullard, ‘Death of a Theory,’
St. Louis Fed Review 94:2 (March/April 2012).
10 For example, see Ben Bernanke, ‘Japanese Monetary
Policy: A Case of Self-Induced Paralysis?’ working paper
(Princeton University, 1999).
11 Milton Friedman, ‘Reviving Japan,’ Hoover Digest 2 (1998).
12 Frederic Mishkin, The Economics of Money, Banking and
Financial Markets, 9th ed. (Boston: Addison Wesley,
13 See Annalyn Kurtz, ‘Federal Reserve Official Aims for
6.5% Unemployment,’ CNNMoney (27 November 2012),
14 Scott Sumner, ‘The Case for Nominal GDP Targeting’
(Arlington, Virginia: Mercatus Research, Mercatus Center
at George Mason University, 23 October 2012), http://
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