American liberalism, circa 2007

While his points about fiscal austerity in the 1990s and 2013 having little if any effect on growth are noteworthy data points, it’s hard to see how monetary policy had a big impact when it’s clear that 1) the money sat in the bank unused and 2) business investment is short an accumulated $1T, according to reasonable estimates. I suspect neither fiscal or monetary policy had much effect for much the same reason: an unwillingness by the private sector to take risk that truly grow the economy and offsetting rational expectations by the small number of sophisticate companies and individual investors who matter.

He makes his case by doing little more than asserting that the US grew faster with monetary stimulus being the only difference. But there were other important differences 1) Their banks are truly bankrupt. 2) Their governments are a larger share of GDP, which contributes much less than the private sector. 3) They lack the productivity enhancing institutional capabilities of companies like Google and communities of expertise like Silicon Valley. 4) Their talented people don’t work very hard. 5) Their inflexible workforce regulations inhibit (re)hiring. 6) They don’t have as much equity per dollar of GDP to underwrite risk-taking that grows the economy. Their growth (i.e., Germany’s) is more dependent on exports—where the world’s growth is slowing—and manufacturing—where productivity gains are eating up employment growth. I call his mistake “over attributing”—i.e., he overlooks all these factors and attributes their impact to his point alone.

"...By early 2013 it was clear that if this new form of liberalism, this rejection of Clintonomics, was going to have any plausibility they needed to be able to show that the Fed could not or would not offset fiscal austerity. And calendar 2013 was the perfect test, as all sorts of austerity came together at the same time. The budget deficit fell by $400 billion in fiscal 2013, but that year begins on October 1st. The tax increases didn’t start until January 1st, 2013, and the deficit fell by an astounding $500 billion during that calendar year. A near perfect test. Some of my critics point out that GDP data is noisy, and that the speed up in growth in 2013 wasn’t particularly significant. Agreed. But the Keynesians didn’t just need a single, they needed a home run. They needed a sharp slowdown. The evidence in favor of monetary offset was becoming increasing persuasive. The Fed doesn’t stop doing monetary policy at the zero bound. If you are going to reject the previous liberal conventional wisdom, reject views held as recently as 2007, ask the public to spend a trillion dollars, you better damn well have a good reason. They desperately needed a slowdown in 2013, and got a speed up in growth instead. That’s why 2013 was so devastating. Not because it was definitive, but because fiscal stimulus was already on its last legs, increasingly rejected even by liberals such as Jeffrey Sachs. Once 2013 went against them, it was game over..."American liberalism, circa 2007

Sumner, Scott, "American liberalism, circa 2007,"The Money Illusion, December 27, 2015. Available at:http://www.themoneyillusion.com/
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Some of my critics point out that GDP data is noisy, and that the speed up in growth in 2013 wasn’t particularly significant. Agreed. But the Keynesians didn’t just need a single, they needed a home run. They needed a sharpslowdown. The evidence in favor of monetary offset was becoming increasing persuasive. The Fed doesn’t stop doing monetary policy at the zero bound. If you are going to reject the previous liberal conventional wisdom, reject views held as recently as 2007, ask the public to spend a trillion dollars, you better damn well have a good reason. They desperately needed a slowdown in 2013, and got a speed up in growth instead. That’s why 2013 was so devastating. Not because it was definitive, but because fiscal stimulus was already on its last legs, increasingly rejected even by liberals such asJeffrey Sachs. Once 2013 went against them, it was game over.

Then Keynesians claimed that even the Fed didn’t believe in monetary offset. That theory lost a bit of force when (in late 2012) Fed officials said they were doing aggressive stimulus (QE3 and forward guidance) partly to keep the recovery going as Congress moved to austerity in 2013. By early 2013 it was clear that if this new form of liberalism, this rejection of Clintonomics, was going to have any plausibility they needed to be able to show that the Fed could not or would not offset fiscal austerity. And calendar 2013 was the perfect test, as all sorts of austerity came together at the same time. The budget deficit fell by $400 billion in fiscal 2013, but that year begins on October 1st. The tax increases didn’t start until January 1st, 2013, and the deficit fell by an astounding $500 billion during that calendar year. A near perfect test.

First the Keynesians argued that monetary stimulus was ineffective at the zero bound. That’s what got me into blogging. But it soon became obvious that monetary policy was still effective. For instance, the dollar dropped 6 cents against the euro on the day QE1 was announced, in March 2009. Then after 2011 we had a controlled experiment, both the US and eurozone did roughly equal amounts of fiscal austerity. But the US did monetary stimulus and the eurozone did not. Both regions had similar unemployment rates as recently at 2010, in the 9% to 10% range. By 2014 the eurozone unemployment rate was twice that of the US (roughly 12% vs. 6%). Monetary policy made the difference.

So “obviously” more G will boost GDP. In fact, it is post-2007 liberals who are the “weirdos,” who have rejected the successful policies of Clinton and replaced them with the failed policies of Obama. (Remember, this is the president who 5 years into the recovery was arguing that unemployment was still so bad that we needed to enact an “emergency” unemployment program.)

GDP = C + I + G

As recently as 2007, the conventional wisdom of American liberals (on fiscal policy) was essentially market monetarist—they believed in monetary offset. The fiscal multiplier is close to zero. Deficits are bad. And yet I get many Keynesian commenters who don’t know this. They act like I’m propounding some sort of weird theory. They tell me that:

Recall that unemployment was pretty high when Clinton took office, much higher than today. Of course today’s liberals would point to one key difference, interest rates were not stuck as zero. (But that’s also true of the eurozone, circa 2008-12.)

Clinton’s 1993 budget bore out these tenets in their purest practical form. Its overall framework was deficit reduction, with the purpose of reducing interest rates and promoting economic health. It also had a strongly progressive tilt, raising the tax rate on the highest earners while expanding low-income subsidies such as the Earned Income Tax Credit (EITC) and Head Start. Six years later, Clinton and his advisers—and even like-minded economists outside the administration—continue to hold up the 1993 budget as their pinnacle achievement.

That intellectual breakthrough forms the bedrock of progressive fiscal conservatism. The principles of this economic synthesis are eminently clear. It begins with a recognition that the Federal Reserve and the bond market wield an effective control over the economy and that these instruments, rather than deficit spending, have become the most effective levers available to government for promoting economic growth. At the same time, there is an understanding among liberals that the burdens of fiscal restraint should fall primarily upon those most able to bear it and that the government should make a special effort to ensure that the benefits of economic growth also flow to those at the bottom.

The question that so bedeviled the White House in 1993——can the Fed and the bond market overcome the effects of tight budgets?——is no longer in doubt, and therein lies the great transformation of liberal economics. Previously, even liberals who favored deficit reduction considered it a painful trade-off: Reducing government borrowing would free up more savings for private investment and, in the long run, improve productivity, but in the short run, it would slow or even halt economic growth and throw millions out of work. The White House accepted this bargain in 1993 and hoped it would work out for the best. Now fiscal restraint is seen not even as a trade-off but, rather, as a way of getting the best of both worlds. This does not mean that forbearance is the one true answer, now and forever. It merely suggests that, under the present economic and political circumstances, the interests of current and future prosperity both argue for reducing deficits or expanding surpluses.

All of these developments were known at the time, but they had not fully cohered when Clinton began to construct his first economic plan. The key decision was not whether to reduce the deficit——given its size, the White House had no other realistic option——but rather what effect this would have upon the economy. Everyone present assumed that raising taxes or cutting spending would, at least in the short run, dampen economic growth. White House economists gave serious consideration to the possibility that their plan would throw the economy into recession. The only way to avoid this dismal fate was if the Federal Reserve or the bond market would lower interest rates to spur economic activity and make up for the depressing effects of deficit reduction. According to Bob Woodward’s account in The Agenda, Clinton replied to this news in a half whisper: “You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?”

Marcus Nunes directed me to a very interesting piece by Jonathan Chait in theAmerican Prospect,from 2001. It begins by pointing out that by the early 1990s American liberals had turned against the deficit spending policy of Ronald Reagan. Then it moves on to the Clinton Administration: