There were two posts yesterday. The first was “Bankers, Workers, Obama and Summers:”
Brad DeLong has an excellent piece distinguishing between two views of central banking. There’s the “banking camp,” which sees the central bank’s job as being to secure the stability of the financial system – full stop. OK, maybe also price stability. And then there’s the “macroeconomics camp,” which sees the central bank’s job as being to achieve full employment; banking stability and even price stability are basically means towards that end.
Brad complains that the Fed has ended up being much more in the banking camp than many macroeconomists would have wanted. See, for example, the harsh criticisms leveled at the Bank of Japan by one Ben Bernanke in 2000, criticisms that apply almost perfectly to the Bernanke Fed of today.
But I think Brad casts his net too narrowly: it’s not just central bankers who fall into these two camps. And one important consequence of this division is an utterly different read on recent history.
Ask yourself: How well did we respond to the crisis of 2008?
If you’re in the banking camp, here’s what you see:
The financial system was in great danger – but catastrophe was averted. We’re heroes!
On the other hand, if you’re in the macroeconomics camp, here’s what you see:
A catastrophic collapse in employment, with only a modest recovery even after all these years. (It looks a bit better if you adjust for an aging population, but not much). We blew it!
Which brings us to what looks more and more like Obama’s decision to choose Larry Summers as Fed chair, passing over Janet Yellen.
As of right now, Summers is clearly not in the banking camp; the stuff he has been writing about fiscal policy makes it clear that he very much believes that the job of economic recovery is not done. On that basis, you would expect him to prod the Fed into doing much more than it is. On the other hand, given Bernanke’s pre-Fed record you would have expected the same thing — maybe even more so, because Bernanke had strongly emphasized the central bank’s responsibility for economic growth. Once at the Fed, however, Bernanke appears to have been assimilated by the Borg, moving much closer to the banking camp.
Would the same thing happen to Summers? I worry. And one of the strong (though probably futile at this point) arguments for Yellen is that she spent years at the Fed without being assimilated, never losing sight of the crucial importance of employment.
While Summers isn’t in the banking camp, however, Obama is. As Ezra Klein explains, his choice of Summers clearly reflects his view that policy in 2009-2010 was a great success, not a big disappointment, and he wants to keep the winning team together.
Of course, it’s a lot easier for Obama to consider his policies a success given that he was reelected.
Obviously I’m in the macroeconomics camp, not the banking camp, so this is all depressing, in several senses. It means, among other things, that even if Summers is the right choice — which we’ll never really know — it’s a choice that Obama is making for all the wrong reasons.
The second post of the day was “The Arithmetic of Fantasy Fiscal Policy:”
Sometimes — usually, though not always, in a belligerent tone — people ask me, well, how big do you think the stimulus should have been? How much debt should we have run up? Regardless of the tone, that is actually a question worth answering. With the benefit of hindsight, we do know roughly how depressed the economy has been; we have reasonably good estimates of the effects of government spending; so we can put together an estimate of what would have happened if we had, in fact, pursued a policy of government spending sufficient to keep output at potential.
Start with the CBO estimates of potential GDP, which can be subtracted from actual GDP to estimate the output gap. Start the clock at the beginning of 2009, and the output gap — measured quarterly, but at an annual rate — looks like this:
If you add it up, the cumulative output gap since start-2009 comes to $2.29 trillion — that is, $2.29 trillion worth of goods and services we could and should have produced, but didn’t.
How much government spending would have been required to close that gap? The evidence is now overwhelming that when you’re at the zero lower bound the multiplier is greater than one; see,e.g., Blanchard and Leigh. Suppose we take a multiplier of 1.3, which is fairly conservative. Then it would have taken $1.76 trillion in spending over the past 4 1/2 years to close the output gap. Yes, I know, it would have been politically impossible — but we’re just doing the economics here.
So is that an extra $1.76 trillion in debt? No — the economy would have been stronger, leading both to higher revenue and to lower spending on means-tested programs. A fairly conservative estimate is that each dollar of extra GDP would have saved 1/3 of a dollar in the form of higher revenue and lower spending, which means 2.29/3 = $0.76 trillion.
So the net extra debt we would have run up with my fantasy stimulus turns out to be a round $1 trillion. OMG: ONE TRILLION DOLLARS!
But how bad is that? It’s about 6 percent of GDP. And remember, also, that GDP would have been higher — it would have been at potential, not well below. So at this point, instead of where we are — with federal debt at 72 percent of GDP — we would have had federal debt at 76 percent of GDP. Does anyone seriously claim that this difference would have caused a fiscal crisis?
And in return for those 4 points on the debt ratio, millions of American families would have been spared the hardship and humiliation of mass unemployment, lost houses and savings, and more. We can further argue that by avoiding the corrosive effects of long-term unemployment, we would surely have avoided substantial damage to America’s longer-run economic prospects, which in turn means that future revenue would be higher — and my fantasy fiscal program would probably have improved, not worsened, our fundamental fiscal position.
Again, I understand that none of this was going to happen. But you should understand that this reflects bad judgment by bad politicians and bad economists, not the logic of the case.