Krugman’s blog, 8/30/16

There was one post yesterday, “Chris and the Ricardianoids (Wonkish):”

I’ve been trying to parse the Jackson Hole paper from Chris Sims, on fiscal dominance of monetary policy, and am having something of a hard time. Sims suggests that it’s really a simple issue, obscured by the complexities of formal models; but I fear that he’s inadvertently given us a demonstration that formal models can actually be helpful as a check on verbal arguments that seem plausible but don’t actually hold up. This is, by the way, a problem I’ve encountered a fair bit when trying to talk with advocates of helicopter money, which is kind of where Sims is going.

Just to be clear, I’m all for fiscal expansion under whatever excuse. I’m even reluctant to question arguments for helicopter money, lest my intellectual skepticism give ammunition to those still possessed by austerian instincts. But I do think I need to weigh in here regardless.

Here’s Sims on fiscal policy:

Fiscal expansion can replace ineffective monetary policy at the zero lower bound, but fiscal expansion is not the same thing as deficit finance. It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as fi- nanced by future inflation, not future taxes or spending cuts.

I think he’s saying that fiscal expansion works only if it leads to a rise in expected inflation. Or maybe not – the truth is that I’m not sure, which is one problem with too purely verbal an argument. But it’s certainly something I’ve heard from helicopter money types, who warn that something like Ricardian equivalence will undermine fiscal expansion unless it’s money-financed.

But this is a misunderstanding of Ricardian equivalence, on two levels. First, as I’ve tried repeatedly to explain, a TEMPORARY increase in government purchases of goods and services will NOT be offset by expectations of future taxes even if full Ricardian equivalence holds. The kind of argument people like Robert Lucas made sounded Ricardian, but wasn’t – it was Ricardianoid.

Second, less relevant to Sims but very relevant to other helicopter people, a deficit ultimately financed by inflation is just as much of a burden on households as one ultimately financed by ordinary taxes, because inflation is a kind of tax on money holders. From a Ricardian point of view, there’s no difference.

So I’m trying to figure out exactly what Sims is saying. What, ahem, is his model? The little liquidity-trap model I devised way back in 1998 is forward-looking, does implicitly incorporate the government budget constraint, but doesn’t tell anything like Sims’s story. What is he doing differently, exactly? I’m confused – and I hope it’s not because I’m stupid.



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