No they don’t

Paul Krugman:

A perfectly standard New Keynesian model, with intertemporal optimization and all that — the kind of model that is standard in freshwater courses — says that under current conditions fiscal stimulus should be very strong… (emphasis added)

The abstract from a perfectly standard New Keynesian model:

This paper argues that if the zero bound on nominal interest rates is binding [and monetary policy is passive], then the government spending multiplier is large.

From today’s WSJ:
48TSYELD

14 thoughts on “No they don’t”

  1. So, wait, what? — Are you disagreeing with Krugman because a) the nominal lower bound is not binding; b) monetary policy is not passive?

  2. Presumably because the yield curve picture indicates that we are not at the zero bound on nominal interest rates. Sumner’s response to Krugman would be that monetary policy should never be passive and can always be effective.

  3. If I read the graph right, the 3-mo T-bill’s return is zero “Friday” and positive 1 year ago. So, if “current conditions” = Friday…?

    Anyways, the problem here is caused by the fact that people are still following what Krugman says. Big mistake.

    Finally, although I could look into it more, since Ambrosini has been pushing the C.E.R. paper, I took a look and am I the only one who doesn’t believe neither their impulse nor their propagation?

  4. CER provides a framework for discussion. That’s all.

    That said, their pithy abstract should include a qualification about the stance of monetary policy (like the one I added in brackets).

  5. Discussion: you can get a multiplier if you allow for a painfully small set of assets, add add-hoc price rigidity (i.e. independent of the incentives to keep/change prices) and restrict monetary policy to a Taylor rule. Oh, yeah, and this a model with no unemployment (in the serious sense of the word) and no financial imperfection (since there is only one asset?). No investment means no implicit international trade/slippage too.

    I don’t want to be mean or contrarian but I guess this is as good of a time as any to repeat the claim that the “NK” branch of the DSGE tree has thrown the baby out with the bathwater.

  6. Nominal interest rates aren’t zero right now so the liquidity trap papers are silent about fiscal policy. To get fiscal policy to work, the models would have to have even more assumptions. Something like in Gali’s paper where over 25% of agents have to be fully backwards looking.

  7. I also started writing a comment about how I know of a couple of models that “get fiscal policy to work”, for example IS-LM or naive expectations Phillips curve but then I thought, why be an a-hole :-)

    Seriously, though, there’s also the issue of whether you do or do not get a larger than 1 multiplier versus is it a good idea, from a welfare point of view, to do it…

  8. The one year t-bill is a third of a percent (33bp). Isn’t that consistent with zero bounds, as most people would define it?

  9. Well, the 1 & 3 month is at 5 & 6 bps. I’m missing it (I don’t follow these debates closely) – is your argument that the 1 & 3 month could go less somehow, or that the Fed can target the 30-year, sitting at 4.2%?

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