Is There a Keynesian Pickle?
Tyler Cowen does. Surprisingly, I think I agree. But with a few, important, caveats.
My first reaction to the rapidly falling deficit was disappointment that we hadn’t done more. I, after all, have been arguing that we need more short-term stimulus, now. And in the spirit of DeLong and Summers (2012), I even believed our tight policies were self-defeating.
Now, there’s no reason to believe this is not the case. We can’t, after all, test against a non-existent counterfactual. But the Keynesian reaction to recent numbers exposes a certain illogic with regard to falsifiability.
If I think austerity today is self-defeating – and I did – then my measure of bad policy should have been an above trend deficit update; that is we’re doing worse than we thought. But, evidently, my measure of bad policy has been a below trend deficit update. Full faith in the idea of self-defeating austerity and my reaction to the deficit numbers are logically inconsistent.
This is probably my fault. I’m not saying all Keynesians thought the same, but it is quite easy to think so. Either I didn’t believe what I thought I did, or held logically inconsistent priors. Perhaps a mix of both.
However, as I said, there are some big caveats. DeLong and Summers have a fairly solid theory of self-financing stimuli. An important part of the argument is existence of hysteresis effects, wherein labor shocks are permanent (and we see this with the horrible long-term employment situation and crappy Beveridge Curve).
Here’s a crucial point. At the margin, perhaps austerity doesn’t increase deficits. The healthy position right now meant our stimulus was eminently sustainable. It means DeLong and Summers are probably right in the idea of it all. That is, deficits aren’t that much higher than they might have been.
I don’t think the CBO has the capacity to measure this in any effective manner. A weaker labor force will have costs that we may not even realize at the moment. To be fair, the mathematics behind the argument also assume something we cannot know – a flip side of the same coin.
A stipulation is that a lot of the good news is coming from a flattening healthcare cost curve, that a healthier long run aggregate supply. This is entirely divorced from Keynesian theory, and hence can’t be used by austerians.
Ultimately, this is a question of meta-rationality. I’m not willing to update my beliefs about austerity, at least not with this news. We needed more, and we needed it for longer. But I do cede that my beliefs and reaction thereof were internally inconsistent. Further, the argument for self-financing may not be as strong as we once thought it might be. And even if it is, it seems very difficult to falsify.
The idea of self-defeating austerity seems so natural to me, now. But I now have to decide whether I think the deficit is bad news, I do, or whether I maintain my old beliefs. But ultimately, I think the spirit of DeLong and Summers is vindicated. To the same extent austerity didn’t cause deficits, our stimulus packages didn’t send long-term deficits through the roof. That means we’ve tolerated unemployment and bad growth for no particular reason. More to come soon: this is an important conversation.
The idea of a ‘self-financing deficit is (was) a gimmick:
The central bank can’t anticipate all political actions to effectively offset everything – the stimulus, a good example. Also, stimulus doesn’t have to be self-financing necessarily to be worthwhile, I don’t think.