Sumner: Fiscal Stimulus Works Only If Central Bank is Incompetent

     What else is new? Lars Christensen took a lot of comfort in Delong's piece that argues that fiscal stimulus only works at the lower bound-ie, usually the monetary authority is the only one who can restore demand. It's "Even the great Keynesian, Delong admits that monetary policy trumps fiscal."

      For the past 4 years I’ve been arguing that we should generally assume a zero fiscal multiplier, except under very unusual circumstances. Brad DeLong makes a similar point in a recent post:

In trotting around the country giving versions of DeLong and Summers (2012), “Fiscal Policy in a Depressed Economy”, I have found that a point that seemed completely obvious to us is not obvious at all to many.
Here is the point: an optimizing central bank that cares only about inflation and unemployment because it does not find itself at the zero nominal lower bound and does not fear engaging in nonstandard monetary policy will engage in full fiscal offset: it will take care to make sure that if fiscal policy becomes more stimulative then it will make monetary policy less stimulative by the same amount.

     Then DeLong provides a mathematical proof, before concluding:

The important point here is that m and g cannot enter into the objective function h directly, but only indirectly through their effects on inflation and unemployment.
For this reason this argument breaks down at the zero nominal lower bound. At the zero lower bound the central bank does [not?] care only about inflation and unemployment. It cares as well about the magnitude of the non-standard monetary policy measures it must take in order to achieve its net monetary policy impetus value m.
 

     http://www.themoneyillusion.com/?p=19413#comments

     Sumner thinks this is very important and draws some implications:

     "Hydraulic Keynesianism is pretty useless—it tells us almost nothing about the monetary policy reaction function. And that includes the “paradox of thrift” as well as models that evaluate the prospects for NGDP growth by looking at each sector (C, I, G, NX) in isolation."

      " Empirical estimates of fiscal multipliers are nothing more than estimates of central bank incompetence. This means that “the” multiplier will depend on whether Bernanke had a bad nights sleep, or whether a member of the Board of Governors has a world class ability to be open-minded. No mathematical model or empirical study can ever produce a reliable fiscal multiplier estimate."

      I think that the "Sumner Critique"-that the fiscal multiplier is  zero if the central bank does its job:

      "the fiscal multiplier will always be zero if the central bank directly or indirectly targets aggregate demand either as a result of an inflation target, an NGDP level target or for that matter a Bernanke-Evans style monetary rule."

       http://marketmonetarist.com/2013/02/18/brad-delong-on-the-sumner-critique-and-why-the-fiscal-multiplier-is-zero/

      -comes can be changed a little to make it wholly accurate. The multiplier may be significantly undermined if you have a central bank needlessly pursuing an inflation target at all costs. There are those, however, that argue we shouldn't have inflation targeting at all.

     http://bilbo.economicoutlook.net/blog/?p=5451

     http://bilbo.economicoutlook.net/blog/?p=21664

     Something like the Sumner Critique may be true if the Fed does inlfation targeting at the detriment of all else-like output and employment. However, we might ask the Fed to change it's priorities.

     In the comments section, Sumner and fellow MMer, Bill Woolsely make the point I'm getting at.

     Woolsley to Sumner: "Large changes in fiscal policy would lead to higher AD if not offset by reduced private expenditure caused by the expectation that the Fed would prevent more than 2% inflation.   Expectation that the Fed will allow more than 2% inflation will allow large changes in fiscal policy to increase aggregate demand."

    Sumner's response:   "Bill, I agree. I didn’t mean to suggest that the higher inflation causes higher AD, just that it implies higher AD."