Sumner vs. Noah Smith on the Multiplier

     If you have read Sumner for any length of time you know one of his favorite hobby horses is that the fiscal multiplier is zero-even at the Zero Bound. This is the only actual dispute between Sumner and the New Keynesians-who he calls "intelligent Keynesians."

     http://diaryofarepublicanhater.blogspot.com/2013/03/sumner-educates-us-as-to-flaw-in.html

     In his latest he again argues that there is minimal if any effects for AD if the CB does it's job-which he defines as inflation targeting. However, Matt Rognolie in the comments section gets him to admit that there can be positive supply effects to fiscal stimulus-of course this leaves the question of demand side effects unanswered-I discussed it some in the above link.

   "Let’s start with the easy part. New Keynesian theory predicts that the fiscal multiplier will be zero if the central bank is targeting inflation in a forward-looking fashion. That is, increased deficit spending will not increase expected future growth in aggregate demand. The smarter Keynesians know this, but the “smarter Keynesians” are a very, very small group. If you polled PhD trained economists in America, I’d guess less that 10% know this, maybe less than 2%.

Perhaps “less than 2%” know this because it’s not actually true. In general, the moral of the basic New Keynesian model is that if the central bank is targeting inflation, then the responses you’ll see to various policies will just be the neoclassical ones. And the “neoclassical fiscal multiplier” is never exactly 0, unless government spending is a perfect substitute for private consumption. Under typical assumptions it will be somewhere in the range 0.5 to 1."

  "Don’t just take it from me – take it from pages 15-16 of Woodford’s paper on the multiplier, where he considers the case of a strict inflation targeter and concludes “Hence the multiplier will be given by (1.7), just as in the neoclassical
model.” Formula (1.7) gives the neoclassical multiplier as a function of elasticities, and shows that it must lie within the range [0,1]. Surely if anyone embodies “smart New Keynesians”, it’s Woodford, right?"

   "Of course, the fact that the “multiplier” here is greater than 0 is not a justification for stimulus spending; after all, the neoclassical multiplier is always operative, and always greater than 0 (even during booms), and surely NK theory does not provide a justification for stimulus spending during booms. And from a practical perspective I am probably much closer to you than Krugman on this issue anyway. But it still grates me to hear that the multiplier is literally “zero”; unless you have a very different set of assumptions, it’s generally not."

    http://www.themoneyillusion.com/?p=20017

    Sumner is forced to concede the point:

    "Matt, I took it for granted that people would understand that I was excluding supply side effects of fiscal stimulus. Obviously there are fiscal policies that might shift the AS curve to the right. But in terms of demand-side stimulus, if you don’t increase inflation then you don’t increase AD, unless you assume the SRAS curve is flat, which it obviously isn’t."

     He still holds onto the idea that it wouldn't stimulate AD because it wouldn't increase inflation; the only way you can increase AD without increasing inflation according to him is if the SRAS is flat-which of course he like most Neoclassicals don't believe. Steve Keen might argue differently but Sumner just dismisses Keen. 

     Regarding the idea of a supply side impact from fiscal stimulus Noah Smith recent wrote about: his point was that basically even if it were zero there are beneficial supply side effects.

        Actually, regarding the debate over the fiscal multiplier, Smith argues it doesn't matter-at least not at this time:

        "What I mean is: the "pure" or theoretical Keynesian fiscal multiplier doesn't matter, in the United States, at this time."

        "Why not? Because right now, the U.S. should be investing in infrastructure whether "pure" Keynesian stimulus works or not."

        "When economists like Paul Krugman debate "the multiplier" in public, what they're actually talking about is the theoretical multiplier in a Keynesian-type model. That is an interesting theoretical debate, but it is of limited use when making real policy, because there is lots of real-world stuff that those models leave out. For example, as many of the neo-monetarist types like Scott Sumner and David Beckworth have pointed out, the multipliers that come out of those models assume that the Fed doesn't react to neutralize the effects of fiscal policy."

        "But another important thing that Keynesian theory leaves out is public goods. If there are certain kinds of goods that only government can or will provide, and if these goods are complements to private business activity, then government spending could have huge effects even if the "pure" Keynesian multiplier is zero! For example, take the famous paper of Baxter & King (1993), in which there is "government capital" that complements private capital and labor. In that sort of a world, government spending on "government capital" is efficient even without any aggregate demand deficiencies at all. Efficient, that is, as long as the current amount of "government capital" is below the optimal amount - in other words, as long as the country has recently been underinvesting in things like infrastructure."

       "It is pretty clear that "government capital" really exists. There is no country in the world that has produced a world-class network of roads, bridges, and ports without large amounts of government funding. Infrastructure isn't the kind of "pure public good" often discussed in the theoretical literature, but it's clearly something that we need government to do."

     "Now, in a Baxter & King type world, if infrastructure is underinvested, then government investment will generate a big apparent "multiplier" even without Keynesian effects. And indeed, the evidence shows that government investment generates much bigger "apparent multipliers" than government consumption."

        http://noahpinionblog.blogspot.com/2013/01/why-multiplier-doesnt-matter.html

     This in itself is very interesting. I'm not going to cede the point about demand to Sumner as Noah seems happy to do-probably because he doesn't want to argue with Sumner who doesnt' let stuff like this go-however, if there are supply side benefits from stimulus then this is the case even during  healthy economies. As to the question of overheating the economy, as Noah says it doesn't apply as long as the current "government capital" is beneath the optimum amount. There's little question that this is the case in the U.S. today, with our dilapidated schools and slow Internet.