Saturos asked me to comment on a Nick Rowe comment on a Stephen Gordon post:
Saturos: the Sumner Critique (that if the central bank is serious about targeting inflation or NGDP then monetary policy is all that’s needed and the central bank will offset any change in fiscal policy so the fiscal multiplier is zero) is probably correct, in my view. But “probably” isn’t always good enough. If the downside risk is big enough, and fiscal ammunition is cheap enough, there is a lot to be said for giving the bear both barrels at once, just to be sure it’s dead, even if you think the monetary barrel is probably all that’s needed. And in Canada, unlike the US, the Federal debt/GDP ratio was low and falling going into the recession, and there was no “structural” (in the political sense of “structural” — i.e. deep-seated) deficit. So fiscal ammunition was cheap. We were going to need to loosen fiscal policy eventually anyhow, to prevent the debt/GDP ratio going negative. 2008 seemed like a good time to do some of that loosening, on micro grounds as well.
I end up in roughly the same place as Nick, but from a slightly different direction. Let’s start with the fact that if you are ever in a situation in the US where it looks like fiscal stimulus may be helpful, then you aren’t doing NGDP futures targeting. I favor a policy where the one year (or perhaps two year) forward NGDP level is always expected to be right on target. In that sort of world no one would ever even suggest fiscal stimulus. What would be the point? The reason people have recently suggested fiscal stimulus is that they (quite rightly) saw that one year forward NGDP was likely to be far below the policy goal.
Of course (contrary to the pesky blogger “Unlearningecon”) the Sumner critique applies equally well to cases of full employment and less than full employment. All that matters is that the central bank is targeting AD, whether via the Taylor rule, inflation targeting, or NGDP targeting. The target may be too low, but if there is any target then fiscal stimulus won’t boost AD.
However, for smallish open economies like Canada you could argue that the global recession was a sort of real shock, which might mean that NGDP targeting is not enough. I find many people are confused about this issue, so let’s start with a simple example of a big global recession that is 100% caused by a negative nominal shock combined with sticky wages. Now take a tiny country that only produces one good, windshield wipers. It will see a huge drop in demand for its exports. And more importantly, even though the global recession is (by assumption) 100% due to sticky wages, no amount of wage cuts in that small economy will prop up the windshield wiper industry, as this product is basically useless except as an input into car production. Even if you reduced windshield wiper prices to zero, it wouldn’t reduce car prices enough to materially impact car sales. This country will suffer a real recession of high unemployment regardless of its demand policy. Windshield workers must be retrained to do other jobs.
Of course Canada isn’t exactly a small country, but that thought experiment does have some bearing on the Canadian experience, particularly in the manufacturing heartland of Ontario where there are many factories closely tied to US industries like autos. People often say “if the US catches a cold, Canada gets pneumonia.” Actually the reverse is true. We caught pneumonia and Canada got a cold.
Since Canada was hit by a global real shock, one can argue that some fiscal stimulus was justified. The shadow price of labor would fall with higher unemployment, and of course global real interest rates also fell sharply. It’s a good time for Canada to build some infrastructure. Of course it’s also a good time to build some private housing, and NGDP targeting makes that happen.
Does this argument apply to the US? Not quite. In Canada it’s quite possible that mild fiscal stimulus was the optimal policy. Not so for the US.
First a brief digression. The actual name of China is not “China,” it’s “the central country.” That’s the translation of its Chinese name. Today America is the central country (but not for much longer.) In America the optimal policy is never fiscal stimulus. Our optimal AD policy is NGDP targeting, and if we do that then any global problems will have an insignificant effect on our macroeconomy. Remember the recession of 1997-98? I don’t either.
Our obnoxious national arrogance is at least slightly justified—we really are the center of the world economy.
PS. I’ve always wondered about country names. Why is it that weak countries like Myanmar, Sri Lanka, and Cote D’Ivoire can force us to call them by weird names, but powerful countries like Zhongguo and Deutschland are not able to do so? If Germany agrees to a bailout of the PIIGS, then they should demand to be called ‘Deutschland’ in the future. And we should all be willing to appease them.