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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

ny fed paper-austerity makes deficit bigger

Posted by WARREN MOSLER on February 21st, 2012

From the NY Fed:

Deficits, Public Debt Dynamics, and Tax and Spending Multipliers

Cutting government spending on goods and services increases the budget deficit if the nominal interest rate is close to zero. This is the message of a simple but standard New Keynesian DSGE model calibrated with Bayesian methods. The cut in spending reduces output and thus—holding rates for labor and sales taxes constant—reduces revenues by even more than what is saved by the spending cut. Similarly, increasing sales taxes can increase the budget deficit rather than reduce it. Both results suggest limitations of “austerity measures” in low interest rate economies to cut budget deficits. Running budget deficits can by itself be either expansionary or contractionary for output, depending on how deficits interact with expectations about the long run in the model. If deficits trigger expectations of i) lower long-run government spending, ii) higher long-run sales taxes, or iii) higher future inflation, they are expansionary. If deficits trigger expectations of higher long-run labor taxes or lower long-run productivity, they are contractionary.

16 Responses to “ny fed paper-austerity makes deficit bigger”

  1. wh10 Says:

    Interesting. Haven’t read the paper, but the abstract makes clear that what determines whether the deficit is expansionary are long-run expectations. Warren, what are your thoughts on this? Why don’t you see MMT as oversimplifying things when seeing aggregate demand as primarily driven by short-run changes to NFA? Is there any room in MMT to add considerations regarding expectations? Do you think the assumptions underpinning these New Keynesian models are bogus?

    Reply

    RyanVMarkov Reply:

    Expectations fairy.

    It looks to me like they see strange (to them) things happening in reality and try to explain them with nothing but superstitions and voodoo.

    Same thing with Paul Krugman and the laughable liquidity trap he fell in some time ago.

    Reply

    SteveK9 Reply:

    @RyanVMarkov, Krugman also invented the now widely used term ‘Confidence Fairy’, which you are doing as well.

    Reply

    WARREN MOSLER Reply:

    if a larger deficit doesn’t reduce unemployment keep making it larger (cutting taxes/and/or increasing spending)

    best to keep the multipliers as low as possible- for a given size govt that means taxes can be that much lower!

    Reply

  2. walid M Says:

    ‘depending how deficits interact with expectations ‘

    ‘depending how electrons interact with fashion’

    Reply

  3. RWJ Says:

    Gotta love a model that allows for completely opposite outcomes depending on what ‘expectations’ are. How about a model that tells us what expectations are likely to be and why?

    As it is, these models are no more valuable than my neighborhood clergyman’s model that says deficits will be good for us ‘if God allows it’ and bad for us ‘if God doesn’t like it’.

    Reply

    Broll The American Reply:

    @RWJ, Is your neighborhood clergyman advising Santorum?

    Reply

    RWJ Reply:

    @Broll The American,
    Probably not. I suspect whoever is advising Santorum tells him that the deficit is entirely the work of Satan.

    Reply

  4. john newman Says:

    Off subject, but does anyone know a good (readable to an architect rather than economist) monetary history of the US?

    Thanks in advance for any thoughts!

    Reply

    roger erickson Reply:

    @john newman,

    here are some:

    1) Public initiative and the beginning of US currency: A confused electorate can end up pretending to borrow it’s own currency, instead of creating it? http://www.monetary.org/briefusmonetaryhistory.htm
    (the AMI guys don’t understand fiat $, but they have some good history references)

    2) http://press-pubs.uchicago.edu/founders/documents/a1_8_2s5.html

    3) Henry Charles Carey, argued for building on the precedent of non-debt-based fiat money and making the greenback system permanent.
    http://en.wikipedia.org/wiki/Henry_Charles_Carey

    4) History of the Legal Tender Paper Money Issued During the Great Rebellion, Being a Loan Without Interest and a National Currency : 1869
    http://fraser.stlouisfed.org/publications/1869histlegaltender/issue/4630/download/71142/historyoflegaltender.pdf

    5) Greenback Dollar
    http://en.wikipedia.org/wiki/United_States_Note

    6) Marriner S. Eccles and the Federal Reserve Policy, 1934-1951
    http://www.econ.utah.edu/activities/papers/2006_04.pdf

    7) Marriner Eccles – HEARINGS BEFORE THE 1933 Senate COMMITTEE ON FINANCE
    http://fraser.stlouisfed.org/docs/meltzer/ecctes33.pdf

    8) Money and the Price System, CH Douglas
    http://www.alor.org/Library/Money%20and%20the%20Price%20System.htm

    9) The Conquest of Poverty – Gerald Gratten McGeer
    http://thecounterpunch.hubpages.com/hub/The_Conquest_of_Poverty

    10) The monopoly of Credit – CH Douglas
    http://books.google.com/books/about/The_monopoly_of_credit.html?id=TNhHAAAAIAAJ

    11) Ben Franklin (1729): A Modest Enquiry into the Nature and Necessity of a Paper-Currency
    http://etext.virginia.edu/users/brock/webdoc6.html

    And, of course, Randy Wray’s book
    Understanding Modern Money [a historical guide]
    http://books.google.com/books?id=6PMuExCtMe8C&pg=PA18&dq=Understanding+Modern+Money:+The+Key+to+Full+Employment+and+Price+Stability&source=gbs_toc_r&cad=4#v=onepage&q=&f=false

    Reply

    john newman Reply:

    @roger erickson,
    Thank you! I’ve already ordered Wray’s book, now I can’t wait till it arrives. Your links should keep me in reading for at least a month!

    Reply

    Paul Krueger Reply:

    @john newman,

    I recently stumbled across http://eh.net/encyclopedia which is sponsored by the Economic History Association which has been around since 1940. They have a series of papers on more specialized topics. I just got done reading one that described the variations and evolution of the gold standard that I found to be pretty interesting and there are dozens more.

    Regarding specifically money a quick look shows they have:
    Banking — Antebellum (1820-60) Banking, US
    Banking — Civil War to World War II, US
    Banking — First Bank of the US
    Banking — Morris Plan Banks
    Banking — Origins of Commercial Banking, US
    Banking — Panics, US
    Banking — Savings & Loan Industry, US
    Banking — Western US
    Credit, Colonial US
    Debt — Federal Government, US
    Euro and Its Antecedents
    Gold Standard
    Monetary Unions
    Money and Finance in the Confederate States of America
    Money, Colonial America

    so it’s not really encyclopedic, but there are a number of interesting topics.

    Reply

  5. Ralph Musgrave Says:

    For every hundred academic economists keeping themselves employed at the taxpayer’s expanse by exuding hot air about expectations, there is around one economist actually looking for empirical evidence that confirms or demolishes the idea that expectations are important.

    Reply

  6. Paul Krueger Says:

    I just skimmed the paper (which is far easier to do if skip over all the completely opaque DSGE equations) and as far as I can tell their different outputs depend on what they build into it in the way of expectations about “how the deficit will be financed”. They have no model that predicts what will happen if there is NO expectation about how the deficit will be financed, which is the most likely scenario for everyone that I know. Ricardian equivalence is alive and well at the NY Fed.

    Reply

    wh10 Reply:

    @Paul Krueger,

    right, or if the expectation is based on an understanding of mmt

    Reply

  7. kkken530 Says:

    @Paul Krueger, As to Ricardo,Henry Charles Carey named a chapter in his book The Slave Trade Ricardo Liar

    Reply

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