Mark Sadowski on fiscal austerity, with and without monetary offset
In recent years Mark Sadowski has done a lot of empirical work on fiscal austerity, some of which has appeared in this blog. Now he has a new study, but first let’s review the two competing theories:
1. Keynesian: Fiscal austerity is contractionary at the zero bound regardless of whether you have an independent central bank.
2. Market monetarist: Fiscal austerity is contractionary if you lack an independent central bank. Fiscal austerity would not be expected to have much effect if you have an independent central bank, due to monetary offset.
Mark sent me a bunch of regressions for both RGDP and NGDP. I’ll focus on the NGDP studies, which are most relevant for tests of demand-side effects. First Mark replicates recent Keynesian studies showing that growth tends to be lower in countries (like Greece) that did a lot of fiscal austerity between 2009 and 2014. So far we have results that are consistent with both models:
Then he looks at the effect of austerity in just the eurozone countries. These economies lack an independent monetary policy.
Again, consistent with both views.
Then he looks at just those economies that do have an independent monetary policy:
Now we see a very different result, fiscal austerity seems to have no effect. This is exactly what the market monetarists predicted, but conflicts with the prediction of the Keynesian model.
I also have a new post over at Econlog, discussing this issue. In that post, I quote Simon Wren-Lewis saying:
In my experience anti-Keynesians tend to shy away from data series, and especially econometrics, and prefer evidence of the ‘they said this, and it didn’t happen’ kind – particularly if ‘they’ happens to be Paul Krugman.
In fact, there are other studies similar to Mark’s. Benn Steil and Dinah Walker did one, and Kevin Erdmann did another. Keynesians simply ignore them.
BTW, everyone should congratulate Mark, who just earned his PhD a few days ago, at the University of Delaware. Here’s a picture:
And here’s Mark’s data set:
I’ll try to get to the comments tonight.
Tags:
18. June 2015 at 08:44
What is fiscal austerity anyway? In a normal universe that ought to be an easy definition, but it seems to have a very fluid meaning of late.
18. June 2015 at 08:52
Congrats Mark!
18. June 2015 at 08:54
Congrats to Mark.
18. June 2015 at 08:58
Mark, great to hear! Congratulations.
18. June 2015 at 09:04
Strikes me that the opposite is also true – fiscal expansion has no positive or negative effect on GDP growth when there’s independent monetary policy.
So from a growth perspective, governments whether left or right should be pursuing the policy that they think is most appropriate for political and ethical reasons, without too much regard for fiscal stance?
Lots of things governments do can affect growth (e.g. regulatory burden), but is it right to say that fiscal policy is not one of them, in either direction?
18. June 2015 at 09:07
Congratulations Mark! Now we know what you were doing these last few months.
18. June 2015 at 09:22
Andrew, I think that fiscal policies affecting Agg Demand will be offset by monetary policies. If stimulus juices demand so that inflation might go above the 2% target *cough* ceiling *cough* then the central bank would take measures to offset the stimulus to hit its goals. If austerity causes deflation then the CB will inject money to keep inflation in range of the target. Where fiscal policies matter though are in Agg Supply: regulations, employer taxes and costs, policies affecting input costs (food, energy, commodities, labor etc.), free flow of capital, efficient markets, etc.
18. June 2015 at 09:26
Congrats to Mark! UD is right around the corner from me and is a very good school.
18. June 2015 at 09:39
This is a great post. These are the sort of things we need more people working on.
I’m not sure the “Keynesian view” you write at the top of your post is actually a modern Keynesian view. It’s very Old Keynesian. The market monetarist view you write has far more overlap with modern Keynesianism.
The Mundell-Fleming model is New Keynesian, yes? Because the observation that “Fiscal austerity is contractionary if you lack an independent central bank” stems straight from Mundell-Fleming, which is a model taught in all undergraduate econ curricula across the USA. I’m stumped at how people like Krugman don’t even show the least bit of acknowledgement of this model, which stems directly from IS-LM, a model that Krugman himself swears by.
The unfortunate truth is that some self-professed Keynesians have simply forgotten one of their own models. In effect, I think it’s about time we start referring to people who ignore Mundell-Fleming as Old Keynesian for additional clarity.
Anyway, congratulations Mark!
18. June 2015 at 09:57
Seems to me that NGDP response to austerity ranges from quite negative to completely neutral. Why then even attempt austerity given that you could get the monetary response wrong?
It also seems to me that Keynesians say monetary policy is important but countries should not risk the negative impact of austerity at certain times. They agree austerity can be desirable at other times. Nothing illogical or wrong with that.
18. June 2015 at 10:04
And don’t forget that the causality in the “non-independent monetary policy” case could very well be seen as going in the other direction, i.e. that those countries who face the biggest output gaps are forced to do the strongest fiscal budget cuts.
18. June 2015 at 10:25
Congrats to Dr Sadowski!
18. June 2015 at 10:34
Anthony, those strike me as generally more regulatory than fiscal, though fair to note that the line blurs. For example, taxes that are highly distortionary strike me as likely to be more problematic than less distortionary but higher taxes.
To the best I can tell, this is consistent with the data though with such an ideologically fraught area, ‘clean’ data is nearly impossible to get…
18. June 2015 at 11:31
Congratulations, Mark. Interested to read your “Tax Structure and Growth” dissertation.
18. June 2015 at 11:37
Scott, you write:
“This is exactly what the market monetarists predicted, but conflicts with the prediction of the Keynesian model.”
In terms of the future (say over the next 1 to 5 years), can you (or Mark) direct me to a set of concrete predictions from the market monetarist model? Predictions about anything, so long as they constitute something that any proficient economic empiricist (market monetarist or otherwise) can check? Thanks.
18. June 2015 at 11:51
Congratulations Dr. Sadowski. I do not comment much but I have to say that you are probably the most persuasive internet commenter I have come across and that I have learned a lot from your analysis. I cannot believe you did not already have a Ph.D. Hopefully you will go straight from the lecture hall to the FOMC.
18. June 2015 at 12:07
Congratulations to Mark. If his PhD work was a tenth as good as most of his posts, it’s more than well-deserved!
The graphs are very interesting, but I’d be wary about getting your hopes up regarding their reception: I remember bringing up controlling for monetary policy independence at an economics departmental seminar, when there was an empirical paper on “expansionary fiscal contraction”, and it had not even crossed the mind of the presenter to consider the influence of monetary policy on growth, or AD generally. And this was someone from Chicago! I can only shudder to think how widespread monetary policy neglect must be in the macro profession at large.
18. June 2015 at 12:20
Do these charts have any bearing on the Ricardian equivalence blog debates from a few years back? Wouldn’t you expect less consumer responsiveness to government spending for under an outsourced monetary regime?
18. June 2015 at 13:00
@Tom Brown:
The best test of market monetarism right now is the path of future interest rates. The market thinks that Fed Funds will be less than 50bps at the end of 2015, about 1.0% at the end of 2016, and about 1.6% at the end of 2017. But the Fed thinks that they will be about 56bps at the end of this year, 1.75% at the end of 2016, and 3% at the end of 2017.
Market monetarists think that the Fed is targeting inflation at something less than 2%, which is consistent with the market’s implied short term rates of less than 2% for many years. The Fed thinks it is targeting 2% inflation so with a real rate of 1%, they will have hit their inflation target by the end of 2017 (2% inflation + 1% real rate = 3%).
So by the end of 2017, we will have completed a pretty good test. If inflation has been consistently lower than 2% between now and then, and Fed Funds has been less than 2%, then that would be strong empirical evidence that markets are better at evaluating monetary policy than the Fed is. But if Fed Funds are well over 2% and inflation has been been at the 2% target, then you would probably have to say the opposite.
18. June 2015 at 13:10
Congrats Mark! Would love to read the thesis as well!
18. June 2015 at 13:27
Wonderful post! This is just what I’ve been waiting for – a honest multi-country comparison of the two hypotheses.
Now I can disagree with Krugman with a clear conscience.
18. June 2015 at 13:38
You have a different understanding of Keynesianism than I do. It seems that Keynesians assume that at the ZLB, an “independent” central bank will be too constrained politically by the fears of inflation hawks to use “unconventional” policy vigorously enough to effectively offset shifts in the degree of austerity. Whether or not that’s a good theory for every sub-period, for the period 2008-15 I think it holds up pretty well.
Isn’t MM more than just assuming that a “independent” central bank WILL offset changes in austerity?
18. June 2015 at 13:57
Tom, the most testable market monetarist beliefs seem to be:
(1) NGDP stability matters more than inflation stability. Suppose country X lets inflation rise when real growth drops and vice versa. Suppose country Y pursues low stable inflation at all times, no matter what growth is doing. We exoect country X will do better overall at unemployment and real growth.
(2) a stable overall path of NGDP/inflation matters more than a stable annual rate. Suppose country X has year-to-year volatile NGDP but “makes up for” overshoots and undershoots to hold a 5%/yr trend. Suppose country Y hits its 5% target in almost every year, but if there is a bad year, it never bothers to make up for it. Loosely speaking, country X’s nominal variables are more predictable at the 10-year level, country Y’s at the 1-year level. We expect country X will do better overall at unemployment and real growth.
(3) the market knows better than the central banks. That is, prediction markets, or failing that the right basket of financial instruments, will do better at predicting a fall or rise in NGDP than official central bank projections.
(4) NGDP stability obviates fiscal policy. Suppose country X and country Y appear to face similar imminent recessions. Country X does better at stabilizing NGDP. Country Y does more to expand government spending. We expect that country X will do better at minimizing unemployment and recovering real growth.
(5) Monetary policy trumps fiscal policy. Countries with independent central banks will have their NGDP determined far more by the central bank’s policy than by the expansion or contraction of government spending. (Indeed, per Mark’s graphs, fical policy has essentially *zero* impact on NGDP where central banks are independent.)
Unfortunately, all of these are just “on average” statements, so looking at single countries doesn’t tell you much. Multi-country comparisons like Mark’s in this post are much better.
18. June 2015 at 14:00
Njnnja, thanks very much. I’m not sure Scott or Mark will agree with you on that being a good test, but assuming they do, is that prediction different than what the bulk of Keynesian models predict? Is the Fed using a model you’d describe as a representative Keynesian model?
I appreciate that you gave some concrete numbers. However, Regarding Fed Funds, your description makes it sound like the MM model is “whatever the market says?” If that’s the case how can you lose with a model like that? You can always say that whatever happens is exactly what your model “predicted” can’t you? For example, say the Fed and the market converge by mid 2016 (to anything) for what the end of 2017 will look like. Would you necessarily stand by your predictions today?
Is there some way now to look at different future scenarios ahead of time with the MM model? Say for example that in X months the Fed were to change their inflation target to Y. Does the MM model have a prediction for what would happen as a function of X and Y? Say I know of a non-MM and non-Keynesian model (call it the Z model) which makes a similar prediction today as MMs do today for inflation and Fed Funds by the end of 2017, but it says it will happen regardless of what the Fed targets, and the Fed then goes ahead and changes its target mid course. Does that give us a way to differentiate between the various models (MM, Keynesian, and Z)?
Thanks.
18. June 2015 at 14:13
Njnnja,
Another example using the hypothetical Z model: the Canadian central bank has been lauded in the past by some MMs for being able to hit their inflation target (yes I know that inflation targeting isn’t favored by MMs, so “lauded” maybe isn’t the correct term). Now say our hypothetical Z model makes predictions for Canadian inflation rates for each year over say the next 10 years, and that differs from the Canadian central bank’s current inflation target, and is independent of that inflation target.
Now suppose that the inflation rate in Canada follows the Z model’s predictions and likewise deviates from the Canadian central bank’s inflation target. How would MMs explain that? Would they say that this evidence falsifies the MM model or would they say that the Canadian central bank lost its mojo as evidenced by what the inflation rate actually turned out to be?
18. June 2015 at 14:31
Daniel, thanks very much. that’s a pretty good list. Suppose I have model Z which makes predictions for a whole set of countries (similar to the list of countries Mark has here) about NGDP growth rates and inflation rates over each of the next ten (or more) years, and those predictions are independent of any specific central bank targets or actions. Do you think we could test such a model against the MM model? My concern is that if the MM model is “whatever the market says” then there’s no way it can lose. Any country with a central bank target deviating from what actually happens will simply be written off as having a central bank that lost its mojo.
18. June 2015 at 14:36
Well done Mark!
18. June 2015 at 16:11
Daniel W Reeves and Tom Brown hit hard with trenchant observations (yes, that’s a word Scott) but Scott’s minions blow them off. Let’s see how the minion’s master responds, probably he’ll also misdirect their questions and comments.
The rest of the posts are meaningless happy-talk along the lines of ‘congrats’, for somebody the posters will never meet. Mark, who should care less about what they wish. Here’s my meaningless comment: Mark looks like a Photoshopped head of a middle-aged man crudely superimposed on a 20-year old’s body. Does Mark even exist, is he for real? Same comment re MM.
18. June 2015 at 16:11
A hearty congratulations to Mark.
Central bankers: stop the pompous pettifogging and start printing money.
18. June 2015 at 16:29
Everyone, Good to see that people remember Mark’s huge contribution to this blog.
Justin, Keynesians tend to define it as a reduction in the cyclically adjusted budget deficit.
Andrew, That right.
Daniel, I agree, but I think at the zero bound even lots of NKs are actually somewhat old Keynesian.
Elwailly, It all depends on whether you have an independent monetary policy.
Sven, Yes, that’s right. Important point.
Tom, I don’t generally make unconditional forecasts, other than whatever the market forecasts is also my forecast. I make forecasts conditional on policy.
But I’ll make things easy for you. In 2007 I would not have forecast the Great Recession. In 2006 I would not have forecast the collapse in housing prices. There’s lots of things I got wrong, and I’ll continue to get things wrong. For instance, I now expect interest rates to stay fairly low for decades (unfortunately Krugman does too, so it doesn’t create any separation.) But I might be wrong on that. I do not claim any ability to predict turning points in the business cycle, or in asset prices.
Here’s another prediction. If the next president (either party) comes in predicting 3% RGDP growth, they’ll fail.
Basically I’ll be wrong as often as markets are wrong. That’s fairly often, but I still view market forecasts as the lesser of evils.
W. Peden, That’s depressing.
A, Maybe a small implication, but Sven’s point (above) is a cautionary note.
Thomas, It’s assuming that it will offset on average, or that zero effect is the baseline assumption. And that’s what Mark’s study finds. It does not predict every point will lie along the line, that never happens in macro, even in the Keynesian studies.
18. June 2015 at 16:31
Ray, Just the sort of tasteless observation I’d expect from someone like you.
And I doubt if Daniel will agree with you.
18. June 2015 at 16:43
Mark does it again. So “explicit”, it should be rated XXX:
https://thefaintofheart.wordpress.com/2015/06/18/failed-fiscalist-forecasts/
18. June 2015 at 16:47
Thanks Everybody!!!
Ray Lopez,
“Does Mark even exist, is he for real?”
Interesting. I’ve occasionally wondered the same about you.
I’ve come to the conclusion that you are nothing more than a slight disorder of the stomach.
“…You may be a bit of undigested beef, a blob of mustard, a crumb of cheese…”
18. June 2015 at 18:22
RGDP is not actually a measure of real growth. It is last period’s NGDP.
Last period’s spending plus the change in spending equals this period’s spending.
NGDP can double and RGDP will be measured as having increased, even if true real productivity has not changed at all.
Sadowski is just manipulating numbers based on economically false assumptions.
18. June 2015 at 18:35
If you took Greece out of the analysis, my ocular econometrics tells me that your first two charts would look pretty much like the third one. Greece is a small country, and in these plots is pretty clearly an outlier, yet it is driving whatever conclusions you’re making from those first two charts. This is what we call fragile inference, as Ed Leamer explained decades ago in an article called “Let’s Take the Con Out of Econometrics”. My guess is Mark has read it, but either forgot about it or got a bit carried away by the fun of refuting Krugman.
If anyone has time to do it, since we have Mark’s data, someone should rerun those first two regressions without Greece.
18. June 2015 at 21:13
Jeff
Surely you have that wrong? Take Greece out of the first two charts and the Keynesian case looks worse. It’s “fairer” to leave Geece in, even if it does unduly bias the result.
18. June 2015 at 22:01
Dr. Sadowski, what if you plot the following: countries with independent central banks that were also at the zero bound? Market monetarism would predict a flat curve, correct? Is that what you get?
18. June 2015 at 22:27
Scott, thanks for the reply. I’m fine with conditional predictions BTW, as long as they are testable. Perhaps on that basis you could put some potential daylight between the Keynesian and MM model predictions. I realize that reality might not cooperate in generating that “natural” experiment, but it might.
18. June 2015 at 22:36
Jeff,
The most important chart for Market Monetarists is chart 3, which doesn’t contain Greece.
When it comes to fiscal policy in countries without independent monetary policy, it depends on how the monetary policy affects that country. For example, if the ECB had been very stimulative, then Greek austerity would not have had anything like the same affect on NGDP.
Where monetary policy has been tight, as in the Eurozone, there can be a relatively straightforward relationship between NGDP and fiscal policy. However, you are right to note that the slope is largely driven by Greece. On a purely visual analysis, there would be an inverse but weak correlation between NGDP and CAPB changes in that dataset if you removed Greece.
18. June 2015 at 23:16
Congrats, Mark. A brilliant future awaits!
18. June 2015 at 23:27
Congratulations Mark!
18. June 2015 at 23:49
Congrats Mark on the doctorate! It has been such a pleasure reading your insights along with Scott’s these past few years. Keep up the good work! I agree with the hunch of others that you are going to do a lot of great things in the macro, if even just your blogging is a small hint of what is to come.
18. June 2015 at 23:53
Congrats Mark!
18. June 2015 at 23:55
As for this post, a very impressive empirical study and argument by Scott and Mark for monetary offset, yet again.
19. June 2015 at 00:46
So, that’s where you disappeared off to, finishing your dissertation.
Congratulations!
19. June 2015 at 01:52
Congratulations, Mark!
19. June 2015 at 02:30
W. Peden,
Eyeballing the chart, I disagree. Greece is not that far below the line. Removing it would change the angle but not that much. Lithuania is a bigger outlier.
19. June 2015 at 02:55
The argument is that fiscal policy has some effect, but only if the central bank is not offsetting it. Charts 1 and 2 are supposed to show a correlation between fiscal policy (“austerity”) and growth. I’m saying that if you take Greece out of there, what remains in both of those charts looks to me like a cloud of points with very little correlation. The charts actually support the idea that central banks don’t offset the effect of fiscal policy because there’s nothing to offset.
I’ve yet to see any evidence that fiscal policy has any influence on demand independent of the monetary policy that accommodates it.
19. June 2015 at 03:06
@Tom Brown,
Not sure if Scott and other MMs would agree, but I see MM as a prescriptive recommendation for policy rather than as a predictive model. I think the only thing MM might predict is that a determined, competent and independent CB can achieve a stable level target for NGDP.
19. June 2015 at 03:12
Congratulations Mark! We look forward to many more contributions from you. Way to hang in there.
19. June 2015 at 05:42
@Tom Brown
your description makes it sound like the MM model is “whatever the market says?” If that’s the case how can you lose with a model like that?
I think Prof Sumner would agree that the MM prediction is “whatever the market says.” (as he has said, that is what puts the “Market” in Market Monetarism) And as he points out, you could have lost with that model with, say, housing in 2006-2007 (and plenty of other times). But the alternative isn’t between the market versus some God’s eye point of view that is always right, it’s between the market versus a handful of economists, or a bunch of politicians, or Alan Greenspan’s “gut”, etc. etc.
Is there some way now to look at different future scenarios ahead of time with the MM model?
One problem with relying on markets is that they are really good at giving point estimates, but not so good at giving distributions. One can sometimes impute things that look like probabilities from market prices, but only rarely are those market predictions; mostly those prices are determined by the requirements of a non-arbitrage assumption.
But what is useful is that all of this prediction is conditional on the basic regime remaining constant. So if the market and the Fed’s predictions converge at about the same time that the Fed starts to say that their decision process is changing (e.g., language to the Fed minutes that states that ZIRP will continue for longer than 2015), then that would actually be evidence that the market was probably right that policy was too tight to meet the Fed’s predicted path of rates, and that because of the change they will now meet their target.
Now suppose that the inflation rate in Canada follows the Z model’s predictions and likewise deviates from the Canadian central bank’s inflation target. How would MMs explain that?
Note that if one actually created a “Z model” that could beat the market then they would probably use it to make money in the market. As that person entered the market and took bets in the direction of Z model’s prediction, prices in the market would change to incorporate this new prediction, and since you can’t keep a secret for long, once enough investors came to see the correctness of Z model, the market would converge to the Z model prediction.
19. June 2015 at 06:07
Question for Mark and Scott:
The view that Scott attributes to market Monetarists: (“Fiscal austerity is contractionary if you lack an independent central bank. Fiscal austerity would not be expected to have much effect if you have an independent central bank, due to monetary offset”) would also be held by New Keynesian in situations outside of the ZLB, wouldn’t it ?
On the other hand statement 2: “Fiscal austerity is contractionary at the zero bound regardless of whether you have an independent central bank.” would really only be held by Keynesians.
Given that: Shouldn’t the analysis focus on comparing only countries at the ZLB with and without independent CBs ? The datasets in the post appear to include countries not at the ZLB and (unless I have missed something) are not really relevant to statement 1. If I am correct you are just confirming what both New Keynesians and Market Monetarist both believe (statement 2).
Can you clarify ?
19. June 2015 at 06:29
Hey Scott, take a look at these graphs created using IMF data:
http://imgur.com/a/fXrQV
Now, the first graph clearly shows a negative correlation with fiscal consolidation and GDP per capita growth in the Eurozone whereas the correlation is roughly flat in non-EZ countries with an independent monetary policy.
However, if you scroll down to the second graph which excludes Greece there appears to be the same roughly-flat correlation even inside the EZ. Can you account for this?
19. June 2015 at 06:32
Congratulations, Mark. As far as I can tell, you’re real and you’re spectacular!
19. June 2015 at 07:07
@ W. Peden, Jeff
Take Iceland out of chart 3 as well.
Also, look at your t-stats, no only to your slope estimates …
having said that, visually it looks to me that the slope in chart 3 without iceland will not be significantly different from zero, whatever its value is …
19. June 2015 at 07:09
[…] reason for this is summed up in this post by Scott Sumner. From which this […]
19. June 2015 at 07:31
@Ashton, did you make the plots in your link?
19. June 2015 at 07:42
@TomBrown
No, I got them from a user on /r/economics over at reddit. He doesn’t mention flat correlation explicitly in his EZ graph excluding Greece, but it stood out to me as odd.
I’m probably just missing something obvious though.
19. June 2015 at 08:03
With respect to potential outliers (Jeff, W. Peden, Ashton, and Jose Romeu Robazzi) let me try and put my David Giles hat on.
1) Greece
Let’s do this backwards and drop Greece first and then talk about whether it is an outlier.
If Greece is removed from the Advanced Nation graph the p-value rises from 0.0008 to 0.127 so the relationship moves from being statistically significant at the 1% level to no longer even being significant at the 10% level.
If Greece is removed from the Euro Area graph the p-value rises from 0.0003 to 0.0547 so the relationship moves from being statistically significant at the 1% level to being significant at the 10% level.
Is Greece an outlier? There’s several rules of thumb for this, and unfortunately no hard rules on the subject. (Also it’s not always clear that dropping an observation is the best thing to do even if you decide that it is an outlier.) Greece is more than three standard deviations away from the mean in both CAPB and NGDP in the Advanced Nation group, and less than three standard deviations away from the mean in both CAPB and NGDP in the Euro Area group. In my opinion in each group it is a borderline outlier, although the argument for it being an outlier in the Advanced nation group is stronger than for it being an outlier in the Euro Area group.
In any case dropping Greece doesn’t lead to any results that Market Monetarism would find surprising.
2) Iceland
An argument can be made for Iceland being an outlier in terms of CAPB in the Monetary Policy Zone group. If it is dropped then the p-value falls from 0.9816 to 0.8118. So this still isn’t anywhere close to being statistically significant.
19. June 2015 at 08:12
Everybody: note how dishonest Sadowski is with the outliers, first admitting they distort the data, then backtracking and parsing his answer. Short answer: his study is nothing but data mining using too small of a sample size in too short of a time frame. Further, Market Fiscalist brings up good points not addressed. Finally, at Econlog Sumner makes this coded reference that is hard to decrypt: (Sumner): “I guess that’s why (left) liberal economists like Jeffrey Sachs think fiscal stimulus has failed—blind faith in laissez-faire economics. ” – wtf? Smearing Sachs somehow, in a snarky insider joke way. Classic Sumner, who blows hot and cold and is harder to pin down than a spineless jellyfish.
19. June 2015 at 08:18
@Ashton, thanks.
@Mark: just for clarity, if we were to increase the weight on the “Euro Area” point in plot #3 to be equal to the number of Euro Area countries (assuming all points currently have a weight of unity currently), would we end up with the same curve fit as in plot #1? I’m guessing “no” since I believe you weight them one per country in plot #1. How did you determine the Euro Area point to begin with?
What are your thoughts on weights on the points? Is it best to assign weights as 1 per independent central bank?
19. June 2015 at 08:28
With respect to the zero lower bound in interest rates (Tom Brown and Market Fiscalist),
if this should be our focus then there’s no reason to be looking at the individual nations of the Euro Area at all (as Krugman has repeatedly done) since we should get the same result, at or away from the zero lower bound, anyway. (All other things equal, if the government builds an Air Force base in Fargo, North Dakota it raises GDP there relative to Bismark, North Dakota, regardless of what the Federal Funds rate is.)
So which of these monetary policy zones are, or have been, at/near the zero lower bound in interest rates during 2009-2014 AND have independent central banks?
Well that would be the Czech Republic, the Euro Area, Japan, Sweden, Switzerland, the UK and the US. That’s only seven observations, but regressing change in NGDP on change in CAPB for these zones results in a p-value of 0.6705. (And, not that it really matters, but the slope is positive 0.39131.)
19. June 2015 at 08:45
@Mark,
It’s not just the p-value that matters. An effect can be statistically significant without being economically significant, and I suspect that’s true in this case.
CAPB (Cyclically Adjusted Primary Balance) is at an annual rate, I think. measuring the change in the annual
Suppose, for example, that the slope came out to be -0.5 rather than -2 in the second plot. That says that to get 5 percent more NGDP over 5 years, which is only 1 percent per year, you have to increase annual spending by 10 percent of potential GDP. That’s a multiplier of about one-tenth. Recessions often see dropoffs in NGDP of several percent. If the fiscal multiplier is only 0.1 and the government budget is 25 percent of GDP, you’d have to double or triple government spending just to get out of a pretty mild recession.
19. June 2015 at 08:52
The question isn’t whether Greece is an outlier, it’s whether it is too influential in the regression. Of course, there are no set rules on that either, but it has a crazy influential Cooks distance of about 2(!) in the all country analysis, so the fact that removing it turns a statistically significant result into a non-statistically significant result means that one had better figure out whether Greece belongs in your analysis or not! The first cut answer is the analysis presented here; namely you don’t include it if you are looking at countries with independent central banks, and you do if you aren’t.
Greece still has a large Cooks distance (about 1.2) in the Euro-only analysis, but that is a lot less important since its inclusion in that analysis is pretty well justified. And while it may be hugely influential, it is hardly an outlier. It may be the most important data point in the whole analysis.
19. June 2015 at 09:24
Tom Brown,
For the aggregate Euro Area NGDP data I added EA-12 NGDP to the other seven members to get EA-19 NGDP. I found this data at AMECO Online.
If you do weighted least squares with the Euro Area given 19 times the weight of the other points it leads to a p-value of 0.5228, so it is still not statistically significant.
More importantly, in my opinion, it’s an odd thing to do. There has to be some rationale for thinking that an observation is 19 times more important than the rest, other than it has 19 states in it. The important thing is the information each observation is giving us about the relationship between the two series, not how many states a monetary zone can be divided into. Weighted least squares is almost never used in cross-sectional studies because there’s usually no rationale for doing it.
19. June 2015 at 09:36
“Fiscal austerity is contractionary if you lack an independent central bank. Fiscal austerity would not be expected to have much effect if you have an independent central bank, due to monetary offset.”
Somewhat misleading, it gives the impression you need to have a central bank for austerity to not be contractionary. In fact, all you need is a banking system that offsets any change in government expenditures, it doesn’t have to be a central bank at all, independent or otherwise.
19. June 2015 at 09:43
@Mark, thanks. If you’re trying to disprove the Keynesian model then you should eliminate those not at the ZLB shouldn’t you (regardless whether or not you eliminate those w/o an independent CB or not)? After all, Scott writes above, when describing the Keynesian model:
“1. Keynesian: Fiscal austerity is contractionary at the zero bound regardless of whether you have an independent central bank.”
If that’s what you’re trying to address, then you pretty much are forced to eliminate the non-ZLB points, which leaves you with data you can’t draw a conclusion from (that is if you also eliminate those points w/o an independent central bank). Is that the correct interpretation?
Since the Keynesian model (as Scott describes it) includes both countries that have independent central banks and those that don’t, isn’t it valid to do yet another regression now with those countries (independent central bank or not) which are at the ZLB if we want to test the Keynesian model (using Scott’s description of it)?
19. June 2015 at 09:54
@Mark A. Sadowski
I haven’t looked at the full study, so correct me if I’m wrong and you have considered the issue, but isn’t there a methodological problem with aggregating the data over 2009-2014, instead of taking it year-by-year?
Also, wouldn’t there be issues with lumping large and small economies together?
Finally, given the nature of the scattering across the graphs, isn’t there a suggestion there that something is dominating the regression, or something is affecting the transmission of monetary/fiscal policies into nGDP despite the unified monetary regime? Or could such disparities *all* be put down to the difference in the aggressiveness with which such countries pursued their relative policies?
19. June 2015 at 09:55
@Jeff,
In the second graph, if we drop Greece, the slope coefficient is -1.379249.
@Njnnja,
Thanks for estimating the Cook’s distances! (And I agree.)
19. June 2015 at 09:57
Oh also, given the framing Scott used at the beginning regarding the Keynesian and the Market Monetarist position (if anything, I’d consider myself in the latter camp, by the way), wouldn’t it be better to look at data regarding *only* countries who are at the ZLB?
I think the idea of liquidity traps leaves a lot to be desired, but it seems that the best empirical consideration would isolate the countries who should, according to Keynesians, be in such a trap and then check the effect of fiscal consolidation + monetary policy.
19. June 2015 at 10:04
Mark, from you comment above, the p-value in plot #3 is 0.9816? So eliminating the non-ZLB points from plot #3 decreased the p-value to 0.6705?
19. June 2015 at 10:24
[…] despite these facially stimulative fiscal policies, given his obsolete views on monetary policy. Scott Sumner and Mark Sadowski have convincingly made the case that a sufficiently expansionary monetary policy can overcome and offset the ill-effects of fiscal […]
19. June 2015 at 10:31
Ashton,
Aggregating the changes in CAPB across time is not really a problem since the effect of fiscal policy on GDP is proportional to the change in the fiscal balance and not to its level. Furthermore, the major models assume that the great majority of this effect occurs within the first year. Thus with annual data we needn’t be too concerned about lagged effects.
On the other hand, the longer we stretch the time period, the less meaningful this sort of exercise becomes.
The data from small countries is more problematic than data from large countries. (Scott has done a few posts on that subject.) So if a small country has excessive influence on the overall results, it probably should raise some concern.
In the Euro Area the R-squared value tells us the proportion of NGDP growth variation that can be explained by the estimated linear relationship between NGDP and CAPB. While large (56.5%) it is a long way from 100%. There’s clearly other things going on here.
19. June 2015 at 10:42
Tom Brown,
If you’re making a claim about the effect of fiscal policy at the *zero lower bound* then by definition you are making a claim about *monetary policy*. The last thing you would want to do is to eliminate monetary policy from a regression to test that claim, which is what you would be doing by regressing on the individual states within a single monetary zone.
Yes, the p-value fell from 0.9816 to 0.6705, but the slope is *positive*. What exactly are you implying?
19. June 2015 at 11:31
@ Mark Sadowski
Thanks for the statistical clarifications (and patience). And even though we will probably never meet, congratulations on your (I’m sure hard earned) Phd.
19. June 2015 at 11:32
Mark, regarding the p-value: I’m not implying anything… just wanted to make sure I had the correct numbers.
Regarding the Keynesian model: I’m still having trouble squaring what you wrote with Scott’s description of this model (which seems to imply that a state can both be at the ZLB and not have it’s own monetary policy).
Are you disputing my interpretation of Scott’s description of the model, or are you disputing the logical coherence of the model (assuming my interpretation is correct)?
Maybe it’s easier if I just ask the following: how would you describe the Keynesian model?
19. June 2015 at 11:50
Sadowski!â„¢
19. June 2015 at 12:30
Tom Brown,
My impression is that you are allowing yourself to get tripped up by semantics. If you don’t mind, I’ll let Scott field the rest of your questions.
19. June 2015 at 12:38
OK, Mark, thanks.
19. June 2015 at 13:02
Tom Brown is right, the analysis here is garbage. Only ZLB countries should be studied if the test is to make any sense.
Somehow logic is not the strong suit for MMs.
http://informationtransfereconomics.blogspot.com/2015/06/this-analysis-is-so-bad.html
http://informationtransfereconomics.blogspot.com/2015/06/still-angry-about-sumners-analytical.html
19. June 2015 at 14:25
“let’s review the two competing theories:
“1. Keynesian: Fiscal austerity is contractionary at the zero bound regardless of whether you have an independent central bank.
“2. Market monetarist: Fiscal austerity is contractionary if you lack an independent central bank.”
To test these two theories against each other, we want to look at countries and situations where one of them is true and one is false. If either is false, then the country engaged in austerity but did not experience a contraction. So those are the conditions that we want to look at.
If the Keynesian theory is true and the market monetarist theory is false, then the country did not have an independent central bank and was not at the zero lower bound. If the market monetarist theory is true and the Keynesian theory is false, then the country did have an independent central bank and was at the zero lower bound.
19. June 2015 at 14:58
Mark’s regression tests appear to show a correlation between an independent monetary policy and absence of effect of fiscal austerity, which is fine.
As the datasets includes both ZLB and non-ZLB economies I was initially confused as to how they were relevant to disproving the claim that “Fiscal austerity is contractionary at the zero bound regardless of whether you have an independent central bank.”.
But I think the answer is this: The dataset includes some economies at the ZLB. If the Keynesian were right then these economies would have had contractions if they had fiscal austerity, and the regression line would slope down just like in charts 1 and 2. The fact that it doesn’t is the proof Scott was pointing at.
19. June 2015 at 17:17
Everyone, It looks to me like the line is still downward sloping without Greece, but flatter than before. I don’t have strong views on that case, and neither result would surprise me.
I’ll do a separate post on whether the non-zero bound countries should be included.
19. June 2015 at 17:34
@ssumner – you would do well to respond–in detail–to the blog links posted by OhMy that go to the heart of your arguments. And you would surprise the physicist – economist blogger there, who assumes you are ideologically hide bound and set in your ways. Prove him wrong please.
19. June 2015 at 17:44
Scott, Mark writes in a comment above:
“In the Euro Area the R-squared value tells us the proportion of NGDP growth variation that can be explained by the estimated linear relationship between NGDP and CAPB. While large (56.5%) it is a long way from 100%. There’s clearly other things going on here.”
The R-squared is close to zero for plot #3 (“Monetary Policy Zone”). Does that say there’s likely other things going on there as well? Does it make sense to try to factor in some of those things? For example: growth trends for the different monetary policy zones?
21. June 2015 at 07:39
Morgan – very nice!
21. June 2015 at 12:51
Ray, Have you read Jason’s blog? (I have a post that responds)
Tom, Yes, Keynesians need to do much more work to prove their point. I wish them luck.
23. June 2015 at 03:25
I am not sure whether anyone as already pointed this out, but the composition of the euro area in 2009 and in 2014 is not the same. Estonia joined in January 2011; Latvia and Lithuania in January 2014. Maybe they were de facto members before, but maybe not and so they pursued their own monetary policies.
Also, the correlations shown in Figure 1 and 2 seem greatly dependent on the data for Greece. Excluding it in figure 2 lowers r2 a lot, so that the association between both variables looks almost irrelevant.
23. June 2015 at 16:51
Wonka, Yes, but I am pretty sure it’s still significant w/o Greece. But I agree it looks less significant w/o Greece.
24. June 2015 at 16:21
“In fact, there are other studies similar to Mark’s. Benn Steil and Dinah Walker did one, and Kevin Erdmann did another”
Umm, are these in fact “other *studies*, or just “other *blog posts*”?
Congrats to Mark.