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Monday, January 12, 2009

Honest Brokers

There's been a lot written recently about what a paper by David and Christina Romer's says about spending versus tax multipliers, and whether Christina Romer's public views on behalf of the Obama administration are consistent with the results of this paper. Since this all started with Greg Mankiw saying that Christina Romer is supporting policies in public that she actually disagrees with, or at least should disagree with if she believes (Greg's version of) her own research, i.e. this is a way to say that she is not being an honest broker, let's give the microphone to her colleague Brad DeLong for a response. First, Mankiw:

Team Obama assumes that tax changes are less than half as potent in influencing the economy as the new CEA Chair estimated them to be in her own research.

He repeated this in NY Time column. Here's DeLong:

The Romer View of Tax and Spending Multipliers Revisited, by Brad DeLong: My statement:

There appears to be an error in N. Gregory Mankiw's "Economic View" column of January 11, 2009. The error is the association of Christina Romer with the proposition that the tax multiplier--the effect on GDP of a tax cut--is twice the spending multiplier. The Romers' article does not distinguish between the two, referring only to the "substantial multiplier... due to the procyclical behavior of investment" (p. 37 of the working paper version, at http://tinyurl.com/dl20090111). David Romer in conversation two years ago characterized the paper to me as "hyper-Keynesian... suggesting very large multipliers..." The Romers believe in a tax multiplier no larger than the spending multiplier, and they certainly do not believe that a balanced-budget equivalent reduction in taxes and spending provide any Keynesian stimulus at all.

Mankiw's comparison of the 1.4 estimated spending multiplier from Valerie Ramey's study with the 3.0 estimated tax multiplier from the Romers' study is inappropriate. The two studies use very different methodologies. They are not comparable. For example, the Ramey study on the effects of government spending--while a superb contribution to the literature, and one that I have assigned to my graduate students--does not fully control for the tax increases that often accompany spending increases. Thus it is very likely to understate the effects of spending increases alone: her study assesses the impact of the Korean-War military spending increase without taking account of the fact that it was accompanied by a large tax increase.

What Romer and Romer's study (and their earlier work on monetary policy) shows is not that tax cuts are uniquely effective, but rather that failing to consider the reasons for policy changes leads to underestimates of the effects of all types of stimulus. Because these issues of omitted variable bias are likely to be as strong for spending as for tax changes, the most reasonable interpretation of their paper is that all types of fiscal stimulus are more potent than conventional estimates would lead us to believe.

It is somewhat puzzling that Mankiw appears to believe that the Romers do think that tax multipliers are larger than spending multipliers, as they do not, and this is something that he could have very easily checked.

More from Brad:

Note to Self: Tax and Spending Multipliers: Is there any way to interpret Greg Mankiw's Sunday New York Times other than as an elbow to Christie's ribs while he thinks the ref's eye is elsewhere?

Christie certainly does not believe that tax multipliers are twice the size of spending multipliers.

My own view is simple, I don't think Christina Romer is supporting things in public that she doesn't believe privately. Maybe past CEA chairs did that and are hence sensitive on this issue, I don't know, but I have no reason to believe she'd be anything but straightforward on the issue:

I'm going to assume that Christina Romer is the best judge of her own research and how it applies to the present situation.

But that's not to say I think that about every CEA chair. This makes you wonder:

CEA Chair Lazear on the Economy, by Menzie Chinn: From the Washington Post:

..."It does look like a great eight years, aside from the last quarter, unfortunately," Edward P. Lazear, chairman of Bush's Council of Economic Advisers, said in a recent interview...

Anyway, for more fun, see Nate Silver's post on Mankiw's NY Times article, Greg Mankiw's response, Andrew Gelman's follow-up (Mankiw can be found there in comments - too bad he doesn't allow comments on his own site so that others could do what he did and respond to his some of the claims that he makes), then see Free Exchange and Nick Rowe in follow-up posts. The question is, essentially, whether policy effects are state dependent (vary with the state of the economy). I have a J. of Econometrics paper that finds state dependency for monetary policy (it's much less effective in recessions than at full employment), and as I've noted here many times over the last few years, I believe fiscal policy is similarly dependent on the state of the economy, though I would expect - consistent with basic Keynesian theory - that the effects run in the opposite direction. That is, unlike monetary policy, fiscal policy is most likely to be effective when the economy is sputtering (one reason is that crowding out, the main factor that undercuts fiscal policy effectiveness, will be small or non-existent), and least effective at full employment. That's why, from the start of this thing, I have been pessimistic about the ability of monetary policy to do the recovery job alone and have been pushing for strong fiscal policy measures. We are finally moving in that direction, though we aren't there yet, so let's hope that the delay to this point, and the attempt by some to further undermine and forestall fiscal policy, isn't fatal.

    Posted by on Monday, January 12, 2009 at 05:22 PM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (24)



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