Home > Economics > The fiscal multiplier (redux)

The fiscal multiplier (redux)

December 23, 2011 Leave a comment Go to comments

Maybe we can make this all a lot simpler. Everyone should agree that under the following conditions, the fiscal multiplier is roughly zero

 

1) The central bank has a mandate that it fulfills through setting the level of Aggregate Demand in the economy

2) The central bank has the operational ability to set AD to be whatever it likes

3) The central bank will always set AD to be at a level it believes will fulfill its mandate.

 

Arguments over the existence of a ‘liquidity trap’ attack premise 2. I do not find those arguments persuasive, but I won’t list why here (I have no comparative advantage. For a good explanation, I can’t better this). The point that Noah Smith made the other day would be an argument against premise 3. He essentially points out the fact that central banks have, in fact, failed to meet their mandate. The central bank should want more AD, can deliver more AD, but isn’t delivering more AD. Under this condition, there would be a positive fiscal multiplier (up until the point AD reaches the desired level of the central bank).

So the circumstances where central bank ‘incompetence’ results in a fiscal multiplier are actually very limited. The central bank could be incompetent in ways that don’t result in a multiplier (for example, being mistaken as to the level of AD necessary to fulfill its mandate). It is only the bank being seemingly inconsistent (wanting x, being able to produce x and not doing so) that generates a multiplier. There is a non-zero probability that this has happened. But I agree with Scott writing in my comments section that Keynesian models of the multiplier are still useless. This would be a Pyrrhic victory for the Keynesians.

So there you have it. Now if we could all come up with a good model explaining why central banks are being inconsistent, then that would be super. My suspicion is there’s some public choice factors lurking in there somewhere, caused by the astounding incoherence of the implicit economic models used by both the political establishment and the economic elite. But I don’t have any answers… yet.

 

Categories: Economics
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  1. June 9, 2015 at 2:27 pm

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