I am still reading this much discussed research by Christina Romer and Jared Bernstein where they estimate the impact of Obama plan (Econbrowser has a nice graph which explains the impact in a nutshell). Both head Council of Economic Advisors of President elect Obama, so it is a must read. Another thing to read is CBO’s estimate of the US economy (I will try and do a comparison later on; for insights read Krugman’s blog).
Coming back to Romer/Bernstein estimation, NYT points:
Christina Romer, whom Mr. Obama has designated to be his chief economist, concluded in research she helped write in 1994 that interest-rate policy is the most powerful force in economic recoveries and that fiscal stimulus generally acts too slowly to be of much help in pulling the economy out of recessions, though associates said she now supports a big stimulus package if policy makers roll it out early enough in the recession.
This is so true. The article refers to this paper (it is a paid paper; i am unable to locate a free version) from C.Romer:
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
(emphasis is mine)
Now, this crisis is still not as bad as 1980 crisis or 1945 crisis and we are still far away from Great Depression figures. And as per Romer monetary stimulus alone was enough to get US economy out of great depression. This point has been raised by Friedman and Bernanke as well- monetary policy is what led to Great Depression in US (Bernanke’s speech sums it up) and monetary policy is what led to a recovery (Romer’s paper; I am still reading on what ended Great Depression and there is wide disparity – read Ohanian’s views as well; It is for no reason that Bernanke calls it the holy grail of macroeconomics)
So, what makes Romer do the flip and support the fiscal stimulus? And that too with Bernanke at the helm who knows quite a bit of what all this is about? Fed and Bernanke have reiterated that Fed has the tools and Fed has been quite aggressive as well. So, does Romer (and her team) believe Fed would not be able to get the desired results as the crisis is expected to be more severe? Or does she believe that both fiscal and monetary stimulus would be needed. Eitherways you look at it it is a flip which needs to be explained.
All this takes me to Niranjan’s blogpost (also read ME comments on the post). Niranjan pointed that despite Raghu Rajan’s research showing financial markets are not what they are made out to be, he has different ideas for India. Why should this be? Is it the case that though their research points out something, economists’ policy prescription is different? Why should this flip be? I have read Raghu Rajan’s prescription for India and was surprised not to find his paper being mentioned anywhere. The financial sector reforms are for a longer run and one should also be advising the policymakers on how to mitigate the same excesses he saw in developed financial markets.
On similar lines why can’t Romer simply say Fed is the best way out. Puzzling and interesting indeed.