Christina Romer advocates monetary stimulus in research and fiscal stimulus in policy

 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.

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8 Responses to “Christina Romer advocates monetary stimulus in research and fiscal stimulus in policy”

  1. MC Shalom Says:

    Even The Right Monetary and Fiscal Policy Can’t Get Us Out of the Depression

    DIE ZEIT: Can the right monetary and fiscal policy keep the US out of a recession?

    Alan Greenspan:

    “Probably not. Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market.

    Two to three decades, ago central banks were dominant throughout the maturity schedule.

    Thus, the more important question is the direction of long-term real interest rates.”

    Alan Greenspan
    The Great Irony of Success
    © ZEIT online, 30.1.2008

    If short-term risk-free interest rates are 0% doesn’t it that mean that credit is worthless?

    A Credit Free, Free Market Economy will correct all of those dysfunctions.

    The alternative would be to wait till, on the long run, most of our productive assets get physically destroyed either by war or by rust.
    It will be either awfully deadly or dramatically long.

    We Need, Hence, to Cancel All Interest Bearing Debt and Abolish Interest Bearing Credit.

    This Age of Turbulence People Want an Exit Strategy Out of Credit,
    An Adventure in a New World Economic Order.

    Exit Strategy out of Credit
    http://edsk.org/

    A Specific Application of Employment, Interest and Money. [For my Fellows Economists]
    http://edsk.org/interest.html

    Press release of my open letter to Chairman Ben S. Bernanke:

    Chairman Ben S. Bernanke, Quantitative Easing Can’t Work!
    http://www.prlog.org/10165667.html

    Yours Sincerely,

    Shalom P. Hamou AKA ‘MC Shalom’
    Chief Economist – Master Conductor
    1776 – Annuit Cœptis.

  2. MC Shalom Says:

    Ben S. Bernanke Exposed

    “The debate about the ultimate causes of the prolonged Japanese slump has been heated. There are questions, for example, about whether the Japanese economic model, constrained as it is by the inherent conservatism of a society that places so much value on consensus, is well-equipped to deal with the increasing pace of technological, social, and economic change we see in the world today.

    The problems of the Japanese banking system, for example, can be interpreted as arising in part from the collision of a traditional, relationship-based financial system with the forces of globalization, deregulation, and technological innovation (Hoshi and Kashyap, forthcoming). Indeed, it seems fairly safe to say that, in the long run, Japan’s economic success will depend largely on whether the country can achieve a structural transformation that increases its economic flexibility and openness to change, without sacrificing its traditional strengths.

    In the short-to-medium run, however, macroeconomic policy has played, and will continue to play, a major role in Japan’s macroeconomic (mis) fortunes. My focus in this essay will be on monetary policy in particular. Although it is not essential to the arguments I want to make—-which concern what monetary policy should do now, not what it has done in the past—-I tend to agree with the conventional wisdom that attributes much of Japan’s current dilemma to exceptionally poor monetary policy-making over the past fifteen years (see Bernanke and Gertler, 1999, for a formal econometric analysis).

    Among the more important monetary-policy mistakes were 1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the “bubble economy”; 2) the apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash; and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously

    Bernanke and Gertler (1999) argue that if the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better. Bank of Japan officials would not necessarily deny that monetary policy has some culpability for the current situation. But they would also argue that now, at least, the Bank of Japan is doing all it can to promote economic recovery.

    For example, in his vigorous defense of current Bank of Japan (BOJ) policies, Okina (1999, p. 1) applauds the “BOJ’s historically unprecedented accommodative monetary policy”. He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to 2 Posen (1998) discusses the somewhat spotty record of Japanese fiscal policy; see especially his Chapter 2.its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?

    I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—- objections which, I will argue, could be overcome if the will to do so existed.

    My objective here is not to score academic debating points. Rather it is to try in a straightforward way to make the case that, far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.”

    Prof. Benjamin Shalom Bernanke
    Japanese Monetary Policy: A Case of Self-Induced Paralysis?
    For presentation at the ASSA meetings, Boston MA, January 9, 2000.

    So Mister Chairman Ben S. Bernanke is not fit to deal with the present situation he does not even readily understand.
    Moreover, he advocates illegality.
    There is no pilot in this plane! We are going to crash!

    If short-term risk free interest rates are at 0.00% doesn’t that mean that credit is worthless?

    A Credit Free, Free Market Economy will correct all of those dysfunctions.

    The alternative would be to wait till, on the long run, most of our productive assets get physically destroyed either by war or by rust.
    It will be either awfully deadly or dramatically long.

    In This Age of Turbulence People Want an Exit Strategy Out of Credit,
    An Adventure in a New World Economic Order.

    We Need Hence Abolish Interest Bearing Credit and Cancel All Interest Bearing Debt.

    A Specific Application of Employment, Interest and Money
    [Intended to my Fellows Economists].

    http://esdk.org/interest.html

    Exit Strategy Out of Credit
    http://edsk.org/

    Press release of my open letter to Chairman Ben S. Bernanke:

    Chairman Ben S. Bernanke, Quantitative Easing Can’t Work!
    http://www.prlog.org/10165667.html

    Yours Sincerely,

    Shalom P. Hamou AKA ‘MC Shalom’
    Chief Economist – Master Conductor
    1776 – Annuit Cœptis.

  3. Rajiv K Raman Says:

    Nice stuff. Am a regular visitor and read some. On Romer’s paper of the Great Depression, you can find a free preprint at http://www.nber.org/papers/w3829.pdf

  4. Nick Says:

    It’s pretty straightforward really. The reason people are advocating a fiscal stimulus is that the Fed is running out of options. The Fed funds rate is basically 0. They are still doing this “quantitative easing” which involves buying illiquid assets and exchanging them for treasuries and more liquid assets, but the effectiveness of this policy is far more debatable than the effect of interest rate cuts. Back during the Great Depression we still had a Gold Standard until Roosevelt went off, and there was not doubt that going off Gold was a major factor in the recovery. There is no such equivalent today – it is highly unlikely that monetary policy could really lead this recovery.

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