Bernanke on fiscal policy By Scott Sumner

Fiscal policy is the one area where I disagree most strongly with Ben Bernanke. In his new memoir (p. 387), he indicated that he supported Bush’s fiscal stimulus of early 2008.

But why? Bernanke gives no explanation at all. He also supported President Obama’s fiscal stimulus, however in that case he does give an explanation–near zero interest rates. But in early 2008 the Fed still had room to cut rates. So why didn’t they? If the economy needed fiscal stimulus, presumably it needed more aggregate demand. But that implies money was too tight. So why didn’t the Fed ease policy further in early 2008?

I know the answer—-the Fed was worried about high inflation. OK, but if you are worried about high inflation, then why would you favor more fiscal stimulus? It makes no sense, and Bernanke provides no explanation. (Was Bush doing the policy that his clueless colleagues at the Fed refused to do?)

Towards the end of the book he sums up what we have learned, and seems to put way too much emphasis on fiscal policy. On page 568, he suggests that the US recovery was stronger than elsewhere because our fiscal policy was less restrictive. And yet others who have looked at the data (such as Mark Sadowski) say this isn’t true. US fiscal policy during 2010-2014 was as tight if not tighter than in the Eurozone, and yet the US economy did dramatically better, it wasn’t even close. Bernanke also mentions that the US had more stimulative monetary policy, but actually gives the Fed too little credit. Monetary policy explains virtually all of the divergence between the US and the Eurozone after 2010.

On page 569 and 570 he notes that the UK also pursued a stimulative monetary policy, but then indicates that the UK had lower RGDP growth due to the fiscal austerity of the Cameron government. But the problem in the UK was not employment, which actually did better than in the US, but rather productivity. So Bernanke’s theory makes no sense. Demand-side policy reduces output by reducing employment. Supply shocks reduce productivity. How could British employment have done much better than US employment, if British fiscal policy was reducing aggregate demand?

On page 538 Bernanke indicates that the CBO estimated that fiscal austerity “would lop 1.5 percentage points off economic growth in 2013—growth we could ill afford to lose.” Many Keynesians worried that fiscal austerity could push us into recession. In fact, real GDP growth (4th quarter over 4th quarter) almost doubled in 2013, from 1.28% in 2012, to 2.45% in 2013. Monetary offset worked beautifully. Again, Bernanke gives himself too little credit. A few pages earlier he points out that in late 2012 the Fed had engaged in aggressive monetary stimulus because of fears that fiscal austerity would slow growth. So why didn’t the Fed take credit when it worked?

At least Bernanke does believe that QE is effective, and points to studies showing that it boosted growth. Some Keynesians adopt an even more bizarre position, that the fiscal austerity of 2013 dramatically slowed growth, and also that QE is ineffective. But they can’t have it both ways! Suppose you are a Keynesian, and you really believe that the $500 billion reduction in the Federal deficit in calendar 2013 reduced growth by 1.5%. That means you believe that without the austerity, growth would have been almost 4%, not 2.45%. But then consider this counterfactual. Suppose the Fed’s innovative moves in late 2012 had boosted growth from 1.28% in 2012, to 3.95% in 2013. Would there be a single economist in America who denied the power of QE3?

So when they talk about fiscal stimulus, they suggest that growth was only 2.45% in 2013, no big deal. QE is not very powerful. But when they talk about fiscal policy they tell us that the austerity was sharply reducing growth in 2013. But if that’s right, then QE must have been really powerful. Keynesians want to have it both ways—use the 2.45% figure when they want to discount the importance of QE, and then use the 3.95% figure when they want to point to the growth we could have had with a neutral fiscal policy. Well, which is it?

(Again, these final comments are not directed at Bernanke, who does acknowledge the effectiveness of QE, but rather to Keynesian skeptics who believe monetary policy is ineffective at the zero bound.)