Download Summary of DeLong-Summers View

Discussion by Valerie A. Ramey
Brookings
March 23, 2012
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1.
Summary of DeLong and Summers view.
2.
Notable elements of their model.
3.
4.
5.
Test of ability of government spending to
reverse hysteresis effects.
Test of differential multipliers at times of slack
and low interest rates
A word of caution on extrapolating from past
interest rates.
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Traditional Elements
-Most of the time output is supply-determined,
so output is equal to potential.
- During times such as the Great Recession and
aftermath, output is below potential and is
demand-determined.
- Government spending can raise output when
it is below potential.
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Less Traditional Elements
- Hysteresis effects of current output gaps on
future potential output.
Operate through the effect of reduced investment
on future capital and the effect of unemployment
on worker skills and labor force attachment.
- Interest rates at the ZLB
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For a variety of parameter values short-run
increases in government spending during a
slump can pay for themselves in the long-run.
Thus, we shouldn’t let fear of government
budget deficits prevent us from enacting
another stimulus package now.
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It’s the Keynesian Version of
“Supply-Side Economics”
Or
Say’s Law: “Government spending
creates its own financing”
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The DS model is missing the “GE” of the DSGE
model - No general equilibrium.
No specification of the assumptions about
fundamentals, such as preferences, technology,
and resource constraints.
Policies are evaluated solely by effect on output,
not on household welfare.
Overall, the model lacks the rigor of modern
macro models.
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The reason that we can criticize modern
macroeconomic models is that they are explicit
about their assumptions about fundamentals
such as preferences, technologies and resource
constraints.
Of course, being precise means making
simplifying assumptions that are often
questionable – there are many elements of
modern macro models that I question.
However, replacing them with models based on
vague intuitive ideas is not an improvement.
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Hysteresis effect
on future
potential output
Multiplier
𝜂µ𝑟
𝑟<𝑔+
1 − µ𝑟
growth rate of potential
output
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DS assume not only that an output gap today leads
to lower future potential output but also that
raising output with government spending will
reverse this effect.
It is not obvious to me that an increase in
government spending would create the private
investment and skill-building jobs required to
reverse the effect.
We can test this hypothesis on U.S. data: if G raises
Y in the short-run, it should have a persistent
effect on output.
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EVAR from Ramey (2011): 1939q1-2008q4
gdp
-.1
-.5
0
0
.1
.5
.2
1
.3
1.5
.4
government spending
4
8
12
16
20
0
4
8
12
16
quarter
quarter
total hours
nonresidential investment
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-1.5
-.1
-1
0
-.5
.1
0
.2
.5
.3
0
0
4
8
12
quarter
16
20
0
4
8
12
16
20
quarter
Blanchard-Perotti SVAR shows the same patterns
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Standard VARs suggest that the effect of
government spending on output lasts only as
long as the government spending.
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My recent paper (Ramey (2012)) uses a
more precise way to estimate the multiplier
in a VAR and using IV.
It looks at the effect of government
spending on private spending (Y – G).
This method indicates that multipliers are
significantly below unity – about 0.5 when
tax effects are accounted for.
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DS and numerous others have argued that
the multiplier may be higher when there is
slack in the economy and when interest
rates are at the Zero Lower Bound.
In principle, it is possible to test these
hypotheses on historical data.
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Monthly Data from 1931 to 1951
Civilian Unemployment Rate
15
10
percent
1931 1935 1939 1943 1947 1951
0
0
5
1
percent
2
20
3
25
3-Month Treasury Bill Rate
1931 1935 1939 1943 1947 1951
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∆𝑌𝑡
∆𝐺𝑡
∆𝑌𝑡−1
= 𝛽0 + 𝛽1
+ 𝛽2
+ 𝜀𝑡
𝑌𝑡−1
𝑌𝑡−1
𝑌𝑡−2
• Monthly data, 1933m1 – 1951m12
• Gordon-Krenn GDP and government spending
data
• My unemployment series to create slack variable
• IV using lagged government spending (my news
variable had low first-stage f-statistics)
• Allow β’s to differ if unemployment>7%
∆𝑌𝑡
∆𝐺𝑡
∆𝑌𝑡−1
= 𝛽0 + 𝛽1
+ 𝛽2
+ 𝜀𝑡
𝑌𝑡−1
𝑌𝑡−1
𝑌𝑡−2
• Estimate of β1 = 0.593, s.e. 0.116 during nonslack times. Increment to β1 during slack times
is -0.031, s.e. 0.530.
• The estimates also show that the multiplier
during this period of accommodative monetary
policy doesn’t seem to be any bigger than for the
1939-2008 period studied in my previous work.
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DeLong and Summers look at historical data on
long-term government interest rates to argue
that it is unlikely that interest rates will rise
significantly.
It is always wise to bear in mind the Lucas
Critique – historical data was not generated in a
regime when entitlements led to projections of
every-rising deficits.
Consider the following example:
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A Tale of Two Countries
3
4
5
6
7
Long-Term Interest Rates on Government Debt
2000
2002
2004
month
Country A
2006
2008
Country B
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0
5
10
15
20
25
Long-Term Interest Rates on Government Debt
2000
2004
2008
2012
month
Country A
Country B
20
20
25
Long-Term Interest Rates on Government Debt
10
15
Greece
0
5
U.S.
2000
2004
2008
2012
month
Country A
Country B
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DeLong and Summers offer the intriguing and
thought-provoking idea that temporary stimulus
packages might be self-financing.
I have qualms about the lack of rigor of their
model. It would be great to see these ideas
incorporated in a modern macro model.
I can’t find any empirical evidence to support
their key mechanisms.
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