Wednesday, March 27, 2013

Could '09 Fiscal Stimulus Have Slowed GDP Growth?

Yes.  Scott Sumner via The Monetary Illusion, see here, explains.

Short version.  Essentially, New Keynesian Theory predicts that when the Federal Reserve Bank engages in inflation targeting behavior (which is what it does and what its mandate is) the fiscal policy multiplier is zero.  That is, when the Federal Reserve Bank behaves the way that the Federal Reserve Bank behaves, fiscal policy has zero effect and may have an impact that is worse than what would have occurred had the Federal Reserve Bank been left to utilize all of its available tools. 

Confusing?  Think of it this way: the Fed has tools that are better than the government's.  When the government uses its tools, the Fed puts away theirs, and the economy is the worse for it.