On the fifth anniversary of President Barack Obama’s fiscal stimulus, defenders of the policy were out in force making the case that it worked. Most of their arguments failed to address the strongest reason for doubting that it did much good.
That reason has to do with the Federal Reserve. To the extent that the central bank has a target for inflation (or nominal spending), and has the power to hit that target, the Fed constrains the power of fiscal policy. If Congress tries to stimulate the economy during a slump, for example, the Fed will offset that stimulus by loosening money less. Some of this offsetting will actually be automatic, based on market expectations that the Fed will stay on target.
It's likely that if Congress hadn't enacted a large stimulus, the Fed would have done more quantitative easing early on, lowered interest on reserves or taken some other expansionary step. Here is some evidence that when you take account of this possibility, fiscal stimulus has no effect.
That evidence does not mean that fiscal stimulus can never have a positive effect on an economy in a slump. Maybe the Fed has only a rough target, or faces insurmountable political obstacles to hitting it in some circumstances. Or maybe the market is too rattled for expectations to be stable.
But evaluations of fiscal stimulus will vastly exaggerate its effect if they ignore the Fed -- and the estimates that defenders of Obama's stimulus have been citing, and the arguments they've been making, have almost always ignored it. This recent essay defending the stimulus, for example, doesn't mention the words “Fed,” “Bernanke,” “central bank” or “monetary.” Neither does this one.
The argument about monetary offset has been made most strongly in recent years by "market monetarists" such as the economics professors Scott Sumner and David Beckworth. Market monetarism has been rising in influence. The fact that smart economic commentators don't feel the need to mention monetary offset, let alone grapple with it, suggests how far it still has to go.
(Ramesh Ponnuru is a Bloomberg View columnist, a visiting fellow at the American Enterprise Institute and a senior editor at the National Review.)
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