US / Christina Romer: Use fiscal policy, the other main tool

In a fascinating speech last week at Johns Hopkins (via Matthew Klein), former Obama economic advisor Christy Romer proposes a totally different framework for stimulus.

Essentially we lean on fiscal stimulus more, but we set it up so that it’s permanently flexible … and thus more like monetary policy.

So when the economy goes to crap, payroll taxes automatically drop and other extra benefits automatically rise. And when the economy recovers, payroll taxes begin to rise and other benefits are pulled back. Basically, counter-cyclical fiscal policy is just built into the law.

She says:

The most obvious way around the problem caused by the zero lower bound is to use the other main tool in the government’s arsenal to deal with recessions—that is, fiscal policy. If we cannot spur spending and recovery by lowering interest rates, because they are already at zero, we can do it by temporarily lowering taxes and increasing government spending. However, as someone who played a role in crafting the Recovery Act, the fiscal stimulus passed in February 2009, I am acutely aware of how hard it is to get adequate fiscal stimulus through Congress and out into the economy in a timely fashion—even in the midst of a terrible economic crisis.

But fiscal stimulus does work. Study after study has been done on the Recovery Act and the impacts of fiscal stimulus more generally. Though the studies find that some fiscal actions are more effective than others, almost all conclude that tax cuts and spending increases do help spur the economy in the near term. If the fact that normal interest rates are now lower means that we will be hitting the zero lower bound more frequently, we may want to consider ways to use fiscal stimulus faster and more effectively.

You may be surprised to hear that I am a supporter of some form of balanced budget amendment. The fiscal stalemate and irresponsibility in Washington simply has to stop if we are going to remain an economic superpower. But within a framework of fiscal responsibility, such as a balanced budget amendment, it would be possible and, I think, sensible to build in more fiscal fire-fighting power.

We could set up a system that automatically cuts tax rates and increases unemployment benefits and food stamps when the economy weakens. This would get us fiscal stimulus quickly when the economy needs it. To balance out this automatic fiscal expansion, we could require automatic debt reduction in particularly good years. Such a new fiscal policy framework could get us the macroeconomic stability we want, with fiscal responsibility, despite the existence of the zero lower bound.

Romer is far from the first to go in this direction.

Chosen excerpts by Job Market Monitor. Read the whole story at 

via Christina Romer On Automatic Fiscal Stimulus – Business Insider.

Related Posts

US / Fiscal ‘mess’ undermines Fed on jobs says Dallas Fed President Richard Fisher

“As long as inflationary expectations are held at bay, we can fully open the monetary throttle in an effort to deliver on the mandate Congress gave us to help achieve full employment,” said Fisher. “But it is for naught as long as the fiscal authorities are slamming on the brakes and leaving everyone in the dark as to how they will cure the fiscal mess they have wrought.” Continue reading »

Fed Nomination / Obama Praises Yellen

President Obama on Wednesday announced what he called perhaps his most important economic decision, nominating Janet L. Yellen to lead the Federal Reserve system and be his independent co-steward of the economy, calling her “one of the nation’s foremost economists and policy makers.” Ms. Yellen, 67, would be elevated from the Fed’s vice chairwoman to … Continue reading »

Fed / Aggressive easing needed says Yellen in an address to AFL-CIO

The Federal Reserve’s aggressive easing of monetary policy is warranted given the still-battered state of the U.S. labor market, Fed Vice Chairwoman Janet Yellen said on Monday. In an address to the politically influential AFL-CIO, the largest U.S. labor group, Yellen, a potential successor to Fed Chairman Ben Bernanke next year, bemoaned the unusually weak … Continue reading »