Political Economy
Toward a Political Economy of Macroeconomic Thinking
Gilles St. Paul
NBER Working Paper, September 2011
Abstract:
This paper investigates, in a simplified macro context, the joint determination of the (incorrect) perceived model and the equilibrium. I assume that the model is designed by a self-interested economist who knows the true structural model, but reports a distorted one so as to influence outcomes. This model influences both the people and the government; the latter tries to stabilize an unobserved demand shock and will make different inferences about that shock depending on the model it uses. The model's choice is constrained by a set of auto-coherence conditions that state that, in equilibrium, if everybody uses the model then it must correctly predict the moments of the observables. I then study, in particular, how the models devised by the economists vary depending on whether they are "progressive" vs. "conservative". The predictions depend greatly on the specifics of the economy being considered. But in many cases, they are plausible. For example, conservative economists will tend to report a lower Keynesian multiplier, and a greater long-term inflationary impact of output expansions. On the other hand, the economists' margin of manoeuver is constrained by the auto-coherence conditions. Here, a "progressive" economist who promotes a Keynesian multiplier larger than it really is, must, to remain consistent, also claim that demand shocks are more volatile than they really are. Otherwise, people will be disappointed by the stabilization performance of fiscal policy and reject the hypothesized value of the multiplier. In some cases, auto-coherence induces the experts to make, loosely speaking, ideological concessions on some parameter values. The analysis is illustrated by empirical evidence from the Survey of Professional Forecasters.
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Andrew Young & Russell Sobel
Public Choice, forthcoming
Abstract:
We examine the US state-level pattern of American Recovery and Reinvestment Act (ARRA) spending. We relate spending to (1) Keynesian determinants of countercyclical policy, (2) congressional power and dominance, and (3) presidential electoral vote importance. We find that the ARRA is, in practice, poorly designed countercyclical stimulus. After controlling for political variables, coefficients on Keynesian variables are often statistically insignificant. When they are statistically significant they are often the "incorrect" sign. On the other hand, statistically significant effects are associated with majority party House of Representative appropriations subcommittee and authorization committee membership. One striking result is that the elasticity of ARRA spending with respect to the pre-ARRA ratio of federal grants and payments to federal taxes paid is estimated to be greater than unity in most specifications. States previously capturing large amounts of federal funds continue to do so under the ARRA stimulus.
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Can Government Purchases Stimulate the Economy?
Valerie Ramey
Journal of Economic Literature, September 2011, Pages 673-685
Abstract:
This essay briefly reviews the state of knowledge about the government spending multiplier. Drawing on theoretical work, aggregate empirical estimates from the United States, as well as cross-locality estimates, I assess the likely range of multiplier values for the experiment most relevant to the stimulus package debate: a temporary, deficit-financed increase in government purchases. I conclude that the multiplier for this type of spending is probably between 0.8 and 1.5.
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Eric Swanson
Brookings Papers on Economic Activity, Spring 2011, Pages 151-188
Abstract:
This paper undertakes a modern event-study analysis of Operation Twist and uses its estimated effects to assess what should be expected for the recent policy of quantitative easing by the Federal Reserve, dubbed "QE2." The paper first shows that Operation Twist and QE2 are similar in magnitude. It then identifies six significant, discrete announcements in the course of Operation Twist that could have had a major effect on financial markets and shows that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significant but moderate, amounting to about 15 basis points (bp). This estimate is consistent both with time-series analysis undertaken not long after the event and with the lower end of empirical estimates of Treasury supply effects in the literature. The effects of Operation Twist on long-term agency and corporate bond yields are also statistically significant but smaller, about 13 bp for agency securities and 2 to 4 bp for corporates. Thus, the effects of Operation Twist seem to diminish substantially as one moves from Treasury securities toward private sector credit instruments.
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Laffer paradox, Leviathan, and political contest
Toshihiro Ihori & C.C. Yang
Public Choice, forthcoming
Abstract:
This paper considers a political contest model wherein self-interested politicians seek rents from the public budget, while general voters make political efforts to protest against politicians' rent seeking directly (for example, through voting in referendums such as the passage of Proposition 13) or indirectly (for example, through donating money to organized groups such as the National Taxpayer Union). We show that the political contest may ironically lead to the Laffer paradox; that is, rent-seeking politicians may intend to set the tax rate higher than the revenue-maximizing rate. For taming Leviathans, political protests may not be as effective as competition among governments.
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Fiscal Stimulus in a Monetary Union: Evidence from U.S. Regions
Emi Nakamura & Jón Steinsson
NBER Working Paper, September 2011
Abstract:
We use rich historical data on military procurement spending across U.S. regions to estimate the effects of government spending in a monetary union. Aggregate military build-ups and draw-downs have differential effects across regions. We use this variation to estimate an "open economy relative multiplier'' of approximately 1.5. We develop a framework for interpreting this estimate and relating it to estimates of the standard closed economy aggregate multiplier. The closed economy aggregate multiplier is highly sensitive to how strongly aggregate monetary and tax policy "leans against the wind.'' In contrast, our estimate "differences out'' these effects because different regions in the union share a common monetary and tax policy. Our estimate provides evidence in favor of models in which demand shocks can have large effects on output.
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An Empirical Analysis of the Revival of Fiscal Activism in the 2000s
John Taylor
Journal of Economic Literature, September 2011, Pages 686-702
Abstract:
An empirical review of the three fiscal stimulus packages of the 2000s shows that they had little if any direct impact on consumption or government purchases. Households largely saved the transfers and tax rebates. The federal government only increased purchases by a small amount. State and local governments saved their stimulus grants and shifted spending away from purchases to transfers. Counterfactual simulations show that the stimulus-induced decrease in state and local government purchases was larger than the increase in federal purchases. Simulations also show that a larger stimulus package with the same design as the 2009 stimulus would not have increased government purchases or consumption by a larger amount. These results raise doubts about the efficacy of such packages adding weight to similar assessments reached more than thirty years ago.
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The Quality of Public Investment
Shankha Chakraborty & Era Dabla-Norris
B.E. Journal of Macroeconomics, 2011
Abstract:
Macro-level estimates of the productivity of public capital are typically larger than micro-level estimates. The evidence also shows sizable cross-country differences in the quality of public capital. A general equilibrium growth model is introduced to explain both facts. The productivity of firms specializing in differentiated intermediate inputs depends on public capital whose provision is subject to bureaucratic corruption. Higher corruption lowers the quality of public capital and discourages specialization as well as development. Persistent difference in this quality results from multiple equilibrium levels of corruption. Simple calculations show that (i) relatively small micro-level productivity effects of public capital generate large macro-level effects, and (ii) quality differences in public capital can potentially explain a large fraction of the income gap between rich and poor nations.
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Economic freedom, culture, and growth
Claudia Williamson & Rachel Mathers
Public Choice, September 2011, Pages 313-335
Abstract:
How do economic freedom and culture impact economic growth? This paper argues that culture, as measured by the World Values Surveys, and economic institutions associated with economic freedom are both independently important for economic prosperity, but the strength of their impact can be better understood only when both are included in the growth regression. Our results indicate that economic freedom is more important than culture for growth outcomes, suggesting substitutability between the two. We posit that culture is important for growth when economic freedom is absent, diminishing in significance once economic freedom is established.
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Andrew Berg, Jonathan Ostry & Jeromin Zettelmeyer
Journal of Development Economics, forthcoming
Abstract:
We identify structural breaks in economic growth in 140 countries and use these to define "growth spells:" periods of high growth preceded by an upbreak and ending either with a downbreak or with the end of the sample. Growth spells tend to be shorter in African and Latin American countries than elsewhere. We find evidence that growth duration is positively related to: the degree of equality of the income distribution; democratic institutions; export orientation (with higher propensities to export manufactures, greater openness to FDI, and avoidance of exchange rate overvaluation favorable for duration); and macroeconomic stability.
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Is the Fundamental Science of Macroeconomics Sound?
David Colander
Review of Radical Political Economics, September 2011, Pages 302-309
Abstract:
Recently, Ben Bernanke has argued that in the events leading up to the financial crisis, mistakes were made, but they were primarily engineering or management mistakes, not mistakes in the fundamental science of macroeconomics, which he sees as sound. This paper argues that Bernanke is wrong and that standard macroeconomics has not recognized, and still does not recognize, the limits of science and of formal modeling when studying something as complex as the macro economy. This failure to recognize, and adequately convey to policy makers, the limits of our scientific understanding of the macro economy, has led standard macroeconomics to combine fundamental science and policy applications in ways that undermine both. This paper advocates a classical methodological approach, which Keynes followed as well, that strictly separates fundamental science from policy analysis. Policy does not directly follow from models; it follows from reasoned analysis which uses models, but which combines models with institutional knowledge, intuition, and common sense.
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Saeid Mahdavi & Joakim Westerlund
Journal of Policy Modeling, forthcoming
Abstract:
Most state (and local) governments in the U.S. operate under formal fiscal rules which limit their ability to run budget deficits and resort to debt financing. A priori, one would expect to find evidence in favor of an intertemporally balanced budget, or fiscal sustainability, for states, especially those characterized by a high degree of fiscal stringency. We test this hypothesis for a panel of 47 state-local government units (1961-2006) using four budget balance definitions and several subsamples defined based on regional classifications, or presence of certain balanced budget requirements (BBRs). Our results, obtained from panel estimation techniques that allow for general forms of serial and cross-sectional dependence, suggest that a sufficient condition for "strong" sustainability is consistently satisfied for the full sample and all subsamples in relation to balances that include special funds and/or federal grants. However, we find evidence consistent with the "weak" version of sustainability for the full sample and some regional subsamples (particularly Far West dominated by California) in at least one of the two balances that exclude these items. Finally, the BBRs seem to matter only in relation to the sustainability of the more narrowly defined balances. We discuss the implications of these findings for the role of fiscal rules and federal grant policies.
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Citizen "Trust" as an Explanation of State Education Funding to Local School Districts
James Alm, Robert Buschman & David Sjoquist
Publius, October 2011, Pages 636-661
Abstract:
Many previous studies have examined the level of state grants to local K-12 school districts. However, these studies have not considered the role of citizen "trust" in state versus local governments as a factor. We hypothesize that the role of the state in funding education reflects citizen "trust" in the relative capabilities of governments. We measure "trust" directly via public opinion polls that capture citizen attitudes about the appropriate responsibilities of state versus local governments; we also measure "trust" indirectly, by the role of state government as revealed by its relative importance in overall service provision (net of K-12 spending). We find that the state share of K-12 education spending tends to be higher when there is greater citizen trust in state versus local governments.