Mechanisms vindicated

The IMF's admission (p41 of this pdf) that "the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession" is being interpreted as a victory for Keynesianism, because it means that fiscal austerity is doing more damage than the IMF originally estimated.

However, I suspect it is also a vindication for thinking of economics as a bunch of mechanisms rather than as formal models.

To see what I mean, let's concede that the pre-recession evidence pointed to lowish or even negative (pdf) fiscal mulipliers. Mechanism-based thinking would ask: what mechanisms could generate such a result? Answers would include:

- Fiscal tightening can be offset by lower interest rates.

- Cuts in the government wage bill reduce workers' bargaining power and hence expected profit margins, which can encourage capital spending.

- Lower government spending leads to anticipations of lower taxes, which might encourage increase household and corporate borrowing and spending.

This automatically draws our attention to reasons to doubt that low mulipliers would exist now. Monetary policy is less effective now we are at the zero bound; and an inability or reluctance to borrow limits how far private spending can rise to fill the space left by public spending.

We'd therefore expect to see higher multipliers now, not because Keynesians are always right and Austerians are always wrong, but because the mechanisms generating low multipliers happen not to be powerful here and now.

My approach - actually Andrew Glyn's and Jon Elster's: I steal from the best - contrasts with the idea that economics should be like physics. It is sceptical of whether there are deep parameters that yield eternal true predictions. Granted, there might be a few stylized facts and rules of thumb - my favourite being cubic power laws - but important as these are they are often not sufficient basis for policy or investment action.   

If economists can learn anything from physicists, it is not the latter's pursuit of simple models that try to explain everything, but rather the mountain of unglamorous gruntwork they put into gathering data.

Comments

[Yet another Chris]

Surely multipliers to the problems of the likes of Greece and Spain, or even the UK. Consider Greece. Okay, so the government continuing to spend might have improved growth prospects. But to continue spending, the Greek government would have to borrow money. The markets would not lend. There is a big difference between theory and the real world.

[Frances Coppola]

Economics can only be like physics to the extent either that it directly relates to the physical world or that it is an image of the physical world. The more economics concentrates on money (which is only a symbol) and ignores real products, the less like physics it becomes. Unless physics is doing the same, of course - confusing the symbol with the real thing.

[FRauncher]

Delong and Krugman have been saying the same thing, but it helps to come at it from a new direction as you have done. Bravo!

@Yet another Chris-
Greece can't borrow, but ECB can.
Stockton, California can't borrow, but US Treasury could, if GOP didn't block all constructive efforts.

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