Students of economics looked to 2013 with particular glee because, as luck would have it, the year was poised to settle the longstanding debate between two colliding schools of thought about monetary and fiscal policy.
In one corner you had the Keynesians, starring Paul Krugman, and opposite them were the monetarists.
Keynesians argued that fiscal retrenchment (i.e., the sequester) would seriously harm growth in 2013.
Monetarists were sceptical about how much the sequester would stifle the economy, saying the Federal Reserve had the mechanisms to do whatever it wanted to jumpstart growth, fiscal policy be damned.
And so the battle for 2013 was on. Did the Fed have the capability to spur growth amid fiscal headwinds? Or would Washington, fettered in a political battle over the budget, sink any hope of recovery? Here’s Mike Konczal characterising the duel in April of last year:
If you look at macroeconomic policy since last fall, there have been two big moves. The Federal Reserve has committed to much bolder action in adopting the Evans Rule and QE3. At the same time, the country has entered a period of fiscal austerity. Was the Fed action enough to offset the contraction? It’s still very early, and economists will probably debate this for a generation, but, especially after the stagnating GDP report yesterday, it looks as though fiscal policy is the winner.
Now that the year is over, was fiscal policy really the winner? Sure, public sector layoffs proved a major drag on the economy, but otherwise 2013 kind of plugged along impressively.
Either the sequester didn’t really hurt as much as people feared, or monetary policy helped dress the wound (there are of course other explanations, like the fact that 2013 austerity was front-loaded on the calendar).
As BI’s Joe Weisenthal admitted in his “mea culpa” for the year, “You have to say that Bernanke did pretty well for himself. The economy is operating at its best level since the crisis…But the economy has clearly done better than I and a lot of other people would have guessed given the austerity, and it seems likely that the Fed played a role.”
There you have it, central bankers more or less take 2013!
So where’s Krugman on all of this? His critics say this year basically discredited his Keynesian gusto, but Krugman isn’t saying he was wrong. Here he is reflecting on 2013:
One way to look at the US economy in 2013 is that it was, in effect, trying to begin a strong recovery, but was held back by terrible federal fiscal policy. Housing was making a comeback, state and local austerity was, if not going into reverse, at least not getting more intense, household spending was starting to revive as debt levels came down. But the feds were raising the payroll tax, slashing spending via the sequester, and more.
Incidentally, these other factors are why I don’t take seriously the claims of market monetarists that the failure of growth to collapse in 2013 somehow showed that fiscal policy doesn’t matter. US austerity, although a really bad thing, wasn’t nearly as intense as what happened in southern Europe; it was small enough that it could be, and I’d argue was, more or less offset by other stuff over the course of a single year.
Let’s flash back. Here’s Krugman reflecting on Konczal’s piece back in April clarifying his views on monetary versus fiscal policy:
I’m not claiming that there is nothing the central bank can do; but as I’ve tried to explain before, monetary policy can, for the most part, gain traction under current circumstances only by changing expectations about future actions (and changing them a lot). Meanwhile, fiscal policy has a direct, current effect on the economy, which easily trumps attempts to move the economy by changing the Fed’s messaging.
We’ll see what 2014 has in store.
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