Suppose I were totally indifferent about the size of government. Because I thought that the government was always equally good (or equally bad) at spending money as private households and firms. And not just at the margin, but everywhere. Never better, never worse, but always exactly the same. Whether G is 1% of GDP, or 99% of GDP, I don't care. The marginal benefits to government spending (adjusting for the marginal deadweight cost of taxes, and relative to the marginal benefits of private spending) did not diminish.
Then I would find it hard to argue that fiscal policy was worse than monetary policy. You fiscalists want big government spending sometimes, and small government spending at other times? Whatever. We could use monetary policy instead, but who cares?
But if I really cared about the size of government, because I thought there were some things the government really should be buying, and other things the government really shouldn't be buying (initially high, but strongly diminishing marginal benefits of government spending at the optimal point) then I would strongly object to the use of fiscal policy instead of monetary policy to stabilise aggregate demand.
For example, if I thought that government should do all the spending on education, and nothing else, and if I thought there was an exactly right amount to spend on education, and that spending either too little or too much would be very wasteful, then I would strongly object to macroeconomists telling me to increase or decrease government spending to control aggregate demand. I would want a very strong covariance between government spending and the number of kids needing schools and teachers, and no covariance between government spending and the number of workers needing jobs. Monetary policy should handle that.
My beliefs about the optimal size of government don't matter for my beliefs about fiscal policy. My belief that the size of government matters and that there is an (interior*) optimum does matter for my beliefs about fiscal policy. It's why I'm against it.**
I accuse fiscalists of (implicitly) not caring about the size of government. You bad people you! You should care! Government spending is important, and its size is important too! (Sorry, I couldn't resist.)
Just adding my twopenceworth to the debate about politics and fiscal policy. I think this is just standard economics; diminishing marginal benefits and all that.
* strictly greater than 0% and strictly less than 100% of GDP
** OK, there might be other reasons too, like lags and irreversibilities and stuff.
Worthwhile Canadian Initiative 
Jamie, are you going to be around for this post for awhile?
“Money can be a medium of exchange but it can also be a store of value. If government bonds are money then they are primarily a store of value. The simplest possible explanation of something often needs to exclude minor exceptions. In my experience, exceptions (and some finance people) are often the trees which prevent us from seeing the woods.”
I would say government bonds are often used as means of clearing (MOC?), thus creating an alternative for the base money. In theory banks could clear in normal times without the reserves (assuming no requirements) but don’t because they are the most convenient way. But in theory treasury could emit 1-day electronic t-bills to mimic base money. And store of value of course.
I like alpha-beta division and it is theoretically neat way. Yet in practice, IMO, the debt matters also. E.g. selling bonds is QE in reverse (consolidated) or that the changes in its present value affects the value of the currency.
“I agree that central bank money is different from other money. However, my distinction would be that government bonds are money with debtors attached (as are commercial bank loans). Hence, someone always has to use up some of their income to pay interest on this money, and someone else can act as what leftists call ‘rentiers’ and earn an income from this money. Central bank money doesn’t have a debtor attached so doesn’t earn rentiers an income. Hence, after selling bonds under QE, a pension fund has to try harder to earn an income compared with just sitting on its government bonds.”
I would view base money and bonds having practically the same debtor behind them, the consolidated government balance sheet. The latter has to pay interest mostly because of the duration – and maybe secondly because the government might have a strategic option to default the debt – mainly through inflating it away. I would add that even zero is a number and in the end of the day what matters is the real return, also paying IOER blurs the picture.
W Peden: you are probably doing the right thing for the internet. Ron Waller has been commenting on economics blogs for a couple of years now. It is clear from his above comments he hasn’t even learned the basics. If he had said “Despite what everyone else thinks, helicopter money is in fact a form of supply-side stimulus, not demand-side stimulus.” he would be wrong but at least he would not be revealing his total failure to listen to and understand the conversation going on around him. By saying ‘it is certainly supply-side stimulus’ he does the latter.
Yes, “trickle down” is one of those phrases beloved by economically illiterate journalists and their readers, because it is a metaphor they understand. “Helicopter money” is a metaphor Milton Friedman used. Taken semi-literally, it describes money-financed transfer payments to a wide section of the population. Ron is just stringing together a bunch of cliches he doesn’t understand into a self-contradictory melange. He is shouting slogans from his soapbox, waving his arms wildly, but not adding to the conversation.
There are other people, equally ignorant of economics, who actually do add to the conversation. At the very least, they don’t subtract from it.
@Nick Rowe:
Ron: I have unpublished your most recent 3 comments. Find a soapbox somewhere else.
Majro: (it’s good to see a good comment!) “This post starts with the assumption (for the sake of argument) that the marginal benefits of C and G are always equal. This is inconsistent with an increasing marginal cost of tax revenue.”
That’s why I stuck in my clause about “adjusting for the marginal deadweight cost of taxes” in “The marginal benefits to government spending (adjusting for the marginal deadweight cost of taxes, and relative to the marginal benefits of private spending) did not diminish.”
To be indifferent about the size of government, I would need to assume BOTH:
A. (Marginal benefits of G/marginal benefits of C+I) is independent of G/Y
AND
B. Marginal deadweight costs of T is independent of T/Y
(OR, just maybe, have A increasing at the same rate as B, which would be a really weird assumption.)
If you are saying that the hypothetical I needed to start the post with is a really really daft hypothetical…I would agree with you.
It’s not a totally daft hypothetical, since it’s true in a banana-economy. If people earn money by picking bananas and then use the money to buy bananas, then it doesn’t matter whether they do so directly or whether the government taxes money, buys bananas on the peoples’ behalf, and distributes the bananas.
That’s the trivial reduction of assuming that the level of G is indifferent — that the goods provided by G are identical to the goods provided by everything-but-G.
On the other hand, this stacks the deck in favour of old-Keynesian thought. Endogenous investment doesn’t exist in this framework, therefore marginal propensities to save and consume take on exactly their “high school economics” significance. All unemployment is necessarily an AD deficiency.
On the gripping hand, part of government spending is an exact substitute for private spending: transfer payments. A government levying taxes (or taking on debt) to build a bridge is providing something distinct from the private sector, so we can talk about an optimal level maximizing society-wide utility for a particular utility function[1]. However, taxing me to subsidize you (or vice versa) has far more ambiguous effects. Borrowing from me to subsidize you further muddies the waters.
Ultimately, I think that borrowing for government transfers is an interesting component of aggregate demand. If there is no Ricardian equivalence, then the borrowing is a net AD increase as the demand curve for money shifts up. If there is full Ricardian equivalence, then the borrowing is fully and instantly compensated for by changes in private savings to pay back the expected future taxation and AD remains unchanged. Perhaps we can distinguish between these cases based on crowding-out and increases in interest rates?
[1] — And going over or under this optimum leads to supply-side effects from a mis-allocation of real resources. That is fundamentally not a story about money, and it works if the Pharaoh is conscripting labour to build pyramids.
Majro: “It’s not a totally daft hypothetical, since it’s true in a banana-economy. If people earn money by picking bananas and then use the money to buy bananas, then it doesn’t matter whether they do so directly or whether the government taxes money, buys bananas on the peoples’ behalf, and distributes the bananas.”
Yes, if the taxes were lump-sum taxes.
But yes, this does get into the question of Ricardian Equivalence. In a normal NK model, even when RE holds, increases in G still affect AD (for given r). But if government spending is a perfect substitute for private spending (the government does our shopping for us) then if the government buys everyone a banana we just all buy one banana less, eating the same total number of bananas, and even increases in G have no effect on AD.
Does the use of fiscal policy as an economic tool result in immediate budget cuts or increases?
Majro: yep.
financewhiz: people normally talk about it that way. But in some models, it’s expected future government spending and taxes that matter as much (maybe even more) than current spending or taxes. And we could have a fiscal policy that amounted to making commitments about the future rather than changing G or T today. But when that future time arrives, the government would have to change G or T as it had previously promised, otherwise its fiscal policy would lose credibility.
Too Much Fed: Jamie, are you going to be around for this post for awhile?
Hi. I hope you are well. As you can see I am still reading this thread but I don’t currently have anything else to add to my previous comments.
Nick: in recession, holding on to money is paramount, at the expense of banana-eating. G can buy a banana and I will eat it gladly even if I still hold to my money. There is no RE in these circumstances. (And the shadow-price of babanas is nil anyway.)
Jamie said: “So, are government bonds money?”
I am going to agree with Scott Sumner on this one. Gov’t bonds are not “money” because they do not have a fixed conversion rate.
“K will perceive that the money supply is increased when the government creates new bonds. He will also perceive that QE does not change the money supply as it replaces one type of money with another.”
What are these “another” type(s) of “money”?
“S will perceive that the money supply is not increased when the government creates new bonds. However, he will perceive that QE does increase the money supply as it replaces non-money with money.”
Let’s assume a commercial bank does “QE”. Does the “money” supply increase?
“Nick: “But even then they are beta money, which makes a difference”
I agree that central bank money is different from other money. However, my distinction would be that government bonds are money with debtors attached (as are commercial bank loans).”
I disagree that gov’t bonds are “beta money” and disagree that demand deposits of the commercial banks are “beta money”. I believe demand deposits of the commercial banks are both medium of account (MOA) and medium of exchange (MOE) because they have a fixed conversion rate (it just happens to be 1 to 1) thru the central bank to currency. That makes those demand deposits “alpha money”.
From:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/12/alpha-beta-and-gold.html
“csissoko: Yours is a fair point. When there’s a run on a beta bank, the alpha leader will temporarily act like a beta. If there’s a run on all the beta banks, the alpha might have to choose a different path, because the beta wolves can’t keep up with him. The Bank of Canada would have to allow inflation to exceed its 2% target, to bail out the commercial banks.
If this happened all the time, and if betas were never disciplined for failing to follow the alpha and needing the alpha to bail them out, then my alpha-beta distinction would be meaningless.”
Jamie, I am not sure if am reading that correctly, but I believe some version of it is true. If there are runs on all the “beta” commercial banks along with all of them being solvent, the central bank will “bail them out” all of the time by increasing currency so the alpha-beta distinction is meaningless.
Thoughts on those?
Hope you are well too!
Ok Nick I’ll just put it out there. I’m presuming this post was inspired by a piece Scott did on fiscal policy and the size of government. The piece was literally called ‘fiscal policy isn’t about the size of government.’
http://www.themoneyillusion.com/?p=29763
Do you agree with the post-because he seemed to be saying it’s not about the size of government while your post seems to say it is about the size of government.
In a way then are you saying that monetary policy is preferable assuming that government is already the optimal size prior to the need for stimulus?
Mike: put G/Y on the horizontal axis. (That’s a measure of the size of government, as a fraction of GDP.) Draw a downward-sloping Marginal Benefit curve, and an upward-sloping Marginal Cost curve. Where (you think) those two curves cross determines (what you think is) the optimal size of government.
Scott is quite correct in saying that your beliefs about where the curves cross should have no effect on whether you agree or disagree with the use of fiscal policy.
I am saying that (your beliefs about) the slope of the two curves where they cross should affect how much you dislike fiscal policy. If (you think) both curves are steep, you will strongly dislike fiscal policy. If (you think) both curves are fairly flat, you won’t mind fiscal policy much.
It’s not the size, it’s the variance around that size.
Why am I using a visual explanation for an artsie?
“There are other people, equally ignorant of economics, who actually do add to the conversation. At the very least, they don’t subtract from it.”
Yes… that last bit there: that’s what I inspire to be! Lol
or maybe, “that’s what I aspire to”
OK that was mildly brilliant.
Trying to pin them down on the idealk ratio is… interesting. Martin Wolf once told me he thought WW II was a good starting point(!).
Kevin: But the main point here is that ‘fiscalists’ don’t need to advocate silly projects, either in theory or in practice.
Heh, sending people checks for nothing has somehow become less silly than a Bridge to Nowhere or a Hole-Digging Brigade.
That amounts to repealing welfare reform, EITC, and renouncing the entire philosophy behind them. Incentives matter.
Anyways, exchanging money for nothing is needlessly distortionary when the Fed can bid on every asset in existence.
TallDave: thanks.
It’s also tricky in practice even to measure the size of government. If the government sends every individual a cheque for $1 million, and also imposes a tax on every individual of $1 million, it looks like government just got a lot bigger, but nothing has really changed, except for the admin costs. And if we measure it by government expenditure, as opposed to transfer payments, is there much difference between the government buying you glasses, and giving you the money to buy glasses? (Though maybe you get the style you want.)
Tom: you’re doing fine.
Too Much Fed: “Thoughts on those?”
My focus in this thread has been the thought experiment I described in my first post. What I don’t want to do is to discuss whether specific non-economists like you or me think that government bonds are (or are not) money. I’m interested in how real economists think about this and whether their belief on the matter is a good predictor of whether they are New Keynesian (bonds are money) or Market Monetarist (bonds are not money).
With that in mind, you say: “I am going to agree with Scott Sumner on this one. Gov’t bonds are not “money””. If you are correct that Scott believes that government bonds are not money then that is consistent with my thought experiment. Note however that Nick said that he thought my thought experiment more accurately described the difference between Post Keynesians and Market Monetarists.
The key here is that minor differences in semantics can lead to major differences in policy prescriptions. I’m not sure that there is a “correct” definition of money. However, that may limit any ability to come to a consensus on policy matters.
Nick,
Actually, Milton Friedman devised a way to measure the size of the U. S. government by counting the number of entries into the federal register. Only, the U. S. government kept shrinking the size of the font used for printing the register.
Majormax,
In the spirit of the U. S. Constitution, there is consolidated versus divided government. With a consolidated government there are no political parties, no separate branches of government (judicial, executive, legislative), and no separate layers of government (local, state, federal).
There is a tradeoff between large democracies and small autocracies. With autocracies, there are fewer checks on the power that a government official can wield.
Jamie said: ” I’m interested in how real economists think about this and whether their belief on the matter is a good predictor of whether they are New Keynesian (bonds are money) or Market Monetarist (bonds are not money).”
Do New Keynesians actually think bonds are “money”?
“I’m not sure that there is a “correct” definition of money. However, that may limit any ability to come to a consensus on policy matters.”
Exactly on the consensus part.
I think you need 3 groups.
The first one thinks that the monetary base is “money” and that bonds are not “money”.
The second one thinks that the monetary base is “money” and that bonds are “money”.
The third one thinks that currency is “money” and that certain demand deposits are “money”. Also, are there any “real economists” in the last group?
But if I really cared about the size of government, because I thought there were some things the government really should be buying, and other things the government really shouldn’t be buying (initially high, but strongly diminishing marginal benefits of government spending at the optimal point) then I would strongly object to the use of fiscal policy instead of monetary policy to stabilise aggregate demand.
Why doesn’t the same apply to the CB buying private assets?
On the one hand, you say that there is an optimal amount that government should spend on education that correlates strongly with the amount of pupils and teachers. Spending more (or otherwise increasing the amount of money that schools get to keep, say by reducing taxes?) increases the size of government with diminishing returns. Fine.
On the other hand, If I may misrepresent your position in my own words, you would say that if the CB bought shares in private schools this would leave them with more cash which they would then spend on more teachers or more school buildings or something similar. In any case, the schools could not just go out and spend the money on hookers and blow. The board wouldn’t approve. Is that not an increase in the size of government? Considering they could only spend the money on things related to schooling, how is that not shifting the size of schooling beyond the optimal point? Government owns more school assets and has artificially increased the size of schooling relative to what the market was willing to fund before. Either that or you’re conceding that monetary policy has no effect other than shifting ownership claims onto government books in exchange for money. Why aren’t there diminishing marginal benefits to monetary policy? Because there aren’t any benefits in the first place? I somehow doubt that is what you’re saying.
What am I missing? Is it only about the inefficiency of taxation? That seems to me not about the size of goverment but about the optimal size of different sectors of the economy. Of course government might be bad at hitting that spot. But then so might CBs.
Also, where do you draw the line between fiscal and monetary policy? I’ve only ever seen you write about what monetary policy is and possibly what fiscal isn’t, but not what fiscal policy is. Maybe you have a post somewhere along the lines of Majro’s comment above I could read?
Actually, forget the above. I saw my mistake. The schools aren’t the ones who own the assets. Sorry for wasting webspace…