When to Use Fiscal Stimulus

Dang it all, but Greg Mankiw does have me going this week. Guy’s got a fine mind, want to see him applying it more acutely.

Yesterday he pointed to Alan Blinder’s 2004 The Case Against the Case Against Discretionary Fiscal Policy (PDF), wherein Blinder gives three possible reasons to use fiscal stimulus (note the “or’ here):

…there will be occasional abnormal circumstances in which monetary policy can use a little help, or maybe a lot, in stimulating the economy–such as when recessions are extremely long and/or extremely deep, when nominal interest rates approach zero, or when significant weakness in aggregate demand arises abruptly.

Mankiw points out two current/predicted conditions…

The relevant question is whether the
current situation, with unemployment at 5 percent and a consensus
near-term growth forecast of about 1 percent, qualifies as one of these
"occasional abnormal circumstances."

…neither of which (directly) addresses Blinder’s three criteria. Let’s look at them:

1. Long/deep, recession. No, but we don’t know if it will be. And let’s not forget that if fiscal stimulus is not “prompt and large,” it doesn’t do any good. Makes this criterion difficult to act on.

2. Nominal interest rates approaching zero. Nope, we’re not there.

3. Abrupt weakness in aggregate demand. This is where Mr. Mankiw could bring his considerable skills to bear in analyzing the current situation.