Memo to the IMF: Think Nominal
This is how Olivier Blanchard and Daniel Leigh introduce their statistical analysis in the recent IMF WEO report, when revising their estimate of the fiscal multiplier:
Our basic approach is the following: focusing on the recent episode of widespread fiscal consolidation, we regress the forecast error for real GDP growth during 2010–11 on forecasts of fiscal consolidation for 2010–11 that were made in early 2010.
I won’t quote any more, because honestly, what is the point?
If you are trying to measure the effects of fiscal policy on aggregate demand you cannot use real GDP. You will measure something which is part demand-side, part supply-side, and no way to separate the two. Real GDP measures output not demand.
Instead, you could think about how fiscal policy effects the nominal economy. And how can you measure the effects of fiscal policy on the nominal economy, without considering the role of monetary policy in providing a nominal anchor? Blanchard and Leigh only mention the “constraint” of the zero bound. They should read some more Sumner.
Here is the number of months during which the Bank of England has been unable to hit (as in “has undershot”) its nominal target during the Coalition’s fiscal consolidation:
So what “constraint” is the zero bound on monetary policy again? UK fiscal policy has so harmed the nominal economy that we have had thirty-three consecutive months of above-target inflation?
Again we see any semblance of helpful debate die in a ditch. The Bank of England’s Chief Economist wrings his hands and talks about how the Bank needs to “bring down inflation“, and the Keynesians lobby the Treasury to take the fantastic opportunity to borrow and spend.
Epic fail, and epic tragedy.