Clearing Up the Fiscal Multiplier Morass


A comment

    Lucas irrationality  
© Christian Müller 2018
«home   Would it not be great to know what effect fiscal policy has on the economy? Of course, it would. Economists discuss these effects in terms of the so-called «fiscal multiplier». Its value offers a handy way to gauge fiscal policy's impact on aggregate economic activity. So far so clear.  
    Though trouble is that nobody really knows the numbers and, therefore, policy advice is very hard to come by. To make bad things worse, as Leeper et al. point out in a recent AER article, researchers have created a «fiscal multiplier morass» that provides little guidance about what best to do.  
    Therefore, «Clearing Up the Fiscal Multiplier Morass» would be a very useful exercise and Leeper et al. say that they have achieved exactly that. Unfortunately, the authors draw on a methodology that is seriously flawed because it does not take into account rational expectations.  
    The model entertained poses as the last word word ever to be said about the structure of the economy and the way people make decisions. Leeper et al.'s expertise notwithstanding, this is obvioulsy a gross exaggeration and against all logic and historical experience. Of course, economic agents and policy makers are well aware of the fact that our understanding of the economy and hence economic models constantly change (if not improve). Unfortunately, this obvious insight is not part of the rational expectations solution that the authors entertain.  
    By ignoring publicly available information about the dynamic of economic models Leeper et al. deviate from the rational expectations imperative they otherwise claim to respect. The inevitable conclusion, therefore, is that instead of clearing it up, Leeper et al. have made the «fiscal multiplier morass» even messier.  
    Read the full story.  
    © Christian Müller 2018  
    Jacobs University Bremen