Grasping Reality on TypePad, by Brad DeLong

Whenever I build a model in which expansionary fiscal policy fails to reduce unemployment, it is for one of three reasons:

1. Expectations of the present and future deficits cause the price level to jump now, so that increased nominal spending does not translate into increased real demand (i.e., Mitterand ca. 1981)
2. The expansionary effect of higher deficits is offset by higher interest rates that crowd out private investment and exports, offsetting the stimulative effect of the fiscal policy (i.e., Kohl ca. 1982)
3. Households expecting higher future tax liabilities cut back on their spending and boost their savings now, thus offsetting the stimulative effect of the fiscal policy (i.e., I can't think of a historical episode).

Jeff Sachs writes:

Time to plan for post-Keynesian era: Taking office in January 2009, President Barack Obama inherited the largest peacetime budget deficit in US history. By increasing it further, he made it his rather than his predecessor’s. He and his advisers ignored one of the key insights of modern macroeconomics: that the result of fiscal policy depends not only on current taxes and spending but also on their expected trajectories in the future. The US was not in a credible position to raise an already enormous deficit “temporarily” because the prospect for future deficit cutting was and remains extremely clouded. America has absolutely no consensus on how to restore budget balance, as it is trapped between a federal government that provides too few public investments and services and a public that is almost maniacal in its opposition to tax rises. One cannot build a credible long-term fiscal policy by starting off in the wrong direction, with larger rather than smaller deficits...

In the model in which Sachs is working--I think--the passage of the ARRA was coupled with a massive jump in U.S. long-term interest rates as financiers lost confidence in the ability of the U.S. to solve its long-run fiscal problems. The consequent appreciation of the dollar reduced exports and the steep rise in interest rates reduced investment spending so that the fact that the government was spending money didn't boost employment relative to what it would otherwise have been.

The problem, of course, is that U.S. Treasury rates did not jump at all.

When Jeff Sachs writes "[Obama] and his advisers ignored one of the key insights of modern macroeconomics: that the result of fiscal policy depends not only on current taxes and spending but also on their expected trajectories in the future," he puts a period where Adam Smith and company put a comma--and after the comma comes and the channel through which expected future deficits affect current spending is the term structure of interest rates.

Thus I really do not know what model Jeff is working in: it seems to rely on some spooky action-at-a-distance unmediated by any shifts in relative prices at all. Sociologists are allowed to say that people's behavior shifts without any substantial changes in relative prices. I did not think economists were.