No, John Taylor's Piece Doesn't Say What Taylor Says It Says: Noah Smith to the Rescue! Weblogging
Noah Smith plays Three-Card Monte, and wins! Taylor has a model in which (a) interest rates can go negative, (b) the Federal Reserve is successfully stabilizing GDP, and (c) the damaging effects of taxation on work effort are so large that western Europe ought to be an impoverished hellhole.
Noahpinion: John Taylor's austerity model: [Y]our friendly neighborhood Noah is here to read and explain where Taylor is getting his arguments…. The "1970s" reference is pure conservative herp-derpery. People weren't trying to fight stagflation with fiscal policy in the 70s; deficits were quite low. "The 70s" is just a word that conservative writers throw into their pieces so that conservative old men who read the article will nod their snowy heads in sage agreement and mumble "Yes, the 70s. Carter. Stagflation. Mmm-hmm!"…
Why does Taylor think austerity will produce growth?… This is NOT the "Treasury View."… This is NOT the "Confidence Fairy."… Taylor's model has distortionary taxation in it, and the distortions are large…. [T]he GDP boost in Taylor's model doesn't come from reducing the deficit, it comes from cutting taxes…. Taylor assumes that the Fed… cancels out… positive demand shocks from stimulus. So it's hardly surprising that Taylor is not going to see government spending doing much good for the economy; he's assumed that 1) the Fed is… managing aggregate demand, and 2) the Fed will tighten to… counteract stimulus…. There is no Zero Lower Bound…. The "New Old Keynesians" such as Paul Krugman and Gauti Eggertsson, who advocate fiscal stimulus, explicitly make reference to the ZLB as the reason stimulus works. Taylor just ignores that idea…. In Taylor's model, if you cut government purchases, it throws the economy into a recession. Taylor's suggested austerity plan makes big spending cuts, but the cuts are almost entirely cuts in transfers…. Now as you should remember from Econ 102, government purchases make much more effective stimulus than transfers…. The reason he gets short-run benefits from spending cuts has everything to do with the fact that it's almost all transfers being cut….
Upshot: If you have no Zero Lower Bound, and if the Fed partially counteracts the demand-side effects of fiscal policy, and if people have forward-looking expectations, and if you don't cut government purchases much, and if taxes are very distortionary, then austerity works…. [T]he result… ignores the real Keynesian critique that… the Zero Lower Bound matters a lot… assumes… taxes are… more distortionary than they really are… overestimates the Republicans' real willingness to cut transfers… underestimates their willingness to cut government purchases… ignores distributional concerns, but that's pretty much par for the course…
