Which Fiscal Policy Works?
In Bloomberg, I talk with Ricardo Reis about a new paper he has written with Alisdair McKay. Reis and McKay find that relieving borrowing constraints and underinsurance are the two most important qualities of fiscal stimulus -- and that somewhat revises the dominant view of aggregate stabilization:
In a new working paper, Ricardo Reis of Columbia University and Alisdair McKay of Boston University say no. They find that stabilizing aggregate disposable income plays a “negligible role” in stabilizing the economy as a whole. Transfer payments can indeed stabilize output, they find, but mainly through a different channel -- not by changing disposable income in the aggregate, but by changing its distribution. Fiscal policy, in other words, is all about inequality.I'm looking to do more pieces on interesting economics papers -- the previous one was on the Tideman-Plassman proposal for emission bond futures -- and would definitely welcome suggestions. (Send me an email or leave a comment.)
“It’s the redistribution that has a lot of kick,” Reis said in an interview. “The usual argument for transfers is basically Keynesian. We find that has very low impact in our model.”
Reis and McKay reach this conclusion by building a complex macroeconomic model calibrated to U.S. data, but the intuition isn't all that complicated. Transfer payments yield the highest amount of stabilization per dollar when focused on people who can't effectively insure themselves against macroeconomic volatility -- namely, people with little savings to draw on and limited opportunities to borrow.
“When you look at the different programs, we find that food stamps and similar programs are really the ones that work, because they are being targeted to individuals who are up against their borrowing constraints and aren't going to work less because they are already unemployed," Reis told me. "They have very high marginal propensities to consume and are very underinsured, so it can very stimulative."