Tag Archives: recession

Some Thoughts on Liquidity

The quantity theory relates not so much to money as to the whole array of financial assets exogenously supplied by the government. If the government debt is doubled in the absence of a government-determined monetary base the price level doubles just as well as in the case of a doubling of the monetary base in the absence of government debt. — Jurg Niehans, 1982

Seemingly lost in the discussion of monetary policies various QEs is a meaningful resolution of our understanding of the monetary transmission mechanism.  Sure, New Keynesians argue that forward guidance about the time path of the short term nominal interest rate is the mechanism, Bernanke argues that long term interest rates are the mechanism, and skeptics of the effectiveness of QE argue that it is the interest rate on excess reserves that is the mechanism.  I actually think that these are not the correct way to think about monetary policy.  For example, there are an infinite number of paths for the money supply consistent with a zero lower bound on interest rates.  Even in the New Keynesian model, which purportedly recuses money from monetary policy, the rate of inflation is pinned down by the rate of money growth (see Ed Nelson’s paper on this).  It follows that it is the path of the money supply that is more important to the central bank’s intermediate- and long-term goals.  In addition, it must be the case that the time path of the interest rate outlined by the central bank is consistent with expectations about the future time path of interest rates.  The mechanism advocated by Bernanke is also flawed because the empirical evidence suggests that long term interest rates just don’t matter all that much for investment.

The fact that I see the monetary transmission mechanism differently is because you could consider me an Old Monetarist dressed in New Monetarist clothes with Market Monetarist policy leanings (see why labels are hard in macro).  Given my Old Monetarist sympathies it shouldn’t be surprising that I think the aforementioned mechanisms are not very important.  Old Monetarists long favored quantity targets rather than price targets (i.e. the money supply rather than the interest rate).  I remain convinced that the quantity of money is a much better indicators of the stance of monetary policy.  The reason is not based on conjecture, but actual empirical work that I have done.  For example, in my forthcoming paper in Macroeconomic Dynamics, I show that many of the supposed problems with using money as an indicator of the stance of monetary policy are the result of researchers using simple sum aggregates.  I show that if one uses the Divisia monetary aggregates, monetary variables turn out to be a good indicator of policy.  In addition, changes in real money balances are a good predictor of the output gap (interestingly enough, when you use real balances as an indicator variable, the real interest rate — the favored mechanism of New Keynesians — is statistically insignificant).

Where my New Monetarist sympathies arise is from the explicit nature in which New Monetarism discusses and analyzes the role of money, collateral, bonds, and other assets.  This literature asks important macroeconomic questions using rich microfoundations (as an aside, many of the critics of the microfoundations of modern macro are either not reading the correct literature or aren’t reading the literature at all).  Why do people hold money?  Why do people hold money when other assets that are useful in transactions have a higher yield?  Using frameworks that explicitly provide answers to these questions, New Monetarists then ask bigger questions. What is the cost associated with inflation? What is the optimal monetary policy? How do open market operations work?  The importance of the strong microfoundations is that one is able to answer these latter questions by being explicit about the microeconomic assumptions.  Thus, it is possible to make predictions about policy with an explicit understanding of the underlying mechanisms.

An additional insight of the New Monetarist literature is that the way in which we define “money” has changed substantially over time.  A number of assets such as bonds, mortgage-backed securities, and agency securities are effectively money because of the shadow banking system and the corresponding prevalence of repurchase agreements.  As a result, if one cares about quantitative targets, then one must expand the definition of money.  David Beckworth and I have been working on this issue in various projects.  In our paper on transaction assets shortages, we suggest that the definition of transaction assets needs to be expanded to include Treasuries and privately produced assets that serve as collateral in repurchase agreements.  In addition, we show that the haircuts of private assets significantly reduced the supply of transaction assets and that this decline in transaction assets explains a significant portion of the decline in both nominal and real GDP observed over the most recent recession.

The reason that I bring this up is because this framework allows us not only to suggest a mechanism through which transaction assets shortages emerge and to examine the role of these shortages in the context of the most recent recession, but also because the theoretical framework can provide some insight into how monetary policy works.  So briefly I’d like to explain how monetary policy would work in our model and then discuss how my view of this mechanism is beginning to evolve and what the implications are for policy.

A standard New Monetarist model employs the monetary search framework of Lagos and Wright (2005).  In this framework, economic agents interact in two different markets — a decentralized market and a centralized market.  The terms of trade negotiated in the decentralized market can illustrate the effect of monetary policy on the price level. (I am going to focus my analysis on nominal variables for the time being.  If you want to imagine these policy changes having real effects, just imagine that there is market segmentation between the decentralized market and centralized market such that there are real balance effects from changes in policy.)  In particular the equilibrium condition can be written quite generally as:

P = (M+B)/z(q)

where P is the price level, M is the money supply, B is the supply of bonds, and z is money demand as a function of consumption q.  I am abstracting from the existence of private assets, but the implications are similar to those of bonds.  There are a couple of important things to note here.  First, it is the interaction of the supply and demand for money that determines the price level.  Second, it is the total supply of transaction assets that determines the price level.  This is true regardless of how money is defined.  Third, note that as this equation is presented it is only the total supply of transaction assets that determine the price level and not the composition of those assets.  In other words, as presented above, an exchange of money for bonds does not change the price level.  Open market operations are irrelevant.  However, this point deserves further comment.  While I am not going to derive the conditions in a blog post, the equilibrium terms of trade in the decentralized market will only include the total stock of bonds in the event that all bonds are held for transaction purposes.  In other words, if someone is holding bonds, they are only doing so to finance a transaction.  In this case, money and bonds are perfect substitutes for liquidity.  This implication, however, implies that bonds cannot yield interest.  If bonds yield interest and are just as liquid as money, why would anyone hold money? New Monetarists have a variety of reasons why this might not be the case.  For example, it is possible that bonds are imperfectly recognizable (i.e. they could be counterfeit at a low cost). Alternatively, there might simply be legal restrictions that prevent bonds from being used in particular transactions or since bonds are book-entry items, they might not as easily circulate.  And there are many other explanations as well.  Any of these reasons will suffice for our purposes, so let’s assume that that is a fixed fraction v of bonds that can be used in transactions.  The equilibrium condition from the terms of trade can now be re-written:

P = (M + vB)/z(q)

It now remains true that the total stock of transaction assets (holding money demand constant) determines the price level.  It is now also true that open market operations are effective in influencing the price level.  To summarize, in order for money to circulate alongside interest-bearing government debt (or any other asset for that matter) that can be used in transactions, it must be the case that money yields more liquidity services than bonds.  The difference in the liquidity of the two assets, however, make them imperfect substitutes and imply that open market operations are effective.  It is similarly important to note that nothing has been said about the role of the interest rate.  Money and bonds are not necessarily perfect substitutes even when the nominal interest on bonds is close to zero. Thus, open market operations can be effective for the central bank even if the short term interest rate is arbitrarily close to zero.  In addition, this doesn’t require any assumption about expectations.

The ability of the central bank to hit its nominal target is an important point, but it is also important to examine the implications of alternative nominal targets.  Old Monetarists wanted to target the money supply.  While I’m not opposed to the central bank using money as an intermediate target, I think that there are much better policy targets.  Most central banks target the inflation rate.  Recently, some have advocated targeting the price level and, of course, advocacy for nominal income targeting has similarly been growing.  As I indicated above, my policy leanings are more in line with the Market Monetarist approach, which is to target nominal GDP (preferable the level rather than the growth rate).  The reason that I advocate nominal income targeting, however, differs from some of the traditional arguments.

We live in a world of imperfect information and imperfect markets. As a result, some people face borrowing constraints.  Often these borrowing constraints mean that individuals have to have collateral.  In addition, lending is often constrained by expected income over the course of the loan.  The fact that we have imperfect information, imperfect markets, and subjective preferences means that these debt contracts are often in nominal terms and that the relevant measure of income used in screening for loans is nominal income.  A monetary policy that targets nominal income can potentially play an important role in two ways.  First, a significant decline in nominal income can be potentially harmful in the aggregate.  While there are often claims that households have “too much debt” a collapse in nominal income can actually cause a significant increase and defaults and household deleveraging that reduces output in the short run.  Second, because banks have a dual role in intermediation and money creation, default and deleveraging can reduce the stock of transaction assets.  This is especially problematic in the event of a financial crisis in which the demand for such assets is rising.  Targeting nominal income would therefore potentially prevent widespread default and develeraging (holding other factors constant) as well as allow for the corresponding stability in the stock of privately-produced transaction assets.

Postscript:  Overall, this represents my view on money and monetary policy.  However, recently I have begun to think about the role and the effectiveness of monetary policy more deeply, particularly with regards to the recent recession.  In the example given above, it is assumed that the people using money and bonds for transactions are the same people.  In reality, this isn’t strictly the case.  Bonds are predominantly used in transactions by banks and other firms whereas money is used to some extent by firms, but its use is more prevalent among households.  David Beckworth and I have shown in some of our work together that significant recessions associated with declines in nominal income can be largely explained through monetary factors.  However, in our most recent work, it seems that this particular recession is unique.  Previous monetary explanations can largely be thought of as currency shortages in which households seek to turn deposits into currency and banks seek to build reserves.  The most recent recession seems to be better characterized as a collateral shortage, in particular with respect to privately produced assets.  If that is the case, this calls into question the use of traditional open market operations.  While I don’t doubt the usefulness of these traditional measures, the effects of such operations might be reduced in the present environment since OMOs effectively remove collateral from the system.  It would seem to me that the policy implications are potentially different.  Regardless, I think this is an important point and one worth thinking about.

Money, the Money Multiplier, and Monetary Theory

John Williams recently gave a speech on teaching about monetary theory and policy after the financial crisis. Here is the basic thesis:

When I was an undergraduate at Berkeley in the early 1980s, much of the monetary economics that I learned was based on theories from the 1950s or even earlier. These included the quantity theory of money, Keynes’s LM curve, Milton Friedman’s monetarism, and the Baumol-Tobin theory of money demand, to name a few examples. Now, there’s no question that Keynes, Friedman, and Tobin were among the greatest monetary theorists of all time. Their theories are elegant statements of fundamental economic principles. As such, they deserve to be taught for a long time to come. But viewing them as definitive in today’s world is like thinking that rock and roll stopped with Elvis Presley. The evolution of money and banking since the 1950s is at least as dramatic as what’s happened with popular music—not that I want to compare the Fed with Lady Gaga. The theories of that era need to be adapted to the brave new world in which we now live.

I am not sure what this means, however, given the remainder of the speech. Despite the fact that Williams claims that the work of Friedman, Tobin, and Keynes represent “elegant statements of fundamental economic principles”, he subsequently goes on in the speech to largely disparage this work; in particular, the quantity theory of money and the Baumol-Tobin inventory-theoretic model of money demand. While I share Williams view that we need to understand modern innovations in economic thinking, I also think that it is important to understand and appreciate contributions of the likes of Friedman, Tobin, Keynes, and others. There is much that we can learn from the history of economic thought and, in this respect, it is important to read primary sources of the literature and not second-hand accounts (note: this is a general statement, not a knock against Williams). Thus, while I share Williams’ view that we need to appreciate recent contributions, I think that it is important to give fair treatment to earlier important contributions as well. I will elucidate this point below.

Williams seems to disparage the quantity theory of money by pointing to a fairly standard objection:

There have been a number of attempts to find a broader measure of “money” that has a stable relationship with nominal spending — that is, a constant velocity.

He then proceeds to detail differences in different monetary aggregates and their growth rates during the crisis. Differing growth rates and changes in velocity over the past few decades are then cited as evidence that using using the money supply to forecast nominal spending or inflation is a fool’s errand. This reasoning is flawed for two reasons. First, constant velocity is a straw man as Thomas Sowell details in On Classical Economics:

The idea that the price level is rigidly linked to the quantity of money by a velocity of circulation which remains constant through all transitional adjustment processes cannot be found in any classical, neoclassical, or modern proponent of the quantity theory of money. Changes in the velocity of circulation — short run and/or long run — were analyzed by David Hume, Adam Smith, Henry Thornton, T.R. Malthus, David Ricardo, Nassau Senior, John Stuart Mill, Alfred Marshall, Knut Wicksell, Irving Fisher, and Milton Friedman.

As I have illustrated before, velocity is not constant, but appears to be a stable function of the interest rate. (See Allan Meltzer’s graph.)

The second flaw in the analysis is that Williams is relying on simple sum aggregates, which are theoretically flawed and often produce puzzling empirical results. The question surrounding the quantity theory of money is essentially whether or not money can forecast inflation and nominal income growth and the answer is yes especially using longer time horizons and low frequency data.

Williams similarly caricatures analysis of the money multiplier:

The breakdown of the standard money multiplier has been especially pronounced during the crisis and recession. Banks typically have a very large incentive to put excess reserves to work by lending them out.

I assume that what Williams means by “the standard money multiplier” is the framework put forward in Phillips’ (1920) Bank Credit in which the money multiplier is a parameter. This view of the multiplier might be taught in principles, but I don’t think that it is used beyond that point. Even in Mishkin’s Money and Banking text, which does include analysis of the multiplier, there are explicit references to changes in the underlying factors that determine such a multiplier. Indeed, the literature on monetary theory has long recognized that the money multiplier could not be viewed as fixed coefficient. In the post-war era, this view was recognized by Gurley and Shaw (1960) and Tobin (1963). In addition, Brunner and Meltzer (e.g. JPE, 1968; JPE, 1972) explicitly modeled the money multiplier as a function of interest rates.

Jurg Niehans (1978: 274) elaborates on the points above:

While this fixed-coefficient approach, though perhaps pedestrian, is often useful and , for certain purposed, illuminating, it is also subject to serious limitations. Taken at face value it seems to say that money is very different from other things, inasmuch as demand has no influence on the quantity available; the quantity seems to be purely supply-determined. However, this is a superficial impression. It is well recognized that the coefficients appearing in the multiplier are not, in fact, technological constants, but depend, in turn, on interest rates (Brunner and Meltzer, 1968).

In addition, as Niehans (1978: 274) details, the general equilibrium approach in which interest rates are jointly determined with the money supply was developed by Tobin (1963), but actually has “its long ancestry in the pre-Phillips tradition of money supply theory.” Those who have used the money multiplier in discussions of the crisis have, by and large, recognized these points as well.

Like Williams, I agree that the financial crisis and the broader recession pose important questions for monetary theorists and teachers. However, I believe that there is much to be learned in both the present literature and the past literature on issues of monetary analysis and central banking (see Perry Mehrling’s The New Lombard Street, for example). And I wish that Tobin and Friedman would have received fairer treatment from Williams.

The Future of Too Big Too Fail

As we emerge from the financial crisis, it is important to develop a framework for dealing with failing institutions. In particular, the nature of the doctrine of “too big to fail” must be addressed and re-examined. Recently, John Taylor and Larry White have spoken out about the need for a rule of law rather than a discretionary authority. Their comments and my thoughts are below the fold.

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What Super-neutrality Really Isn’t

Our friend Nick Rowe pays homage to Milton Friedman in one of his latest posts on what monetary policy cannot do. Indeed, Friedman’s speech to the AEA in 1967 should be required reading for any who wish to learn about monetary policy (it is indeed required reading for my Money and Banking students). The purpose of this homage is to absolve monetary policy of any wrong-doing in the current recession and preceding housing boom. Specifically, he argues:

It was in that paper that Friedman introduced the concept of the natural rate of unemployment. Prior to Friedman, most economists thought there was a downward-sloping Phillips curve, and that monetary policy could keep unemployment low provided we were willing to accept higher inflation. Friedman argued that this was true in the short run only, and that in the long run, when expected inflation equaled actual inflation, the Phillips curve was vertical. Monetary policy could target any rate of inflation, but the result would be the same long run equilibrium rate of unemployment.

Friedman needed a name for that long run equilibrium rate of unemployment, and he chose to call it the “natural rate of unemployment”. He chose that name to draw a parallel to Wicksell’s concept of the natural rate of interest.


There is nothing special about unemployment or interest rates in Friedman’s argument. Everything he says about them applies equally well to any real variable. Just as there is a natural rate of unemployment, and natural rate of interest, so there is a natural rate of output, employment, real wages, relative price of houses, or relative price of sardines. The underlying vision is one of the long-run super-neutrality of money.

Monetary policy has real effects in the short run, because it takes time for prices and expectations to adjust to a change in monetary policy. But if we compare alternative worlds where prices and expectations have adjusted to alternative monetary policies with different average money growth rates and average inflation rates, real variables should not be affected. They are pinned down at their natural rates by real, not monetary forces.

I am in agreement with Nick on nearly every point of this argument. Nevertheless, I am puzzled regarding his conclusion about relative prices. When discussing long-run superneutrality of money, he is referencing the idea that a change in money growth will only cause a change in the rate of inflation in the long run and thus have no effect on real variables. However, even accepting long run money neutrality, isn’t it possible (and in all likelihood probable) that relative prices have changed? In fact, this was Hayek’s main point in extending Wicksell’s idea of a natural rate of interest. In Prices and Production, for example, he writes:

. . . it seems obvious as soon as one once begins to think about it that almost any change in the amount of money, whether it does influence the price level or not, must always influence relative prices. And, as there can be no doubt that it is relative prices which determine the amount and the direction of production, almost any change in the amount of money must necessarily also influence production.

The appropriate question is thus whether superneutrality of money not only implies that the change in the rate of inflation is proportionate to the change in the rate of money growth, but also that individual price changes are equiproportional. Nick seems to believe that it is the case, whereas I find this conclusion wanting.

There is no greater illustration of our opposing views than the idea of inflation targeting. Nick argues that monetary policy did not play a role in the Canadian housing boom:

Did a change in monetary policy cause the house price bubble? In Canada, absolutely not. There was no change in monetary policy in Canada. As I argued in my previous post, The Bank of Canada hit its inflation target almost exactly on average over the period when Canadian house prices were rising. With actual CPI inflation at the 2% target, and expected CPI inflation presumably at the same 2% target, there was no sign of the unexpected inflation that is the signature of the short run effects of a change in monetary policy.

The inflation target was 2% and actual inflation was 2%. Nick views as suggesting that monetary policy could not possibly be to blame for rising house prices. I do not find this evidence convincing in the least. What an inflation target does is establish transparency and accountability for the central bank. If the central bank hits its target, all this tells us is that they have hit their goal. It does not tell us about the desirability of the outcome.

It is entirely possible (if not probable) that monetary policy has an influence on relative prices and the allocation of resources without the aggregate level (growth) of money having an effect on the aggregate level (growth) of output. Indeed, the fact that housing prices rose 85% in Canada while the inflation rate was 2% poses interesting questions. Does the price index targeted by the Bank of Canada underweight housing? Is housing measured properly in the price indices? Doesn’t the rise in housing prices suggest that relative prices have changed (in real terms)?

I think that this is the fundamental point surrounding inflation targeting. If one focuses exclusively on the overall rate of inflation and monetary policy affects relative prices, then monetary policy directed in this manner has the potential to create asset price bubbles, resource misallocations (or simply reallocations), and boom-bust scenarios — even if super-neutrality holds.

In Search of Monetary Stability

I have been discussing a multitude of issues including quantitative easing, Ricardian Equivalence, and the current state of monetary policy with Scott Sumner over the in comments of his excellent blog and it has given me the inspiration to provide a more thorough outline of my thinking.

I think that the best way to think about money is, as Leland Yeager might say, in terms of monetary equilibrium. In other words, if we view money as being just one other good in a Walrasian general equilibrium model, then an excess demand (supply) of money is accompanied by an excess supply (demand) of goods and services. Thus, maintaining monetary equilibrium is essential to achieving economic stability. What’s more, the particular problem with an excess demand (or supply) of money is that money has no market of its own. Or as Keynes would say, labor cannot be shifted away from the production of goods where there is an excess supply to the manufacture of money. Further, the fact that money does not have a market of its own implies that an excess demand (supply) of money will have an impact on all markets because money is a medium of exchange.

My view here is not unique. In fact, Nick Rowe recently wrote an excellent post on this very topic that rightfully referenced the work of Robert Clower. The central point is that individuals have notional demands for money, goods, and services. Notional demand is understood as the intended demand. Thus, suppose for example that everyone arrives at some centralized market with their own plans for consumption and ultimate real money balances. If there is an excess demand for say lemonade, individuals can bid up the price of lemonade and the market will clear. If the excess demand is for money, however, there exists no price to adjust to clear the market and the effective demand for goods and services will fall short of supply.

A very simple way to think about monetary equilibrium is in the context of the equation of exchange:


where M is money, V is velocity, P is the price level, and Y is real output. Thus, M is the supply of money and V can be seen as the demand for money. (A particular note: velocity is understood as the number of times that the average dollar — or other medium of account* — is turned over. Thus an decrease in velocity reflects an increase in the demand for money.) Monetary equilibrium therefore implies that the product MV should be constant (and thus so should nominal GDP, or PY. Keep in mind that this is a static analysis).

The maintenance of monetary equilibrium essentially implies that monetary policy should be aimed at satisfying money demand (or nominal income) rather than the price level (as is currently the case). Thus, in a growing economy, the price level should actually be falling as increases in real output and productivity put downward pressure on prices. This type of thinking loosely forms the basis for what George Selgin calls the productivity norm. Such a maintenance of monetary equilibrium has a rich history in the course of economic thought (see Selgin, 1995).

So how does this framework relate to the current situation? Scott Sumner believes that the current recession could have been avoided using a nominal income target (more specifically, using nominal income futures targeting). I am not sure that I agree with this assertion, but it does fit with this framework. Allow me to explain.

If Sumner is correct, then (using our simple equation of exchange model) anticipations of lower nominal income would be reflected in an increase in the demand for money or a decrease in spending (a fall in V). (Alternatively, it is possible that the increase in the demand for money could be an exogenous event such as described by Keynes when there is an increase in uncertainty.) If the central bank was targeting nominal income, they would respond by increasing the money supply to offset the fall in velocity such that nominal income remains at the target level.

Sumner, however, likes to view this phenomenon through the lens of nominal income and expectations rather than through a monetary equilibrium framework (or at least that is my impression). Thus, in his mind, the nominal income target signals to economic agents that the Federal Reserve will do everything that it can to make sure that nominal income does not fall. If the Fed is credible on this point, then nominal income will not fall because people expect the Fed to follow through on this promise. I actually think that my view of monetary equilibrium is consistent with this view, but that Sumner simply has a different way of describing the policy.

In any event, Sumner has recently expressed his concern with the productivity norm view because (as I understand it) he is concerned with nominal wage rigidity. Thus, the falling prices implied by the productivity norm might actually produce malign effects. He would prefer a broader idea of a nominal income target. He might be correct, but I do not share this concern about wage rigidity. The reason is because wage rigidity should only be a concern when prices are falling due to adverse aggregate demand shocks. Falling prices due to productivity advances should have no effect on the nominal wage. In fact, rising productivity should be consistent with higher real wages (in this case due to falling prices). In any event, one need not worry about this problem under the current circumstances because the decline in nominal income is the result of a severe adverse aggregate demand shock.

I am inclined to think that nominal income targeting is certainly more desirable than the current regime. However, the ultimate question is whether or not the current situation could have been avoided under a nominal income targeting regime. Scott Sumner believes that we could have avoided the recession and simply experienced a burst of the housing bubble had we followed a nominal income target. I actually think that we might not have even had a housing bubble if we had a nominal income target (that allows for falling prices). In any event, the current situation has raised interesting questions about the state of monetary policy and monetary stability. Hopefully, we will also stumble upon some of the answers.

* “Money is here called a medium and not, as customary, a unit of account because, clearly, money itself is not a unit, but the good whose unit is used as the unit of account” Niehans (1978).

The Tone

The tone of the debate is growing more and more contentious. This time Greg Mankiw is noticeably cantankerous — and rightfully so. Paul Krugman recently challenged Mankiw’s skepticism that the administration’s forecast for growth is optimistic by dismissing him out of hand despite the fact that Mankiw has actually contributed to the line of research to which Krugman refers. Mankiw responds:

Paul Krugman suggests that my skepticism about the administration’s growth forecast over the next few years is somehow “evil.” Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

There is more. Read the whole post.

The Stimulus Debate and the Stimulus Package

Will Wilkinson has been ridiculing macroeconomics for the last few weeks for the apparent inability of theory to provide a consensus view on the stimulus package. While I admit that there is a great deal of debate among economists about the desirability of the stimulus package, one must understand both macroeconomic theory and the nature of the debate to actually make sense of the bantering. The simple “macroeconomics sucks” mantra, while provocative, is not a legitimate criticism.

The stimulus debate is largely centered around two questions:

1. Can we create a stimulus package that will boost real GDP in the short run?

2. Can a stimulus package get us out of the recession?

The problem with the debate is that those in favor of the stimulus package answer question 2 in the affirmative while actually providing evidence for question 1. On the other hand, those who oppose the stimulus package do not believe that the it will get us out of the recession, but argue on the grounds that it cannot even boost real GDP.

I have already discussed what macroeconomic theory has to say about a potential stimulus package and so I will not belabor the point. Suffice it to say that, if designed correctly, a stimulus package could provide a temporary boost to real GDP. It will not, however, get us out of the recession.

Of course, this brings us to the actual stimulus package. The problem that we are dealing with is that what is being proposed is not based on any type of economic theory, but is rather a grab-bag of goodies to be handed out under the guise of being of the public interest. This is, of course, something that is implicitly assumed by many stimulus skeptics and ignored by many of the stimulus advocates. Nevertheless, the stimulus in its current form likely renders this debate to have been for naught.