First published: December 2015
A New View on the absolute and relative effectiveness of monetary and fiscal policies is now emerging from the recent work of Kaplan, Moll and Violante (2015). This paper is by far the most realistic model macroeconomics has ever got. Not very surprisingly, the conclusions that one can draw from reading it carefully is that fiscal policy is more effective than monetary policy…as original keynesians thought.
The authors show in a paper entitled “Monetary Policy according to HANK’ (Heterogenous Agents New Keynesian) that a model with heterogenous agents, liquidity constraints, liquid and illiquid assets and sticky prices implies that :
-Monetary policy is (about 10 times!!) less effective than in the usual representative agent model. The key intuition is that in those models – and in the actual economy – people respond much less to changes in the interest rate than it is traditionally assumed because many people are “optimally” Hand-to-Mouth, i.e. simply consuming their current income.
-Fiscal policy is more effective because many people in this economy are Non-Ricardian in the sense that the timing of the fiscal adjustment now matters for their saving decision. For example, a decrease in taxes today offset by an increase in taxes tomorrow would have a real effect on the economy because Non-Ricardian agents will consume part of the tax rebate – contrary to a Ricardian economy in which all the additional income would have been saved.
The idea that liquidity constraints make both the economy less responsive to changes in the interest rates and more responsive to changes in fiscal policy is not radically new but the novelty is to put those ideas into a quantitative model that features a realistic distribution of income, assets and marginal propensities to consume and get more credible figures for the macroeconomic impact of policies.
That we are back to the original beliefs of old keynesians should not make us conclude that economics has wasted its time over the past 30 years. The large and long detour the universal mind has done is not useless: in the HANK model, one has microfounded what was left ad hoc in the original keynesians model – mainly the hand-to-mouth and the non-ricardian behaviors. Those models are also far richer as they allow for multiple assets and the description of the distribution of households.
The paper can be found here: