|Between the Earth and the Sea|
On the other side is the Ricardian versus Keynesian debate on the exact impact of Fiscal Stimulus on real wages, consumption, and investment; the former advocating a negative effect as consumers adjust their behaviour for future tax increases; and the latter supporting a positive effect which is explained by the recessionary state-contingent phase of the business cycle and animal spirits.
The entire debate is far from settled. Yet its outcome is ever more important; given the differing mindsets settling in across the Advanced World. Plans for reducing budget deficits in Germany and Britain are drowned out by calls in France, Southern Europe, and the US to increase spending to counteract recessionary and contractionary forces.
Some of the best papers are by Ilzetzki et al (2010) and Auerbach and Gorodnichenko (AG, 2012); both claim the FM is situation and time specific. Using a new methodology, the Smooth Transition Vector Autoregression, AG (2012) argue in a recessionary environment Fiscal Stimulus has shown to rapidly increase output, consumption, and investment on past occasions in the OECD and the US.
Queen Elizabeth once asked economists at LSE, whilst opening the New Academic Building, why did they not see the credit crisis coming? The failures of Macroeconomics in accounting for the erroneous DSGE modelling, which lacked any assumptions on financial intermediation and behavioural asymmetries, have been addressed by going back to basics. Using underused Econometric Methodology and Economic History in providing solutions to old problems.
Yet the metaphor given to the FM by some is apt. Imagine if the economy was a rocket; how can one build a rocket if the simulated trajectory is anywhere between the earth and the sea. Up to know, Economics is far from a pukka branch of Human Knowledge. It is then behooved of future Economists to provide the tools and advice necessary to prevent severe busts; like the one we are currently witnessing.