AGREEING FROM DIFFERENT DIRECTIONS:

My answer to the Economist (Alberto Alesina, Harvard.edu)

This week, The Economist suggests that a paper by Silva Ardagna and me is “seriously flawed.” The Economist bases this view upon a chapter from the recently released Chapter 3 of the World Economic Outlook (WEO) of the IMF. While the Chapter of the WEO offers interesting observations, to be further analyzed and all the underlying material disclosed, the drastic judgment of the Economist is unfounded.

The Economist tries to portray our paper and the WEO Chapter as polar opposites. In reality they agree on many points. In particular, they find the same critical result, and potentially the most important one: tax increases are much worse for the economy than spending cuts. The WEO Chapter argues that this effect comes mainly from different reactions of monetary policy, but their claim of having identified separately all of these channels is overstated because interest rates, current and expected, and exchange rates are endogenous to both fiscal and monetary policy. In addition, our paper and the WEO Chapter also agree that after a few years, even large (but spending based) fiscal adjustments create growth for the economy. Our paper and the WEO Chapter achieve the same results using very different methodologies. We use simple statistics and econometric analysis, they use a complex dynamic general equilibrium model. Our time framework of comparison before and after the fiscal consolidation is a five-year window (from two years after, to two years before the adjustment). This is exactly the same window around which the WEO Chapter finds that a reduction of the debt has positive effects on growth, as long as taxes are not raised.