This time is actually different

The following paragraph from Eggertsson is important for those quoting Romer and Romer and, even more importantly, Reinhart and Rogoff. This time may actually be different! I'll take the analysis with a large grain of salt, as to solve even an approximation to his basic equations he invokes Ricardian Equivalence. My main point I draw from this is that conclusions do differ when interest rates are at zero.


The contractionary effects of labor and capital tax cuts are special to the peculiar environment
created by zero interest rates. This point is illustrated by a numerical example in Table 1. It
shows the "multipliers" of cuts in labor taxes and of increasing government spending; several
other multipliers are also discussed in the paper. The multipliers summarize by how much output
decreases/increases if the government cuts tax rates by 1 percent or increases government spending
by 1 percent (as a fraction of GDP). At positive interest rates, a labor tax cut is expansionary,
as the literature has emphasized in the past. But at zero interest rates, it flips signs and tax cuts
become contractionary. Meanwhile, the multiplier of government spending not only stays positive
at zero interest rates, but becomes almost eight times larger. This illustrates that empirical work
on the effect of fiscal policy based on data from the post-WWII period, such as the much cited
and important work of Romer and Romer (2008), may not be directly applicable for assessing
the effect of fiscal policy on output today. Interest rates are always positive in their sample, as
in most other empirical research on this topic. To infer the effects of fiscal policy at zero interest
rates, then, we can rely on experience only to a limited extent . Reasonably grounded theory may
be a better benchmark with all the obvious weaknesses such inference entails, since the inference
will never be any more reliable than the model assumed.