Five Reasons Why Fiscal Stimulus Won’t Work
From Henry Ergas:
the expectation of future deficits may have immediate, adverse consequences for confidence and output. However, the Government’s announcement merely sets a vague commitment to return to surplus through future reductions in spending growth. It does not say how great the cuts in spending will need to be or where those cuts will be made, and it ignores the obvious point that if there is wasteful spending that can be cut tomorrow, it ought to be cut today.
While fiscal stimulus is assumed to be popular, opinion polling is remarkably divided on the issue:
According to the Newspoll survey, 57 per cent of voters believe the economic stimulus package, which includes $12 billion in short-term cash giveaways to boost retail spending, will be good for the economy. Almost half those surveyed, 48 per cent, believe they would be personally better off as a result of the package.
posted on 08 February 2009 by skirchner in Economics, Fiscal Policy
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‘Attacking Iran is a Shovel-Ready Project’
Robert Barro interviewed in The Atlantic.
On Obama’s fiscal stimulus bill:
This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much.
On Paul Krugman:
He just says whatever is convenient for his political argument. He doesn’t behave like an economist.
On war as stimulus:
I think the best evidence for expanding GDP comes from the temporary military spending that usually accompanies wars—wars that don’t destroy a lot of stuff, at least in the US experience. Even there I don’t think it’s one for one, so if you don’t value the war itself it’s not a good idea. You know, attacking Iran is a shovel-ready project. But I wouldn’t recommend it.
posted on 06 February 2009 by skirchner in Economics, Fiscal Policy
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‘The Last Little Timber from a Sunken Boat of Ideas’
Prime Minister Kevin Rudd proudly declared himself to be a Keynesian in his essay for The Monthly and now has a massive fiscal stimulus package to prove it. John Cochrane, Professor of Finance at the University of Chicago Booth School of Business, highlights the extent to which Keynesianism has been thoroughly discredited within modern macroeconomics:
Am I some sort of radical? No, in fact economics, as written in professional journals, taught to graduate students and summarized in their textbooks, abandoned fiscal stimulus long ago.
Keynesians gave up by the 1970s. They saw that fiscal programs took too long to implement. They especially disparaged temporary measures, which would not stimulate the consumption that classic Keynesians thought was important to stimulus. Every undergraduate text has repeated these conclusions for at least 40 years. I learned this view from Dornbusch and Fisher’s undergraduate text, taught by Bob Solow, in the 1970s…
The equilibrium tradition which took over professional academic economics in the mid-1970s has even less room for fiscal stimulus. Some “equilibrium” analyses do say fiscal stimulus can increase output – but by making us feel poorer, work harder at lower wages, and consume less. That’s not what advocates have in mind! A large fiscal program can affect prices, wages, and interest rates with all sorts of interesting general-equilibrium implications, but these analyses haven’t really converged on anything solid, much less the large “multipliers” necessary to make traditional fiscal stimulus attractive.
More deeply, macroeconomics was revolutionized starting in the 1950s, by the realization that what people think about the future is crucial to understanding how policies work today. Milton Friedman started this, pointing out that consumption does not depend statically on today’s income, but on what people expect of the future. People who learn that their jobs are on the line will consume less and save more, even though today’s income may still be good. As I have emphasized, the effects fiscal stimulus will have now depends crucially on whether people expect the new spending to be paid back by future taxes or whether they expect it to be quickly monetized. Classic Keynesian analysis analyzed policies and each time point in isolation. We do not have to agree if expectations are formed “rationally,” all we have to agree is that expectations of the future matter crucially for how people behave today, and the classic Keynesian analysis of fiscal stimulus falls apart.
In textbooks and graduate curriculums across the country, stimulus is presented at best as quaint “history of thought” with no coherent defense that one should believe it in the context of modern economics. (For example, David Romer’s classic graduate text Advanced Macroeconomics) At worst, it is presented as a classic fallacy. (My view of the treatment in Tom Sargent’s Dynamic Macroeconomic Theory and Sargent and Ljungqvist’s Recursive Macroeconomic Theory).
“New-Keynesian” thought is devoted to defending the importance of monetary policy, and incorporating specific frictions in the equilibrium tradition, not to rescuing the ancient view that fiscal stimulus is important and abandoning that tradition. Mike Woodford’s magisterial New-Keynesian opus, Interest and Prices, has no mention at all of fiscal stimulus. More deeply, new-Keynesian economics is completely devoted to the proposition that expectations of the future matter centrally for how the economy behaves today. Its central thesis is that central bankers must manage expectations, not manage “demand.” It has no room at all for the sort of analysis in which one adds up “consumption” “investment” and “government” demands, without considering alternatives for those demands or expectations of the future, to determine output.
These ideas changed because Keynesian economics was a failure in practice, and not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said “we’re all Keynesians now” just as Keynesian policy led to the inflation and economic dislocation of the 1970s, unexpected by Keynesians but dramatically foretold by Milton Friedman’s 1968 AEA address. Keynes disdained investment, where we now all realize that saving and investment are vital to long run growth. Keynes did not think at all about the incentives effects of taxes. He favored planning, and wrote before Hayek reminded us how modern economies cannot function without price signals. Fiscal stimulus advocates are hanging on to a last little timber from a sunken boat of ideas, ideas that everyone including they abandoned, and from hard experience.
posted on 05 February 2009 by skirchner in Economics, Fiscal Policy
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So Much for ‘Liquidity Enhancement’
Australian Office of Financial Management head Neil Hyden gives the game away on the government’s expanded bond issuance program:
“The bonds we’re issuing, the proceeds are all going to be needed for government expenditures…”
posted on 05 February 2009 by skirchner in Economics, Fiscal Policy
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Ken Henry on Activist Fiscal Policy
Treasury Secretary Ken Henry, addressing Australian Business Economists in May this year:
activist counter-cyclical fiscal policy might be frustrated by lags of recognition, implementation and transmission. And its effectiveness might be compromised by Ricardian equivalence, the permanent income hypothesis or import leakages. I noted that these lags and questions of effectiveness pose real challenges for the use of counter-cyclical fiscal policy. But I also noted that they do not rule out such use.
On the issue of import leakages, much is being made of the alleged contribution of the government’s previous stimulus package to December retail trade:
Greg Smith, the managing director of household goods store Clive Peeters, said wide-screen televisions, DVD players, digital cameras and laptop computers had begun walking out of the company’s stores from the day the Government’s first economic package reached the public.
Since all of the mentioned items are imported, this expenditure is a subtraction from Australian gross domestic product. One of the problems with activist fiscal policy is that, to the extent that there is any boost to domestic demand, much of it will spillover into imports, which might stimulate the Chinese and other economies, but will do very little for economic growth in Australia. Retail sales are inappropriate as a gauge of the effectiveness of fiscal policy in stimulating domestic production.
Westpac note that the increase in retail sales was disappointing given gains in disposable income:
More importantly the December retail sales figure points to an even sharper run-up in household savings than previously anticipated. Indeed, it points to a spike in the savings rate to over 8% in Q4 from basically zero in the final quarter of 2007. This would mark the sharpest rise in saving on history back to 1960 by a very long way – effectively double any surge in household saving ever seen before.
posted on 04 February 2009 by skirchner in Economics, Fiscal Policy
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Obama’s Fiscal Stimulus versus the University of Chicago
Professors John Huizinga, Robert Lucas and Kevin Murphy speak at an Initiative on Global Markets Forum at the University of Chicago Booth School of Business on Obama’s fiscal stimulus package. All of their arguments translate directly into the Australian context.
posted on 04 February 2009 by skirchner in Economics, Fiscal Policy
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A $42 Billion Future Tax Increase: Immiseration Not Stimulation
I have an op-ed in The Australian, arguing that the government has just announced a $42 billion future tax increase. In reality, it’s worse than that because of the interest bill on the $42 billion in unfunded spending, plus the future welfare costs associated with an increased tax burden and the government’s diversion of resources away from potentially more highly valued uses. The package will immiserate rather than stimulate.
In the statement accompanying yesterday’s 100 basis point cut in the official cash rate, the Reserve Bank said that ‘the Board took into account the package of measures announced by the Government earlier today.’ If the RBA shares the Treasury’s Keynesian assumptions about the implications of the package for short-term economic growth, then it is entirely possible that yesterday’s rate cut was smaller than it might have been in the absence of the latest fiscal stimulus package. While fiscal policy has been irrelevant to monetary policy in recent years due to a steady fiscal impulse, it is less likely the RBA will ignore the massive turnaround in the budget balance we have seen since May last year. Those ‘free’ pink batts are likely to have come at the cost of a higher mortgage interest rate.
posted on 04 February 2009 by skirchner in Economics, Fiscal Policy, Monetary Policy
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Rudd Bank versus AussieMac
A curious feature of the debate surrounding the so-called Rudd Bank (see previous post) and AussieMac is that the same people have taken different positions on the two interventions. Opposition leader Malcolm Turnbull supported the government’s intervention in the RMBS market, but opposes Rudd Bank. In The Australian today, Christopher Joye criticises Ian Harper for supporting Rudd Bank while opposing the RMBS intervention. Joye supports the RMBS intervention and (at least on a relative basis) opposes Rudd Bank.
In my op-ed for the AFR on Rudd Bank yesterday, I deliberately linked the two interventions, because I see them as suffering from similar problems. Both interventions implicate the government in favouring specific industries and firms, on the assumption that this will prevent wider adverse economic outcomes. This overlooks the fact that those sectors deemed most worthy of assistance may also be those most in need of adjustment and may see low relative returns on government resources compared to alternative policies. Both interventions rely on a rather stretched transmission mechanism from the government’s balance sheet, via the balance sheets of business, to the wider public.
One of the advantages of generalised tax cuts as a stimulus measure is that they are relatively neutral from the standpoint of resource allocation. Tax cuts may also have other supply-side benefits through easing distortions and disincentives flowing from the operation of the tax system. From a demand management perspective, unfunded tax cuts are subject to the same Ricardian equivalence critique as unfunded spending measures, but from a supply-side perspective, they have a distinct advantage.
From a political perspective, however, the advantage of Rudd Bank and the RMBS intervention is that they can be written up as loans and investments rather than outright spending. The fiscal transfers involved are therefore much less transparent. One could say the same of the provision of term funding to banks via the Future Fund, although at least this is at arms length from the government of the day and may not differ significantly from the market-based outcomes that would prevail if the Future Fund did not exist.
posted on 29 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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Rudd Bank Puts Taxpayers Last
I have an op-ed in today’s AFR on the so-called ‘Rudd Bank.’ Text below the fold (may differ slightly from edited AFR version).
Henry Ergas made related arguments in The Australian yesterday.
continue reading
posted on 27 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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The Multiplier Equals Zero
Robert Barro makes the case for a zero multiplier from fiscal stimulus:
A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP—consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one.
This approach is the one usually applied to cost-benefit analyses of public projects. In particular, the value of the project (counting, say, the whole flow of future benefits from a bridge or a road) has to justify the social cost. I think this perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.
What do the data show about multipliers? Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II. The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists.
I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports—personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses—there was a dampener, rather than a multiplier.
posted on 22 January 2009 by skirchner in Economics, Fiscal Policy
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The Failure of US Fiscal Policy
When it comes to activist fiscal policy, it seems that nothing succeeds like failure. The failure of the economy to respond to previous stimulus measures is always seen as an argument for yet more stimulus, rather than supporting the more obvious conclusion that activist fiscal policy doesn’t work. As Philip Levy notes, if the existing US budget deficit won’t budge its economy, there is nothing the Obama Administration can add that is likely to make a difference:
The Congressional Budget Office projected last week that even without a stimulus package, the federal budget deficit will hit $1.2 trillion this year. That’s 8.3% of gross domestic product. Followers of the late John Maynard Keynes should be thrilled. Such a gap between government spending and taxes was just what he prescribed to stimulate a slumping economy.
And yet the stimulus enthusiasts seem unsatisfied. President-elect Barack Obama argues that this level of stimulus would leave us with shattered dreams and long-lasting torpor. Our only chance is to adopt his plan of $800 billion in additional stimulus spending over the next two years. So $1.2 trillion in deficit spending leaves us in despair, but $1.6 trillion in deficit spending brings prosperity…
there is very little science behind arguments that an additional $800 billion stimulus should do the trick.
Unfortunately, the political imperative is for governments to be seen to be doing something, regardless of whether it works or not.
posted on 15 January 2009 by skirchner in Economics, Fiscal Policy
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Thrift is No Paradox
I have an op-ed in today’s AFR refuting the paradox of thrift as a rationale for short-term fiscal stimulus measures. In particular, I highlight the origins of the idea in the discredited ‘secular stagnation’ hypothesis of the1930s. Text over the fold (may differ slightly from edited AFR version).
Greg Mankiw makes related arguments in the US context.
continue reading
posted on 12 January 2009 by skirchner in Economics, Fiscal Policy
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Monetary and Fiscal Policy Effectiveness in a Globalised World
Alan Greenspan, interviewed in Die Zeit, on the effectiveness of monetary and fiscal policy:
Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates…
The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.
The way it should be.
posted on 21 December 2008 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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Rent-Seekers Gone Wild: ‘Shovel-Ready’ Edition
Fiscal stimulus rent-seeking is not just for people:
The Association of Zoos and Aquariums (AZA) today called for shovel-ready zoo and aquarium infrastructure projects to be eligible for Federal stimulus funding…
“Zoos and aquariums are woven into the fabric of American life,” said AZA President and CEO Jim Maddy. “They are viewed by the public as important to the quality of life in their communities.”
Many zoos have their roots in the Great Depression, when the Federal Work Projects Administration (WPA) helped build many zoos across America.
“Zoos and aquariums will deliver incredible value for the Federal government,” added Maddy. “Investment in these institutions will pay-off twice, first in immediate job creation, and second, in the environmental education of our children for years to come.”
The same children can also look forward to paying for them for years to come.
Come to think of it, I also have some ‘shovel-ready’ projects in my backyard that could do with some stimulus.
posted on 20 December 2008 by skirchner in Economics, Fiscal Policy
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Fiscal Stimulus Doesn’t Work - Ever
Tyler Cowen suggests the historical record argues against the effectiveness of fiscal stimulus:
it is very hard to find examples of successful fiscal stimulus driving an economic recovery. Ever. This should be a sobering fact…
It’s up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery. Right now we’re mostly at “It wasn’t really tried.” And then a mental retreat back into the notion that surely good public sector project opportunities are out there.
So what you have is the possibility of faith—or lack thereof—that our government will spend this money well.
And that is under “emergency” conditions, with great haste (“use it or lose it”), with a Congress eager to flex its muscle, and with more or less one-party rule.
Another way of looking at this issue is to ask why we would ever need to experience a significant economic downturn if policymakers could effectively smooth the business cycle with fiscal policy.
Meanwhile, Centrebet is offering $1.22 for a local recession by the December quarter 2009. Assuming an 8% bookie’s margin, this implies a recession probability of around 75%. Needless to say, the Treasurer is not happy with betting shops speaking truth to power:
I think that sort of talk is utterly irresponsible.
posted on 18 December 2008 by skirchner in Economics, Fiscal Policy
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