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Stimulus Skeptics

I’m quoted in a story in The Australian today on the effectiveness of fiscal stimulus.  As I noted in this post, if we are to accept the proposition that fiscal stimulus has been effective in supporting demand, then this implies that monetary policy has had less work to do and that interest rates have been higher than they otherwise would have been.  To be clear, that is not my view, but it is where the logic of the pro-stimulus camp must lead.  In that case, all fiscal stimulus has done is trade-off monetary for fiscal easing.

Kevin Hassett has noted the same inconsistencies in the discussion of fiscal policy in the US:

Democrats opposed the Bush tax cuts from the beginning not because lower marginal tax rates are bad, but rather, because they believed they would lift deficits and interest rates.

The interest-rate effect is so large, goes this line of reasoning propounded by disciples of the “Rubin school,” that the net effect of tax cuts would be harmful.

But now we hear that we can adopt the Obama health-care plan, increase an already massive deficit, and it will be no problem. But if raising taxes can reduce deficits and spur the economy, then cutting spending should do that too. So why are we increasing spending yet again? Democrats have no answer…

The fact is, deficits are a problem precisely because politicians can get away with running them with near impunity. If interest rates did soar in the face of deficits, it would provide a constraint on the growth of big government.

Sadly, there will be no such constraint.

posted on 19 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Policy prescriptions for a very large and largely de-industrialized (at least wrt tradeables) economy are not necessarily relevant for a small open economy like Australia.
Also, fiscal; and monetary stimulus are so different that general remarks regarding subtitution and accumulation effects have to be ignored, unless that take into account the nature of, especially the fiscal stimulus (leaks, externalities, long term effects) the health of the financial system (transmission), and the initial conditions (pre-existing gvt debt and interest rate l;evel). Finally the context is important: Australia has traditionally a trade deficit. A recession resulting in reduced spending on manufactured consumer tradeables while primary exports continue (as is currently the case thanks to China)  will have as its primary effect a GDP boosting contraction of the trade deficit.
Fiscal policy in democracies is a very risky instrument. It may help smoothing the business cycle but probably (espe. in a country where it is becoming more difficult to pass on international price signals to the local labor force due to the untimely removal of institutions designed to suppress labor class politics) at a long term cost. And the rush towards fiscal (rather than monetary) stimulus means that the blame for future cooling down lies with the ARB.

But, no democracy wants politicians with suicidal tendencies either…

Posted by .(JavaScript must be enabled to view this email address)  on  08/22  at  08:27 AM


Policy prescriptions for a very large and largely de-industrialized (at least wrt tradeables) economy are not necessarily relevant for a small open economy like Australia.
Also, fiscal; and monetary stimulus are so different that general remarks regarding subtitution and accumulation effects have to be ignored, unless that take into account the nature of, especially the fiscal stimulus (leaks, externalities, long term effects) the health of the financial system (transmission), and the initial conditions (pre-existing gvt debt and interest rate l;evel). Finally the context is important: Australia has traditionally a trade deficit. A recession resulting in reduced spending on manufactured consumer tradeables while primary exports continue (as is currently the case thanks to China)  will have as its primary effect a GDP boosting contraction of the trade deficit.
Fiscal policy in democracies is a very risky instrument. It may help smoothing the business cycle but probably (espe. in a country where it is becoming more difficult to pass on international price signals to the local labor force due to the untimely removal of institutions designed to suppress labor class politics) at a long term cost. And the rush towards fiscal (rather than monetary) stimulus means that the blame for future cooling down lies with the ARB.

But, no democracy wants politicians with suicidal tendencies either…

Posted by .(JavaScript must be enabled to view this email address)  on  08/22  at  08:27 AM



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