Working Papers

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 28 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 13 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 22 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 19 December 2008 by skirchner in Economics, Fiscal Policy

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Why Stimulus Measures Don’t Work

I have an op-ed in today’s Age, highlighting the Ricardian and open economy macro arguments against using fiscal policy for demand management:

From the perspective of national saving, it makes no difference whether an increase in government spending comes out of the budget surplus or whether the government goes into deficit and borrows from capital markets.  Either way, the government is saving less.

But this doesn’t mean that households will follow the government’s example.  In fact, households are likely to save more in anticipation of a higher future tax burden due to the reduction in government saving…

Demand management is best left to the Reserve Bank and monetary policy, which has already responded aggressively to a slowing economy. 

The sharp decline in the Australian dollar exchange rate is also a powerful stimulus to net exports, but any boost to demand from fiscal stimulus will also have the perverse effect of putting upward pressure on the exchange rate, reducing net exports.  In an open economy, there is no free lunch from fiscal policy.

Fiscal policy still has a role to play in supporting economic growth, but it needs to focus on long-run structural and supply-side issues not short-term attempts at rigging aggregate demand.

This means rewarding labour force participation, not encouraging welfare dependence.  Throwing more money at pensioners and families will not boost economic growth in the long-run and may not work as the government intends in the short-run.

In The Australian, Henry Ergas makes a similar argument against proposals to use superannuation contributions as a macroeconomic stabilisation instrument:

Consumption decisions are shaped not by transient changes in income but by expectations of income going forward, a proposition known as the permanent income hypothesis. A short-term reduction in compulsory savings, soon reversed and followed by a sequence of rapid increases in mandatory contributions, amounts to a pre-announced reduction in disposable incomes. As households respond to the news that their disposable incomes will fall once the temporary cut is reversed, consumption is likelier to decline than to increase.

My Age piece may have fallen victim to a which-hunt.  This line should read:

‘The household saving ratio has already surged from 1.3% in the June quarter to 3.9% in the September quarter.  This implies that taxpayers squirreled away their 1 July tax cuts, which came at the expense of the budget surplus rather than cuts to government spending. ‘

posted on 10 December 2008 by skirchner in Economics, Fiscal Policy

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Saved Not Spent: Ricardian Equivalence Negates Fiscal Stimulus

Westpac crunches the numbers on the household income account, with some predictable results:

All up, the total fiscal boost to household disposable income in Q3 was about $1.9bn. This was mostly due to $7.1bn in income tax cuts, which equates to $1.8bn a quarter.  The boost appears to have done little or nothing to stimulate consumer spending in Q3. Indeed, with aggregate household savings rising by $4.4bn in the quarter, the implication is that, in aggregate, households saved all of the windfall and then some. Most of the savings appears to have gone towards paying down housing debt.

The national accounts figures and RBA credit data imply that households injected an enormous $7.5bn into their housing equity in Q3, most of which would have been via paying down principal. This is only the third net equity injection recorded since June 2001. It is easily the largest ever in dollar terms and is the biggest as a proportion of income since 1998Q3. If Q3 is a guide and households remain as deeply concerned about reducing their debt levels in the months ahead, the implication is that there will be little or no boost from policy stimulus in Q4.

Westpac nonetheless thinks Q4 might be different, on the basis that saving all the stimulus in Q4 would be ‘too extreme’, but unprecedented times are likely to induce unprecedented responses as households anticipate a higher future tax burden.

posted on 04 December 2008 by skirchner in Economics, Fiscal Policy

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