Working Papers

Debunking Bad Narratives on Stimulus

Henry Ergas responds to the 21 economists rounded-up by Nic Gruen to defend the federal government’s stimulus measures (as if the government were not big and ugly enough to defend itself):

The open letter 21 highly respected Australian economists published earlier this week in The Australian Financial Review strikingly illustrates the trend. Endorsing the “too much rather than too little” approach, that letter claims “there is no more effective way to stimulate the economy” than cash handouts.

In reality, the efficacy of that spending is far from established. Rather, much as economic theory would predict, the striking fact is just how smooth the path of consumption has been, despite a substantial spike in income associated with the Government’s cash splash.

Sinclair Davidson makes similar points in The Age:

It would be surprising indeed if the 21 economists were prepared to defend any of the $800 million in ‘community infrastructure’ boondoggles listed here

RBA Governor Glenn Stevens has also been out highlighting the limits of macro policy stimulus:

Macroeconomic policies have not been able to prevent an economic downturn. They rarely can, especially in the face of a global recession of this magnitude. Indeed, attempts to do so have as often as not run into trouble by stoking up bigger problems a few years down the track.

posted on 05 June 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Rudd went too early with the cash handouts and we blew it at the mall.  Monetary policy and the crash in the AUD would have got us through the initial stages of the downturn.  Now the real trade crunch is coming as the AUD rises and new contract prices kick in.  The crash in business investment has dire implications for unemployment down the track as well.

Unless the ‘green shoots’ / China-will-save-us recovery is real, we’re really going to need a fiscal boost in Q3-Q4 but there will be nothing left in the tank.

Boondogle anecdote: The local primary school here is getting $3M for new classrooms, and we’re getting $8M for new sports fields.

Posted by .(JavaScript must be enabled to view this email address)  on  06/05  at  11:57 AM

To see mediocrities like Eslake and Quiggin and Gans sign the letter is hardly surprising, but Freebairn?

Posted by benson  on  06/05  at  04:31 PM

Quiggin’s Keynsian triumphalism is not justified, at least as far as AUS is concerned. His financial analysis completely ignored the fact that the GFC starts in crashing national housing markets. But AUS’s property market has held fast.

In FEB 09 I predicted that the AUS economy would out-perform the OECD way back. In early MAR 09 I corrected a foolish quantitative error in the prediction: unemployment would stay below 8% and metro property price falls would be less than 10%, not 20% as originally predicted.

Mainly because our banks never suffered much spillover from the GFC. There was no AUS NFC, ie National Financial Crisis. No bailouts needed here when the property market remained blue-chip with low rates of non-performing loans and foreclosures.

The main reason for this was our residential property market remains almost bullet proof so long as interest rates stay below 10% and immigration rates are above 200,000 pa. Yes, I am a reconstructed Bull as far as AUS property is concerned. (I was wrong, sorry Steve K).

As I predicted we have suffered a mild economic downturn. But my guess is that it is almost totally a function of the decline in the terms of trade. In early FEB 09 I conditionally predicted a four percent fall in GDP based on a 17% fall in Terms of Trade:

<blockquoteIf a four per cent fall in ToT results in a one percent drop in nominal GDP then a 17%+ terms of trade contemplated by Uren would give a four per cent hit to GDP. Assuming constant exchange rates.</blockquote>

I have not checked the ToT data so far. Obviously the rise in the AUD means that the PRC recovery is faster than expected. Something that I also expected.

As you point out, domestic investment and consump
tion never collapsed. So there was no collapse in effective demand.

More importantly, the RBAs three percent cut in interest rates (cash rate slashed from 7.25% to 4.25% in the space of nine months) delivered a much quicker and bigger financial stimulus than Rudd’s indirect subsidy to Harvey Norman-Star Casino.

Total household debt is at least $1 trillion. Annualise a three percent interest rate cut on that gives $30 billion stimulus. And surely there is plenty of other debt out there benefitting from the cut in interest rates.

Lets do the Fermi BOTE, total household debt. <a href=“http://business.theage.com.au/business/dont-mention-the-debt-20090219-8c6e.html?page=-1”> gives the background figures:

Let’s put the Federal Government’s stimulus package in perspective.  Kevin Rudd reckons $42 billion will stimulate the economy through the hard months ahead, which it will to a point.

fiscal stimulus is better than nothing. It will have some effect. Still, as a vision for the economic future it is akin to staring wistfully at the kitten in the room while ignoring the rogue elephant glowering behind it.

Our combined national debt (taking all government, personal, private and business debt into account) is $2.32 trillion. Each and every Australian then, including babies, accounts for borrowings of nearly $110,500 dollars.

If we use the same method to calculate what the cost of Prime Minster Rudd’s ‘‘stimulus package’’ is to the nation, we end up with a cost of nearly $2,000 per head.

To put it another way, says macroeconomic consultant Mark Beavan, Kevin’s rescue package is increasing the nation’s net debt by little more than 1%.

Of course it will take a year for the financial stimulus of interest rate cuts to flow through their full value. But the same can be said for the fiscal stimulus since it is not all shovel-ready.

But really, the big push in effective demand is coming from the 300,000 pa immigration influx which is a factoral stimulus. That is propping up rents and property values.

But mass immigration is too hot a potatoe to handle for the media-academia-bureuracrat complex to handle.

Posted by Jack Strocchi  on  06/08  at  07:00 PM


I bungled the html tagging and formatting in preceding comment for the following passages.

If a four per cent..

As you point out, domestic investment and consumption never collapsed.

<a >Michael West</a>:

Could you please fix?


Jack Strocchi

Posted by Jack Strocchi  on  06/08  at  10:08 PM

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