Stating the obvious

by on January 10, 2009 at 6:47 am in Economics | Permalink

"We have very few good examples to guide us," said William G. Gale, a senior fellow at the Brookings Institution, the liberal-leaning research organization.  "I don't know of any convincing evidence that what has been proposed is going to be enough."

Here is the article, from today's NYT.  I would reword this slightly, so as to indicate that progrram size alone does not guarantee success.  In fact the larger the stimulus becomes, the fewer good examples we have to guide us.  Aggregate demand macroeconomics does add a great deal of value to our understanding of the economy, but as in all macroeconomic theories the limits to our knowledge are quite severe.

1 babar January 10, 2009 at 7:14 am

not quite true that there is no roadmap. emily dickinson had this to say about stimulus:

To make Routine a Stimulus
Remember it can cease –
Capacity to Terminate
Is a Specific Grace –
Of Retrospect the Arrow
That power to repair
Departed with the Torment
Become, alas, more fair –

2 Harkins January 10, 2009 at 7:44 am

The wonder of the Stimulus Maximus is that no one, from Obama on down, sounds like they really believe it will be effective. “Policy Happens” is the prevailing attitude.

3 Bob Murphy January 10, 2009 at 10:54 am

“Disaggregated” makes the same point I did on my blog when Obama and Biden announced their new target was to create 3 million new jobs. Depending on how big a stimulus you’re talking, it ranges from $200,000 the $333,333 after-tax.

Rather than going down their current stimulus route, if Obama & Co. really wanted to help poor people, they could instead take the $1 trillion (or whatever), identify the 10 million households most in jeopardy, and send checks. I’m not proposing that, of course, but it makes more sense (given their publicly stated objectives) than what they’re going to do.

4 dale January 10, 2009 at 11:10 am

I share misgivings about the use of a fiscal stimulus, but it is foolish to pretent that we “know” it won’t work or help. Given the current conditions, even I would recommend trying a large stimulus – and focusing on tax cuts, some “worthy” infrastructure projects, and mostly support to state and local governments seems to me to be the least bad of the alternatives.

But I think there is too much debate over whether or not to try a fiscal stimulus – and much too little discussion about the long term consequences. The levy paper cited above is helpful in this regard, although I don’t quite understand the macro theory implicit in that paper. Normally, I would expect the large defecits to cause a large fall in the value of the dollar. However, it seems that investors are willing to park their assets in Tbills, even with zero return. So, at present, the dollar may actually strengthen in the face of large defecits. Eventually, I would think this needs to change – but what form will that change take?

Another expected consequence of running such large defecits is that the government will be borrowing money that might have gone to the private sector. What ever happened to “crowding out?”

I’d like to get past the libertarian rhetoric that seems any government policy as a slide towards a planned economy (even if that ends up being the result). Can anybody seriously say that the government should do nothing in the present situation? What I think we need to do is explain what the long term consequences of the stimulus are likely to be. Frankly, I just don’t see the scenario under which the short term policy works and has no lingering long term impacts. The idea that we can engineer a “soft bursting” of the bubble seems ludicrous given the almost nonexistent state of our understanding of the macroeconomy. (sorry to dump on macro, but in 35 years of being a PHD economist, I’ve never understood it and, frankly, think far too much effort has been put into formalizing elegant theories that don’t do any better than sunspot cycles for explaining business cycles).

5 meter January 10, 2009 at 11:49 am

“Can anybody seriously say that the government should do nothing in the present situation?”

I’d like the government to do nothing. This will end up being more welfare for the rich.

6 Superheater January 10, 2009 at 12:11 pm


“I share misgivings about the use of a fiscal stimulus, but it is foolish to pretent that we “know” it won’t work or help.”

“I’d like to get past the libertarian rhetoric that seems any government policy as a slide towards a planned economy (even if that ends up being the result). Can anybody seriously say that the government should do nothing in the present situation?”

Have you thought that the thing government should do isn’t “nothing”, but arguably having contributed mightily to the present circumstances, to discontinue (and I realize how politically unlikely this is) the myriad of interventions?

You implicitly concede fiscal stimulus could be ineffective (or counterproductive, perhaps?) and explictly indicate that the rush to “do something, do anything” approach might have unknown long-term consequences (this sounds awfully familiar) but urge action for its own sake?

Physicians operate by the dictum “first do no harm” and don’t wildly medicate -operating under uncertainty-they try to apply their knowledge of the operative effects of their actions with an appropriate judgment about the potential risks and rewards. If your going to doctor the economy, it might help to know what your “medicine” will do.

7 the buggy professor January 10, 2009 at 12:49 pm

“Aggregate demand macroeconomics does add a great deal of value to our understanding of the economy, but as in all macroeconomic theories the limits to our knowledge are quite severe.” — Tyler Cowen


(i) This observation seems sound enough . . . especially when you consider the range of policy-guides that can be deduced from various macroeconomic theories:


* Real business-cycle theory, the prevailing consensus among free-market economists, says that there is nothing that monetary or fiscal policymakers can do to counteract a recession — only deepen or lengthen the recovery by any misguided policy interference. On this view, the causes of short-term ups and downs — the business cycle — are found in 1) changes in productivity across economic sectors, driven by technological shocks; or 2) marked shifted in consumer preferences (which cover both shifts in what consumers prefer to buy and their willingness to go into debt or not for consumption); or 3) resource problems, such as the unexpected and surging price of oil in 1973 and against in 1979.

Or maybe — forgotten by most economists, it seems — 4)by a big war or 5) a cartel like OPEC that raised the price of oil massively twice in 1973-74 and again in 1979.


* Monetarism — which, of course, entails an increase in the money supply and hence QE (quantitative easing) in its original form, or in its more tamed efforts to lower interest rates as countercyclical policies. Even mainstream Keynesian efforts endorse such policymaking, if it would do the job.

Unfortunately, in a system-wide financial breakdown on a global scale — as in the 1930s when Keynesian economics was born or again in the current recession — monetary policy might not be a sufficient or reliable countercyclical policy. And quite simply because the main thrust of core Keynesianism was diluted or ignored in the IS-LM versions, created by John Hicks of Oxford (a former prof of mine) and the neo-classical synthesis of Samuelson or the even tamer New Keynesianism of Gregory Mankiw and others. The reason? Amid such a systemic financial crisis, psychological factors of wariness, mistrust, or precautionary or outright fearful inter-temporal expectations — in short, animal spirits that are severely depressed — lead to a liquidity trap and nullify reliable monetary expansion.

Wait though. Monetarism won’t work in New Classical theory — pioneered by Lucas and others who emphasize rational expectations (and assume that supply and demand in financial and real economy-markets are always in equilibrium unless shocked from the outside or gummed up by governmental policies) — UNLESS workers and managers of business firms are taken by surprise. Nobody thinks anybody is now being surprised by the Federal Reserve’s policies since last spring, maybe the latest since September of 2008, are they?


*Tax-Cuts — especially of a permanent sort, made credible somehow by policymakers in the here-and-now committing different politicians in the executive and legislative branches of government in the future to adhere to the cuts.

This is the Ricardian version, recreated by Barro, as not just a countercyclical policy to fight recessions, but as, of course — something all free-market theorists would endorse — a stimulus to future economic growth of a long-term sort.

Since nobody knows how to make such a commitment credible, any tax cuts have to fall back on likely short-term effects on a recession — such as conceived by Martin Feldstein back in 2001’s recession and implemented by George Bush and Congress, with a commitment — ha! ha! – to increase most of them again when GDP returns to its long-term path-potential.


* Tax-Cut Multipliers (Take Two):

Back on December 2nd, Tyler linked to two articles (via Mankiw’s web-site) that nonetheless found that tax-cuts offered the most multiplier-impact of any fiscal policies carried out in the US over several post-WWII decades. One was a 2002 study by Blanchard and Perotti and the other 2005 one by Mountford and Ulhlig. Specifically, of the three fiscal stimuli-policies they exam —(i) a deficit-spending fiscal policy shock, (ii) a deficit-financed tax cut, and (iii.) a balanced budget fiscal shock — the most effective by far is a tax cut.

That seemed promising, no? And in fact Mountford and Ulhig specifically showed how their findings were in line with the earlier Blanchard-Perotti study. Alas, Mountford and Ulhig did not refer to a later paper carried out by Perotti — who then ran a similar regression model on several other rich countries in the OECD as well as on the US As it happened, Perotti found that tax-cuts not only over a long time-series — divided into different time-periods (1950-1980, 1980-2001) — not only had a very weak multiplier effect than the original US-only study that he and Blanchard published, but turned out in the US to have a negative multiplier effect since 1980! Yes, not only a weak effect, but an unqualified one.

The later Perotti study is nicely summarized with data-tables in this Blanchard conference paper =


* Austrian Liquidationist Theories —

Governments, on this view, should do nothing but stand by in a recession and wait until the underlying excessive monetary and credit expansion that caused the boom now entailing a recession, however deep, works its impact through asset-deflation; real wages are cut somehow — excessively raised during the boom; and the Central Bank learns the hard lesson not to expand the money supply or reduce interest rates after the recession ends and hence generate “forced savings† again and cause a boom and another round of misallocated investment capital vs. consumption in the present.

The Mises- and Rand-inspired Austrian-followers go further. At some point, so they hope, Central Banks will commit hari-kari and fractional banking will follow, while the capitalist economies return to a gold-standard and are inspired by the writings of Spanish Scholastic Philosophers of the late Medieval period. On the other hand, both Hayek and Lionel Robbins confessed several decades after the Great Depression that they were wrong to counsel patience and non-intervention in the US economy and elsewhere; and Hayek even endorsed the need in a 1979 paper for some fiscal expansion in a serious recession.



* There are, of course, different theoretical versions here — Keynesianism, like free-market theories, a paradigm that spins off often competing versions.


* No need to elaborate much here. For one thing, the comments are already long enough. For another thing, more to the point, the tamed Keynesian theoretical versions — including the prevailing New Keynesianism (which emphasizes hard-to-change menu costs for product-pricing and rigid monetary wages for firm-specific productivity in the future) — ignore the key stress in original Keynesianism on the massive psychological problems that prevail in financial markets and prevent intended investment by business firms from matching up with the intended savings of individual investors.

The tamer versions thus slight or pass over the main thrust of core-Keynesianism — how a complex financial intermediary system, with increasing liquid alternatives for investment purposes by well-to-do capitalists and nowadays by all sort of complex financial derivatives and even mutual funds for investing pension funds, disrupts Says Law about how supply creates its own demand . . . a claim that was taken up early in English economics, with Malthus disputing it and Ricardo defending it. The dispute, by the way, returned off and on in the 19th century, and especially in Marshall’s partial-equilibrium theoretical work that influenced Keynes, his pupil.

Of the present Keynesian theories, Hyman Minsky’s theory of the business-cycle — excessive credit-creation in the boom, with money endogenous, followed by surging pessimism and mistrust in financial markets (right down to mistrust about accurate balance sheets across the board in diverse financial institutions) — seems at least to explain the kinds of recurrent fiscal-crises we’ve experienced since the days of financial deregulation that started in the 1980s.


* Only worth noting, in passing, that all Keynesian theories do emphasize fiscal-expansion to boost aggregate demand in a recession as a countercyclical policy.

They do disagree on the size of the boost and how quickly it will work, not to mention the multiplier effects of specific spending programs. For what it’s worth, Mark Zandi, the head economist at Moody’s economic division, does seem to point to what common-sense would say: target unemployment benefits, food-stamps, state-and-local governments, and public-works . . . the multiplier effects, his studies show, roughly $1.50 for every dollar spent. And he endorses more or less the figure of $750-800 billion that Obama has been talking about.


Michael Gordon, AKA, the buggy professor

8 dearieme January 10, 2009 at 1:59 pm

Mr Wullie Boots – as I think of him – blogs at the FT and had this to say recently. I think it startlingly good.
“Economic policy is based on a collection of half-truths. The nature of these half-truths changes occasionally. Economics as a scholarly discipline consists in the periodic rediscovery and refinement of old half-truths. Little progress has been made in the past century or so towards understanding how economic policy, rules, legislation and regulation influence economic fluctuations, financial stability, growth, poverty or inequality. We know that a few extreme approaches that have been tried yield lousy results – central planning, self-regulating financial markets – but we don’t know much that is constructive beyond that.

The main uses of economics as a scholarly discipline are therefore negative or destructive – pointing out that certain things don’t make sense and won’t deliver the promised results.”

9 Bob Murphy January 10, 2009 at 3:41 pm

Those who favor big stimulus, can you please clarify something? (I’m not being a wiseguy in this post.) Tyler (and others) have been claiming that there are no good examples of stimulus working. The cases where it was tried and failed–such as New Deal and Japan in the 1990s–the pro-stimulus people can plausibly say it wasn’t tried enough. OK fine. But has there ever been a clear-cut example where the economy was headed into a bad recession, then the government spent a bunch of borrowed money and surprised everyone by how quickly the economy recovered?

10 mike January 10, 2009 at 4:21 pm

there is alot to be said about our economic problems, but to sum it up,, a wise man once said “the borrower is slave to the lender,,,” the u.s is borrower, china is the lender,,,, dont spend what you dont have stupid, that needs to be the government motto

11 LWright January 10, 2009 at 5:35 pm

To get the economy rolling again we need money to start flowing from the institutions and the housing market to cycle inventory so that there are manufacturing demands. The government has already appropriated the money for lending, but may need to force their leverage to get it flowing.

What I propose they start for a housing stimulus is a program that would pay 2% of the interest for new mortgages (example; 5 years of 2% payments for existing home purchases / 8 years of payment for new home purchases with a $200K maximum). These mortgages could be piggybacked with a secondary loan for those qualified and interested in the jumbo market. This program would only be available for a 3 – 6 month window of opportunity. This would entice people to BUY NOW, instead of sitting on their hands, waiting on prices to continually drop. A person could sell their house as the payment term ends with no prepayment penalty, so that they could retain their equity (building wealth for investment), or they would just continue at the original rate of the loan (building more equity). Incomes should increase during the time of the payment program, which would allow a homeowner the opportunity to meet their original obligations. A program for refi (2% for 3 years?) could also be effective in helping people with a straining mortgage stay in their residence, warding off foreclosure.

One of the pros for the government is that this program would allow for pay out over 5 – 8 years as opposed to dropping a $trillion dollars in a relative short period of time.

As an example, using simple mortgage calculations; A $200K loan for 30 years at 5.25% equals a monthly P&I of $1,104.41. A $200K loan for 30 years at 3.25% equals a monthly P&I of $870.41. A person would only pay 79% of what they would normally pay for this mortgage. The government would pay $2,808.00 per calendar year. If they helped SELL one million homes in this manner, it would only equate to $2.808 Billion of bail per year. This would equate to $200 billion in residential sales, untold return in tax base revenues, the reduction of housing inventories, new construction starts and a stimulation of the manufacturing sector with the new demand for appliances, HVAC units and other housing related concerns.

Stimulation without incentive is ineffective and should also be accompanied by time constraints. You do not see Black-Friday Christmas type sales all year long. There is a reason they happen and are of such a grand economic scale, as they are limited by an event, timeframe and deadline.

Please quit using our money to pander for votes by trying to purchase them with a $500.00 gratis or $1000.00 tax credit.

12 Bob Murphy January 10, 2009 at 11:28 pm

Stan wrote:

The story I’ve heard about FDR and the Great Depression is a) he applied mild fiscal stimulus in the period 1933 – 1937 and reduced the unemployment rate from the mid 30’s to 14% (lower if you include public employment), b) he reverted to classical economics in 1937 and brought on a severe recession, and c) spent vast sums on the military during WW II and ended the Depression. If this isn’t true, would somebody explain why?
I’m not an economist, and I’m interested in the answer.

Stan, I knew FDR raised taxes in 1937 but I wasn’t sure if he also cut spending; according to this site, he did. So yes, on the surface Krugman would have a pretty strong card to play there.

I’m actually working on a book on the Depression right now, and I’m going to deal with this very point. But for here, some really quick responses:

(1) If you play with the dates on this site, you can see that total federal spending absolutely collapsed during the 1920-1921 (some say -1922) depression. Unemployment shot up to more than 11 percent in 1921. I don’t have the figures handy, but wholesale prices declined very sharply too, I think even more quickly than they fell from 1929-1930. So according to your hypothesis, this should have been an awful Depression, and yet we don’t even hear about it in school. Unemployment was down to 6.7% by 1922, and down to 2.4% by 1923. And really, you should look at how much federal spending fell during this period from 1919 levels; it is shocking.

(2) To explain why the “depression within a Depression” of 1937-38 was so bad, and why unemployment was still over 14% in 1940, Vedder and Gallaway cite the high wages of the period. In particular, in 1937 the Supreme Court ruled that the Wagner Act (NLRB) was constitutional, and union membership shot up by 40% in a single year (the biggest jump in US history). Money-wages rose sharply, thus unemployment shot up. And, I would argue, the fact that you were still smack-dab in the New Deal prevented recovery.

(3) As far as WWII getting the US out of the Depression, the best refutation of that is Bob Higgs’ work. He probably has some essays online, but I am using his collection of essays in the book _Depression, War, and Cold War._ Very briefly, his point is that the official statistics are meaningless in the war years. Sure, measured unemployment went way down, but duh, if you ship millions of able-bodied men overseas, that will happen. And sure, official GDP stats shot up, but when the government imposes price controls and rationing, and then has outlays exceeding 40% of GDP, that will happen too. But it’s not obvious that this is a true economic recovery.

13 Bob Murphy January 10, 2009 at 11:35 pm

*Sigh* One last time: HERE is the link. Sorry, Stan.

14 Stan January 11, 2009 at 9:49 am

Bob, thanks for your responses. I understand that the WW II years in the US were anomalous, but my question was really directed to the postwar period. We started the 40’s in bad shape economically, and we ended them on the eve of a golden period. What happened in between to cause this? According to the history I read in college and later, the large fiscal stimulous caused by heavy deficit spending during WW II ended the Depression. Do you feel differently? And how about the many libertarians who post in this space?

15 Yancey Ward January 12, 2009 at 10:41 am


If your father is still alive, ask him. He seems to know more than Krugman based on your story.

If giving money away to the American people causes one effect, how can having government do the spending be any different?

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