What a massive fiscal boost can and cannot accomplish

I feel like I am repeating myself, but since the topic is so much in the news, let’s give it another go.  A massive fiscal policy could:

1. Generate some investments which are worthwhile on their own terms.  LaGuardia really does need another runway.

2. If the broader monetary aggregates are falling, because of either a credit crunch or a liquidity trap, a fiscal boost can keep aggregate demand from deteriorating.  Note that this is distinct from bringing about a recovery; it is limiting further downside.

3. A fiscal boost can provide a beneficial "sunspot" in a multiple equilibrium model, thereby moving everyone to the higher output equilibrium.

4. If spending needs to fall, a fiscal boost can postpone this fall.  Postponing this fall may be a good idea to prevent immediate economic destruction.  But then the fiscal policy is not really bringing about recovery.  In fact the fiscal policy is (optimally, perhaps) hindering the pace of adjustment and recovery.  Fiscal policy makes the downturn less severe but it also prolongs the adjustment process.

You’ll note that only under #3 does a massive fiscal boost in fact bring about an economic recovery.  But I do not believe that #3 is better for anything than a few good days in the stock market nor do most people rely on #3 in making the case for fiscal policy.

You might also try #5:

5. The economy needs a boost to aggregate demand and since monetary policy isn’t working any more, fiscal policy has to step in.  This is usually followed by drawing a graph with two or three curves on it.

This makes sense if it is reworded to be more precise and to be some combination of #2 and #4.  But still, a huge fiscal boost will not bring recovery because a big chunk of the problem requires real economic adjustments (the simple graph obscures this).  The economy needs to adjust out of housing, out of so much consumption, and out of various classes of associated risky assets.  Those are some pretty massive adjustments and along the way lots of major banks become zombie banks.  A massive fiscal boost won’t get us over those problems.

Just to recap: Because of #1 and #2, you might think that a massive fiscal boost is a good idea, compared to the alternatives.  But you should not argue that a massive fiscal boost will bring about or drive an economic recovery.  It is tempting to cite #5 to justify the fiscal boost but the bottom line is some mix of #2 and #4. 


Regarding Keynsian stimulus of the kind Tyler seems somewhat enamored,
I posted the following at Cafe Hayek:

Keynsian stimuli are orthogonal to microeconomic stimuli (i.e., seeing resources allocated to their highest valuing users. The reason is that the aggregated government variables in the macro models G, T, etc. make no distinctions between different types of, for example, G and T. Following Osama's attack on the United States, the defense portion of G grew. Much of this was socially productive, but lots of other aspects of G grew that allocated resources AWAY from highest valuing users (e.g., various and sundry Congressional pork unvetoed by President George Dry-pen Bush).

The proposal of Obama to "lower taxes for 95% of the American people" would have to be considered by a Keynesian as a reduction in T. But any self-respecting micro economic would have to rhetorically ask, for starters, whether introducing further progression into the tax system would be lead resources to be allocated toward or away from highest valuing users.

G and T in the Keynesian model are blunt instruments; using them on the economy is like doing brain surgery solely using a pliers and a chain saw. It ain't pretty Sherlock!

Oh, I didn't realize it was up when I posted the above, but the reason I draw a connection between Tyler's post and ABCT is that it sounds very similar to my open letter to Gary Becker.

How about an expansion of #2?:

a. In a serious economic downturn, a lot of fundamentally sound, good businesses will close down, just because their customers are broke/need their assets to cover the ill-considered credit protection they wrote/are scared to invest in anything not immediately necessary for their business.

b. If those businesses close down entirely, their continuity of operations will be lost, their assets will be sold off, and restarting them later will be much harder and more expensive.

c. In normal times, those businesses might raise money by selling stock or borrow money from someone who could see that they were a solid business riding out some hard times. But in these times, a lot fewer people are willing to invest or lend money--they need that liquidity themeselves, they've already got too much risk, whatever.

d. In this situation, maybe government spending can keep some of those fundamentally good businesses going, which will decrease the depth of the hole we have to climb out of in a few years.

Now, I have no reason at all to expect that government spending will accomplish this, rather than, say, be used to prop up big, visible, politically important industries that aren't really viable long-term. But it seems like a plausible argument for, say, using government money to have a lot of construction done during this time when lots of construction companies are going hungry.

i think a combination of #1 and PQuincy's post is the best case for the stimulus. we should be spending hundreds of billions of dollars on badly needed investment anyway, in energy, green infrastructure, etc. it also seems desirable not to have the government overthrown by nazis and/or communists (see: 1932).

I guess the really aggressive interpretation of ABCT might be that occasional bouts of revolutionary fervor and economic drop-out-ism are a legitimate part of the "search procedure" of a society! After all, let's not second-guess the ability of individuals to determine their own destiny. Maybe we should start redirecting our investments of attention and dreams into revolutionary socialism. If the market deems it desirable, the market is right!

(Obviously I'm being snarky. But I guess I'm wondering what the moral dividing line is. And doesn't it make sense to consider social dislocation a threat to the very economic freedom ABCTer's want?)


Bob Murphy has provided a link to a really interesting powerpoint that is MUCH better than the old C+I+G model you might be trying to remember (that has you mind "reeling"):


Thanks Bob Murphy for the above posts and insights!

Re #2, it seems to me that the distinction drawn between "bringing about a recovery" versus "limiting further downside" is a false one. Let me suggest the following, perhaps naive model of the business cycle. The natural tendency of the economy is to grow. We have a recession when certain contractionary forces take over; this time it's declining asset values and contracting credit. Once these contractionary forces have exhausted themselves, the natural tendency towards growth reasserts itself; at that point no artificial stimulus is needed. But the further you fall, the further you have to climb. During the Great Depression, nothing was done to arrest those contractionary forces, the bottom was much further down than anyone expected. So limiting downside really is hastening recovery.


Exactly how fast could massive public works projects like "wind farms" get off the ground? Here in California, it typically takes 5 to 15 years of environmental hearings and the like before any dirt is turned. This sounds more like a full employment plan for environmental impact consultants and land use lawyers than something that will have any short major short term impact.

Jim says: "But any self-respecting micro economic would have to rhetorically ask, for starters, whether introducing further progression into the tax system would be lead resources to be allocated toward or away from highest valuing users."

First, following your argument, allocating these resources to those who value it most rather than least, the decreasing marginal utility of money argues that that would be the lower income scales.

Second, Obama's plan would only be restoring the progression that Bush took out back to the Reagan levels.

Lastly, the progressive tax structure doesn't exist in a vacuum but rather with an income distribution which skews strongly in favor of the wealthy, the top 1-2%. Yes, they pay more but they make a lot more.

I've looked at stimuli packages as something to prevent destruction while the market corrects itself. But okay, how do we move out of a consumption economy, what do we actually make that people want to buy? Unless we develop some new nanites, green energy stuff (and we are so far behind the rest of the world) or practical fusion reactors what will we be selling?


"...a lot of fundamentally sound, good businesses will close down..."

Isn't that the same as saying that there is a "fundamentally sound" price and that any deviation from it is a consequence of the business cycle? I thought the price of things was determined by what someone is prepared to pay for them, not some intrinsic value to be divined by "the experts". "Fundamentally sound, good businesses" do not close down; the fact they are closing down is proof that they were not sound.

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