More niggling on fiscal stimulus

Paul Krugman describes and writes:

Here’s how I see it: the opponents of a strong stimulus plan don’t
really have an alternative to offer. They don’t even have a really
coherent critique; as Brad DeLong points out,
if you believe that a surge in private spending would raise employment
– and even the critics agree on that – it’s very hard to explain why a
surge of public spending wouldn’t have the same effect.

The critics are instead mainly engaged in a series of minor complaints, aka niggles; FDR didn’t do so well, the statistical evidence ain’t so great, you can’t trust government, etc., etc..

My view is the disaggregated one that sometimes private spending can stimulate employment and sometimes it cannot. Private spending has the greatest chance of stimulating employment when a) market psychology is on its side, and b) the financial system is relatively well-functioning.  Neither is the case right now. 

Note that under standard theory neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts.  That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I’ve never seen a stimulus proponent deny this point about real shocks but I don’t see them emphasizing it either.  It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.

Maybe a big enough push to aggregate demand could stimulate useful, productive employment (as opposed to merely boosting measured gdp) right now, but since the
U.S. savings rate must rise sooner or later, that would only mean a
steeper decline for aggregate demand some time in the future
.  My discount rate isn’t that high.

The alternative to a huge fiscal stimulus is simple: enough pro-active fiscal policy to ensure that cuts in state and local spending do not bring additional contractionary pressure to bear on the economy.  Otherwise bear the costs of the ongoing sectoral shifts and allow consumption to decline as indeed it must sooner or later.  Aggregate demand macroeconomics really does matter, but it is easier to do badly from negative shocks than it is to engineer good results from expansionary shocks. 

Those looking for other policy alternatives might consider Robert Lucas’s recent suggestions for monetary policy or cuts in the payroll tax, although I am myself not quite (yet?) on either bandwagon (though I think they are better plans than massive fiscal stimulus).

By the way, FDR didn’t do so well, the statistical evidence ain’t so great, and you can’t trust government, etc.  But those are only my minor complaints.

The bottom line remains this: we are being asked to spend ???? hundreds of billion dollars when a) the evidence for fiscal policy is inconclusive, and b) when you consider how real shocks fit into aggregate demand analysis, the theory isn’t there either.

Addendum: Here is a post by Krugman on the "hangover theory."  The answer to Krugman’s #1 is a combination of (perceived) wealth effects, downward nominal and real rigidities, and, during the boom workers at least thought they knew what they should be doing but now they do not.  The coordination problem on the upswing is not symmetric with the coordination problem on the downswing.  In any case it is correct that real sectoral shift theories do not explain all facets of a recession or depression; it is incorrect to conclude that therefore, in light of sectoral shocks, fiscal policy will be effective.


Some, like Alex with his Smart Grid, want to use stimulus to hasten sectoral shifts.

I don't know, are we economic actors all like penguins at the edge of the water? We wait for someone to go first. It might (still) be dangerous. Stimulus does more than just change numeric demand. It gets someone to go first. I think the idea is that seeing success, some will follow.

When you say the alternative to stimulus is to limit losses, I guess you are saying that the penguins will venture out again when they are ready, and we can't rush it.

Ah, the "lack of an alternative to the default big government program" attack spelled out explicitly. I think that's a good sign.

How 'bout deregulating, small biz tax cuts, payroll tax reduction, announcing award incentives, granting more H1-B's, etc. that don't cost anything up front?

We work hard to interpret these guys, why do they think our stuff is going to show up on their door with a bow on it? And just because they don't like some of the ideas doesn't make them not exist.

And, besides, it's really bizarre that they don't have the burden of proof for taking our money and spending it on God knows what. I'd rather have a pig in a poke, because then I can make sure I get a good poke.

I don't think NPV matters Jay. What we want is high poll value for "is the nation on the right track." If you don't want "massive" spending, the trick is to get that right-track belief without it.

For what it's worth, I am for the first time in my life engaging (consciously anyway) in Ricardian equivalence. I simply *know* that my taxes are going to get jacked up when this government spending orgy is over and the Obamacrats *finally* get to do what they are itching to do (i.e. raise taxes), so I need to save more now so I won't be as poor later.

I can't help but wonder how many others are also sitting on the sideline waiting to see the damage before they too choose to either indulge themselves, or give money away to the needy, or to make illiquid investments (that create jobs as a byproduct).

In a sane universe, Cowen bends at the waist to accept the Nobel medal being placed on his neck while Krugman is suffering through soggy submarine sandwiches served at afternoon lunch sponsored by the Mercer County Democratic Club.

Tyler's too modest to admit it but he knows it's true.

Odo, Stimulus does more than just change numeric demand. It gets someone to go first. I think the idea is that seeing success, some will follow

Success at what? Repairing roads and bridges doesn't change anything. I can get my goods and services anywhere I want them to go right now. Education spending is way past the point of performance elasticity. They've got more than enough money to build all the schools they want. Which leaves us with what as the long-term results of this spending frenzy? Green technologies? If those were worth investing in, people would already be doing it.

A $12T+ debt forces you into easy credit as far as the eye can see. The government will not be able to afford the interest payments if rates rise. When (not if) foreign treasury buyers decide to go somewhere else, you're condemned to print money to cover your bills.

If borrowing and spending worked, it would have worked by now.

Shorter version: consumer spending creates profits; public spending creates jobs. Which one you want depends on which one is in shorter supply. (Whatever "shorter" means.)

Team Obama will throw a Hail Mary pass into an empty endzone.

back then many here spewed Laffer Curve and supply-side nonsense in response

Amen, brother. Tax cuts when you've got a deficit are nothing more than a payday loan.

I think that's Krugman right on the "hangover theory." It doesn't really make sense, because there should never be a reason to have a recessionary gap (IE, unemployment above its natural level). In fact, "sectoral adjustment" happens all of the time: it's called creative destruction. The problem with a recessionary gap is that the creation part isn't happening for some reason.

That reason, and I think you're right on this one here, is that market psychology and the financial system just aren't in our favor at this moment in time, and there is nothing that the government can do to fix that, short of becoming the economy and investing in things that the private sector SHOULD be investing in.

The problem being that government SHOULDN'T be investing in these things: it should stick to what it does best, IE, providing public goods. Meaning you shouldn't believe in a big fiscal stimulus unless you believe that the economy is adjusting towards a demand for higher public goods....especially since government doesn't ever seem to shrink.

BTW Odograph, you're right that plenty of Republicans all of a sudden are against deficits when it's not due to George Bush, but I hope that doesn't discredit the critique. And for what it's worth, plenty of Austrians associated with the LvMI were excoriating the Bush deficits all throughout. (I can provide links if anyone wants documentation.)

As Brian Wesbury said, cut spending, cut taxes 50% and let people use the money in the most efficient way possible. In essence put more money in peoples' hand by cutting withholding. It would be cheaper than the current bailout proposals.

Or as McCain said, double the standard exemption. Again, that is lowering withholding taxes.

K.T. Cat,

"Accept the pain. Embrace it." Hmmm. I do not know what you do,
K.T.Cat, but would you be so keen on this sentiment if you or someone
very close to you gets laid off and cannot get another job easily?

Also, I see that on your blog you are more high-minded than four-letter
words, going with "Moron" and eschewing @&*%! How nice.


I am in the same boat, but I cannot avoid asking. Does your support
for federal support for state and local governments have anything to do
with George Mason being a state university?

Barkley, been there and done that in one way or another, got the t-shirt. Estate sales and thrift stores are my friends. You can recover.

Nowadays, Dave Ramsey, savings, thrift and economy are my friends. I don't sweat bad times any more. This is a cultural crisis, not an economic one. We've been having Krugman-style stimuloids for decades. That's how you end up with monster debts permeating the economy at every level. How's that working now?

Failure can be a great teacher.

Barkley Rosser is the intellectual equivalent of a dirty sanchez.

Krugman is a fucking idiot. No word short of that will suffice. Our WHOLE POINT IS THAT YOU CAN'T PLAN YOUR ECONOMY CENTRALLY. So when Krugman says "You have no plan", we smugly say "yes, and you don't either".

But what we *do* have are principles: free markets. A sound currency. Minimal government spending. Free banking.

nostra d.a.,

I probably should not ask, having just googled what a "dirty sanchez" is,
but might you be willing to spell out just exactly which of my remarks here
merits that particular moniker? I doubt that Tyler thinks my question of him
does, and I would be surprised if any Austrians would, although many might
disagree with my remarks.

And as for K.T. Cat, this cool cat took my remarks in stride and came back
with a smart reply. What is your problem?

"the statistical evidence ain’t so great" This is a minor argument?? My boss would kill me if I came to him with an idea that had a poor statistical track record. Krugman is trying to throw sand in your eyes by denigrating your arguments before you make them. They are good arguments.

One trillion dollars for eternal happiness? I think I'd be happier with the trillion dollars

"I don't think NPV matters Jay. What we want is high poll value for "is the nation on the right track." If you don't want "massive" spending, the trick is to get that right-track belief without it."

I don't think confidence is the main problem. Its one problem. The main problem is a massive miss allocation of capital into unproductive business lines. Throwing billions of dollars at this problem will not work. It will probably make things worse. The lack of confidence is a very good sign. People should lose confidence in the system when it isn't working.

Krugman is a fardling idiot. Our WHOLE POINT IS THAT YOU CAN'T PLAN YOUR ECONOMY CENTRALLY. So when Krugman says "You have no plan", we smugly say "yes, and you don't either".

But what we *do* have are principles: Free markets, sound currency, and private property.

To Rick Smith,

Care to explain a little more clearly what you're talking about? You're saying if I pay $100,000 for a car that's really worth $50,000, I'm burning $50,000?

So, what happened in the run-up to the credit crunch, the subprime housing disaster, in which herds of private sector agents bought up houses at inflated and irrational prices, wasn't burning money?

And let's further examine what you've said. If I pay $100,000 for a car that cost $50,000 to make, I'm burning money as opposed to paying what I, a market-participant, has deemed the car worth?

Whether or not we have the courage of our convictions when faced with personal economic loss does not make KT's points any less true.

If we don't face the pain now, the pain will be worse later. MUCH worse. Afraid of losing a job now? You think it's going to be better to have no job when tax rates are confiscatory, businesses are not hiring, and stagflation means your savings have become worthless?

KT, I'm married, but if I weren't, I'd propose. I am so glad to see someone speak the truth so articulately.

Are we talking about human conduct here?

Does that not involve motivation(s)?

Is "stimulus" (actually, we should use "stimulant") to instigate or possibly substitute for motivation?

Are there not countervailing motivations (fear, caution, disorientation) which prevail currently? Is there a stimulant to inoculate against those; an innocuous inoculant?

Barkley Rosser,

while bubbles are regularly given extra stimulus by easy lending
practices (go read Kindleberger and Minsky), I am more inclined
to go with the experimental evidence provided by Vernon Smith and
David Porter and others that suggests that we humans have a very
strong tendency to get into bubbles, even when we know better.

I pretty much agree with everything you posted, though I think loose credit may cause as well as stimulate bubbles, for reasons of rational expectations and adverse selection.

As I've read experimental economics, inexperienced and less knowledgeable investors create more bubbles than more experienced and more knowledgeable ones. If the Austrians are right, at the market rate of interest investors are undertaking (mostly) sustainable ventures. As the rate of interest lowers, however, additional investment funds become available. Investors with rational expectations (presumably more experienced ones) do not take advantage of these low rates to make investments that would not otherwise be profitable, leaving these funds available to others. Investors without rational expectations (presumably less experienced ones, e.g. the barber-turned-house-flipper) do. So if Austrians are correct about finance and capital, I believe artificially low interest rates can easily adversely select for investors without rational expectations. The longer the low rates go on, the more we'd expect the process to select these "malinvestors".

In this scenario, I believe we can think of banks as being part of the "investor". Prudent banks may not take advantage of an increase in reserves to lend, but doing so would leave excess reserves for other banks to acquire and lend out.

I believe there is a paper in the latest QJAE saying much the same thing, but I can't find an ungated version.

After following the debate for some time, I would boil this down to growth versus stability. In both good and bad, government spending will stimulate, provide confidence, allow some sectors to grow, expand the economy, you name it. On the other hand, your modified libertarian ideas allow for easy growth of anything that has real economic value, which may mean most people won't have or seem to have economic growth. The Tyler Cowen ideology allows society to grow a hell of a lot slower, but the economic crashes and growth will be a lot less acute/strong. Krugman's idea is more of a sun is shining today, it's dark tomorrow, but it shines a lot stronger the next day. It allows society to indulge in champagne for a few years and then pay for it by only eating mush and drinking dirty water for a few years.

(WOW this sounds stupid, but I hope someone gets sort of the point)

Consistent slow growth makes for greater longterm growth than does hyper growth alternating with disaster

Your assumption that FDR did not do so well is questionable.

The question is what did he do poorly against.

Over the 8 years from 1933 to 1941 the unemployment rate fell from 25% to 9%,
or 16 percentage points.

Over the first 8 years of the long depression from 1894 to 1902 the unemployment rate fell from 18% to 4%, or 14 percentage points versus 16 for FDR.

From the post WW II 1982 peak in unemployment at 9.7 to 8 years later when it
reached 5.6% or roughly 4 percentage points versus 16 for FDR.

If the unemployment rate only fell one-fourth as much during the Reagan boom as it did under FDR why is Reagan's record great and FDR's weak?

You say FDR did poorly. So I ask you compared to what? If he did better than in the long depression and the drop from the modern peak in the 1980s what is the comparison that makes FDR look bad?.

If we've evaporated what, $14 trillion in wealth globally the past 12 months, does that provide some cover for stimulus?

Our overarching longterm needs involve rebuilding our energy infrastructure, trying to increase our economic sustainability and trying to diminish the toxicity of our environment: All of which traditionally are areas where government spending plays a dominant role.

That is a major shift, is it not, from the most recent private, free market chase to lever up securities for short term gain and long term losses?

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