Axel Leijonhufvud on fiscal stimulus

Here is one bit from a generally interesting article:

Fiscal stimulus will not have much effect as long as the financial system is
deleveraging. Even if that problem were to be more or less solved, the
government deficit would have to offset both the decline in industry investment
and the rise in household saving – a gap that is rising as the recession
deepens. Here, too, the public is sceptical and prone to conclude that a program
that only slows or stops the decline but fails to “jump start” the economy must
have been a waste of tax payers’ money. The most effective composition of such a
program is also a problem.

It is worth noting that Leijonhufvud is generally considered a Keynesian, not a rational expectations theorist.  In my opinion the sophisticated Keynesian view is still that the stimulus won’t work.


Details of the plan are sketchy at best right now. I would agree, a "good" plan would jump start the economy. It is my opinion that a good plan would ease credit and invest in areas that would make it easier for companies to compete globally. How this is done is beyond me and definitely beyond a politician.

E. Barandiaran,

I don't know if the final document has been posted yet, but there have been several pages linking to what will compose the majority of the final legislation. Thus your indication that most people are being kept in the dark about this is pretty hollow.

As far as the plan for rescue the financial system, the details do appear to be vague, but there's hardly some sort of sinister reason behind it. As Tyler himself admitted back in the fall when several institutions were failing and anyone who had a blog or knew someone who had a blog was proposing something, it was hard to keep track of all of the various plans. There are indeed a lot of different suggestions floating around, and since the problems we face are not exactly common, it's a little strange to think that he should settle on something. There's also the idea that this is purposefully vague because the ultimate goal is to determine which institutions are insolvent without being direct with the language so that there isn't more turbulence and uncertainty in the markets.

As far as the stimulus itself and whether it will work, I appreciate the open-mindedness of many on this blog. It's kind of bizarre to see some, like Will Wilkinson, flatly state that the Democrats are not only not going to bring about economy recovery, but that they will deepen and lengthen the recession.

"In my opinion the sophisticated Keynesian view is still that the stimulus won't work." In support of this Tyler cites Leijonhufvud, then selectively quotes from the very article he cites. I offer this quote instead:

"Strong contractionary forces are at work in the US emanating both from the capital and the income accounts. Stabilisation requires major policy actions on both fronts.

* First, the financial system must be recapitalized so as to remove the relentless pressure to deleverage from the banks.
* Second, a spending stimulus sufficient to reverse the rapidly worsening decline in incomes must be administered."

Leij. is clearly saying under current circumstances fiscal stimulus is necessary but not sufficient. That's not the same as saying that fiscal stimulus won't work. It's saying it won't work unless accompanied by recapitalization of the banking system.

Let me add something on a related point. There has been extensive discussion, some of it on this blog, on the efficacy of New Deal recovery programs. Much has been written about fiscal and monetary policy, much less about the extensive efforts to rehabilitate the financial system, which involved both recapitalizing banks through the RFC and measures to deal with residential and farm mortgage debt. These efforts were largely completed by the end of 1935. Whether or not it was cause and effect, it was only in 1935 that a sustained recovery began. At the same time historians have noted that despite these efforts, bankers remained highly risk averse throughout the 1930s, and so efforts at restoring normal flows of credit were never completely successful.

Phil P,

The summary was extremely misleading. Was the quote pulled out of context, given the thrust of Tyler's post? I would say that Axel would be angry with this summary.

My view of his post:

An excellent post. I agree that:
1) We should use a version of the Swedish Plan.
2) The stimulus was a poor mix with too much infrastructure and not enough incentives.
3) Social Safety Net spending is essential, including aid to states for essential services. If unemployment gets much higher and people don't feel secure, serious social disruptions and dislocations could occur. This would be very bad news.
4) We cannot overspend because we don't know at what point foreign creditors will balk. ( Buiter )
5) I am for a guaranteed income in any case, but it would certainly be useful here as a Negative Income Tax.
6) The use of WW II for comparison is strange. What can be conspicuous consumption in a recession can be seen as treason during a world war.
I differ in that I believe that we need to use quantitative easing to attack debt-deflation, a la Fisher. I also believe that a massive stimulus could work as Shiller believes, but we do not have the money to try it in these circumstances.

Don, I agree with you but for number 3. There is no 'safety net' (as semantically rich as that phrase is) in the US. We can't just conjure that up in a few weeks. A funding influx to the varied state welfare/relief programs would be even more wasteful than infrastructure spending based on the percentage of spending per program in the country's 12 biggest welfare consuming regions.

Take the same amount of money and roll back payroll taxes instead and you would create a huge incentive to expand employment-- same social welfare benefit, but with actual social stability results that boost the economy at the same time.

Is the sophisticated Keyensian view that our economy is basically fucked? Is that the sophisticated view from most other schools too?

"history tells us that doing nothing is a really, really dumb idea."

Where in the history of the US economy can you point to an permanent economic problem caused by the government doing nothing?


This is a straight Minsky interpretation of the housing crisis, and one that points to a huge problem when the govt just does nothing when faced with ponzi financing.

The current crisis was caused by the government looking the other way as ponzi financing based products were mass marketed to the U.S. consumer. Specifically, I am talking about option ARMs, which essentially rely upon rising home prices for people to be able to pay them off. These products should have been regulated by the fed, after the fed pushed all other agencies out of the way to be the final regulator for the mortgage market. However, the fed at the time was lead by a person who thinks the free market can always accurately gauge risk. These financial products are not viable in stagnant or falling house price regimes, like for example recessions. Once these products were introduced, we began to see significant price appreciation. Then, the inevitable minor recession began, housing prices stagnated. The weakest ponzi financing products that require rising asset prices began to place pressure for asset owners to sell, causing other ponzi financing product holders to have to sell.

We are now facing a multi-trillion dollar economic problem, all due to regulators sitting on their hands while the system was over leveraged and ponzi financing products were mass marketed.

If the govt had regulated these products, we would have had a much smaller, more gradual real estate boom, and probably would not be in the crisis we are today.

Eric, I'm sorry I didn't get back to you earlier. A tough day. Yes, I would prefer a Sales tax break of $200 Billion, but a Payroll tax cut would be my second choice. Don

The banks, and the market forces in that sector, already are delivering - consolidation.

However, we are, like a kangaroo caught in the headlamps, completely terrified at the thought of this, and prevent it from happening. Though in our case it isn't the approaching lights of a car that have us dumbstruck, but a single terrifying phrase - To Big To Fail. But this notion is nothing but the domino theory repackaged, with about us much scientific validity to back it up as it had the first time.

As this article on the New Deal indicates,
there were over 9000 bank failures in the U.S. during the depression, but a net total of only $1.3 billion dollars of deposits were lost as a result - trivial, even in the 1930s. And of course there is the case of Canada, with zero bank failures in the same period but who suffered a depression just as great as the United States. Bank failures, and inactivity by the Fed, were not the primary cause of the Great Depression.

So what is the problem with letting a few banks fail? Let the industry consolidate of its own accord - stop the bailouts, avoid the moral hazards and prevent a decade or more of zombie banks and a stagnant economy. There is only one thing we have to fear.

It may be possible to classify Axel as a "Keynesian," but he is certainly a somewhat idiosyncratic one,
and is certainly not a "New Keynesian."

He is the original advocate of the "corridor of stability" argument, and clearly thinks we are now outside
of the corridor of stability, where things are probably very much destabilized fundamentally, a difficult place
to be.

Regarding the stimulus, of course some Keynesians are arguing that it will fail because it is not big enough.
Regarding the bank bailout, well, we still do not know what it will be, the vaguenss in Geithner's speech being
its biggest problem.

In spite of being a fiscal conservative, I could get on board with a stimulus package...not THE stimulus package, but A stimulus package. I'm all for the idea of cutting taxes to encourage spending; give people more of their own money to spend or invest. Typical conservative thinking... but perhaps that won't be enough action to get us out of the current downward spiral. If there are infrastructure projects that are truly needed, let's borrow and build and hopefully put enough people back to work to crawl back up out of the hole we're in. If roads need repaving and schools need to be repaired or built, what better time than now to get started and put people to work?

But here's the problem... the 1170 page monstrosity that was touted as the salvation of the U.S. economy was so full of pork and pet projects that it should have been called the "2012 Re-election Plan"... despite what the President said. I'm tired of hearing that this stimulus needs to be "big enough and bold enough". Let's just do what's really necessary to jump start the U.S. economy and maybe that plan wouldn't create a burden of debt that our great grandchildren will still be paying off. Why don't we just come up with a plan that's "sensible enough" to work.

"[Leijonhufvud] is the original advocate of the "corridor of stability" argument, and clearly thinks we are now outside of the corridor of stability, where things are probably very much destabilized fundamentally, a difficult place to be." --- Barkley Rosser

1) After banging out the above post late last night, I noticed this morning --- when I looked it over --- that it doesn't deal with Barkley's singling out Leijonhufvud's concept of a "corridor of stability." A quick google search uncovered this stimulating 2005 article by Robert Dimand: "Fisher, Keynes, and the Corridor of Stability." Click here for an ungated copy.


2) The "corridor of stability" concept is captured in Dimand's second paragraph [buggy paragraphing for readability, plus a change in verb tenses in the initial paragraph below]:

"How [could] a large demand shock, such as that associated with the stock market crash of October 1929, cause years of mass unemployment without automatic movement back to market-clearing equilibrium, even when there exist stabilizing forces able to correct automatically for smaller demand shocks?"

"Axel Leijonhufvud ([1973] 1981: 112n) has suggested "the notion of 'the corridor' within which market forces, as they were traditionally conceived, are strong enough to override the disorganizing tendencies arising from 'trading at false prices', etc." Such a "corridor of stability" (which, Leijonhufvud states, "is not in Keynes") can provide another way of looking at Keynes's insight that the economy is not violently unstable. Leijonhufvud ([1973] 1981: 129) offered the idea of a corridor of stability as a sketch of a theory, an agenda for and invitation to modeling.

"This could provide a response to the problem that "[m]athematical general equilibrium theorists have at their command an impressive array of proven techniques for modeling systems that 'always work well.' Keynesian economists have experience with modeling systems that 'never work.' But, as yet, no one has the recipe for modeling systems that function pretty well most of the time but sometimes work very badly to coordinate economic activities. And the analytical devices and routines of neo-Walrasian general equilibrium theory and Keynesian theory will not 'mix' " (Leijonhufvud [1976] 1981: 340)."


3) Hopefully, these observations by Dimand will stimulate some interest in Leijonhufvud's approach that aimed at creating a dynamic disquilibrium-model of the market economy using a reoriented Keynesian theory that stressed the problems of market coordination of tens and hundreds of millions of economic agents' beliefs and expectations if the price-mechanism isn't fully rigid --- a postulate that some readings of Keynes uncover in his work --- nor fully flexible as in neo- and new-classical postulates. But rather "partly flexible" and hence prone to deviations from full employment and long-term growth-potential as a result of "endogenous" shocks . . . as opposed to "exogenous" shocks that are the only ones New Classical economics focus on in real business cycle theory.


Michael Gordon, AKA, the buggy professor

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