The Need for a Stimulus Package

Transcript

Comments

[ndk]

Why won't anybody challenge the efficacy of Keynesian stimulus? While it's a nice theory under widely used macro models, there's still very little empirical evidence that it actually works, and several very good arguments why it's not enormously helpful and may even be counterproductive. Crowding out is very real and evident, even at a ZIRP bound, in both empirical evidence and economic theory, regardless of the school you sympathize with.

In my day job, I'm well acquainted with beautiful theories that are completely impractical and fail in the messy real world. Keynesian stimulus strikes me as one of those theories, and I wish an advocate would address its lack of success in practice, and particularly why it's appropriate in a country that already runs massive fiscal and external deficits. It's very easy to refer to an unused pile of labor and materials, but why is that not evidenced by our prior experience?

Furthermore, our creditors are getting a little antsy, though I think they have a realistic assessment of their chances of making good on their mercantilistic investments. They view this as our failure to reinvest their funds in productive, rather than consumptive, sectors. I'm very sympathetic to arguments that this too is due to mercantilism, but again, I like to deal with the facts as they present themselves, not stylized theories.

[ndk]

I should add that I'm also dubious about quantitative easing and expectation targeting in deflation. Even if you were successfully convincing in your inflation target, wouldn't a rational actor build that into capex plans, which also factor in their own real expectations, and actually make them more hesitant to invest? If I can see that a project is likely to yield only 1%, due to deflationary pressures in my own industry(which happen to be widespread, but heck, I trust the Fed), imposing a 3% inflation discount rate on money would seem to make me less likely to invest those funds.

[reason]

ndk
Surely your link contradicts your own statement. But I think the real issue is that fiscal stimulus is not fiscal stimulus, it matters what you do and when and that makes the empirical work difficult. I'm sympathetic with the view that we have entered a recession in spite of an enormous fiscal stimulus (war and badly directed tax cuts) that were offset by an overvalued currency. What is really needed is a root and branch rebuilding of the dysfunctional international financial system.

[Bruce Wilder]

ndk: "wouldn't a rational actor build that into capex plans, which also factor in their own real expectations, and actually make them more hesitant to invest? If I can see that a project is likely to yield only 1%, due to deflationary pressures in my own industry(which happen to be widespread, but heck, I trust the Fed), imposing a 3% inflation discount rate on money would seem to make me less likely to invest those funds."

No. Inflation makes the investment deal more likely.

This goes to the heart of why deflation is so terribly, lethally bad.

The alternative to doing the investment is to hold onto the money. Deflation makes holding onto the money relatively more desirable. An investment that is worthwhile in strictly real terms goes out of reach, because there's a positive return on holding onto cash.

Inflation makes it less desirable to hold cash, imposes a penalty on holding cash. Inflation -- at least, steady, well-anticipated inflation -- does not do anything to prevent investment, since inflation applies as much to the real returns from investment as anything else. If the investment promises a real return of 1%, a 3% inflation rate means that a 4% nominal return is available, with which to do an investment deal.

[a]

If I may, I have some questions about stimulus and healthcare, since I have heard health care mentioned as possibly a part of the stimulus package.

My understanding of the optimal health care reform is to have the government pay more than it is currently, but for over-all spending on health care to decrease. That is, the U.S. spends too much currently, and by changing the rules - including the government paying more - it should manage to spend more wisely, with over-all spending going down. So, the first question is,

1/ Is that a correct assessment?

If the answer is "no", ignore the rest, because I suppose the answer is "yes". So then I'm wondering where the health-care stimulus effect can be.

2/ Is it, that in order to save money over-all in the medium- and long-term, we need temporarily to spend more (over-all) money in the short-term?

and

3/ If that's the case, then why? Is it just the usual start-up costs of instituting something new (there needs to be a certain over-lap between the old and new systems, so there are transition costs)? Or is it for some other reason?

4/ If that's not the case, then where would be the stimulus (in health care)?

Thx.

[Bruce Wilder]

ndk: "While it's a nice theory under widely used macro models, there's still very little empirical evidence that it actually works, and several very good arguments why it's not enormously helpful and may even be counterproductive."

On what planet?

"Very little empirical evidence"? "several very good arguments"? Are you daft?

At bottom, Keynesian policy in response to a spiral into deflation is straight-forward. There's nothing mysterious about it. The immediate problem is disemployment of resources, due to declining aggregate demand. The Keynesian policy is for the government to spend more money buying stuff. If the government is buying stuff, it adds to aggregate demand.

The line of causality is not exactly mysterious here. Gov't buy stuff. More stuff gets bought. A cave man ought to be able to do the arithmetic.

[Bruce Wilder]

a: "If that's not the case, then where would be the stimulus (in health care)?"

There isn't one. This is the garbage pail theory, well-expressed in Rahm Emmanuel saying, "A crisis is a terrible thing to waste."

A bunch of Saudis with box cutters flying planes into the World Trade Center was not an obvious justification for squandering billions on a "missile shield" or invading Iraq, but there you go. That's politics.

[reason]

BW
fully agree with your criticism of ndk, but you could have been clearer on this:
imposing a 3% inflation discount rate on money would seem to make me less likely to invest those funds."
clearly this ignores the effect of positive inflation is neutral (you are right about deflation) because although the discount rate (through the interest rate) is raised, so is the expected revenue.

[Bruce Wilder]

ndk: "I'm well acquainted with beautiful theories that are completely impractical and fail in the messy real world. Keynesian stimulus strikes me as one of those theories, and I wish an advocate would address its lack of success in practice, and particularly why it's appropriate in a country that already runs massive fiscal and external deficits. It's very easy to refer to an unused pile of labor and materials, but why is that not evidenced by our prior experience?"

If the test of Keynesian theory is going to be your judgment or your good taste, there's really no point. Your judgment is terrible.

I cannot imagine what "lack of success in practice" means. A simple review of the economic history of the United States would provide a number of vivid examples of the business cycle being driven by monetary and fiscal factors in constellations that the Keynesian framework well connects with outcomes.

The recession that followed FDR's budget balancing of 1937, for example, is pretty classic, and would be well-expected from a Keynesian perspective. And, the recovery to full employment in WWII, with massive deficit spending -- again, pretty clear. The Kennedy-Johnson taxcut of 1965 did exactly what it was predicted it would do. So, did McNamara's lying about the cost of the Vietnam War -- the economy overheated right on schedule; Nixon, too, in his reckless pursuit of re-election got exactly the economic euphoria he wanted for 1972 -- we're all Keynesians now, he said. Reagan-Volcker? QED, once again. Clinton? Check.

It is much harder to find anything in the historical record to support, say, the laissez-faire recommendations of the classical theorists. Nothing much to support the gold bugs, either. Laffer, not so much.

Keynes, though, does a pretty good job.

ndk: "why it's appropriate in a country that already runs massive fiscal and external deficits."

It's appropriate for a country facing the prospect of massive unemployment.

The Keynesian framework makes the problems of fiscal and external deficits analytically separable. It doesn't solve those problems, nor does it deny them. But, it also doesn't connect them with a moral fable or a magic incantation to the sacrifice of the lives and economic welfare of millions.

We can see the effects of the trade deficit, for example, on employment and income, because Keynesian theory helps us to see the connection. If policymakers pay attention, they can shape economic policy accordingly.

Personally, I would raise taxes and tax rates on the rich and on capital and on the net income of business corporations. I would bolster labor unions. I would invest in a crash program to reduce oil imports. And, I would press a weak dollar on China like a hot iron, as soon as fiscal stimulus had restore domestic inflation and the liquidity trap was over. All of these are reasonable considerations -- and all are policy areas where nuance counts. None of these considerations, however, provide support for the idea of just standing around and watching deflation devastate employment and bankrupt business.

[Bruce Wilder]

reason: "you could have been clearer"

No doubt. I will try again.

A low, steady (non-accelerating), well-expected rate of (monetary) inflation is ideal, because:

1.) Any positive inflation rate discourages holding transactions balances outside the banking system.

2.) The nominal terms of an investment contract can be adjusted to include an inflation premium, neutralizing any well-expected, steady rate of inflation, without prejudicing the viability of investments promising a positive (private) real rate of return.

I might also have mentioned that the prospects for business investment, overall and in aggregate, are profoundly affected by the balance between capacity and demand. High resource availability doesn't do much for private business investment in practice, when high resource availability is a consequence of aggregate demand falling well below productive capacity. When existing productive capacity exceeds current and short-term expected demand, for most businesses, net disinvestment will be indicated.

That's a stilted way of saying that depressions are not good for business investment, because depressions are not good for returns on investment in new capacity. One would think this an obvious point, but, hey, whole schools of economics have been built on ignoring even more obvious aspects of reality.

[Bruce Wilder]

As for Mankiw's "Fiscal Policy Puzzles", he's really getting into the minutiae, to sow doubt for ideological and partisan reasons.

Conservatives don't want what progressives want; liberals don't want what authoritarians want; libertarians don't know what they want. They are aiming at different targets, so it is never simply a matter of technical differences of opinion. Also, conservatives lie about what they want, because they couldn't get an electoral majority if they told the truth.

Let's say that Obama proposes, as part of his massive fiscal stimulus, funding for a lot of public construction. Public construction will go up sharply, as commercial and residential construction goes into the deep, dark pit of nothingness. In 2038, a conservative ideologue at the University of Chicago will "prove" that the Obama stimulus crowded out private construction investment.

[reason]

In 2038, a conservative ideologue at the University of Chicago will "prove" that the Obama stimulus crowded out private construction investment.

Nup. By then resource shortages will have killed the last vestages of Libertarianism.

[a]

"I would invest in a crash program to reduce oil imports."

I agree with a lot of your program, and I agree even with this - except for the word "crash". I think we need to get over the idea that if it can't be done quickly, then it shouldn't be done. If Ford and Carter had allowed a gradual increase in a gas (or energy...) tax - an extra 25 cents per gallon every year for the next 50 years -, then, even if the energy problem wouldn't have been solved immediately, there would have been enough incentive put into the system to effect some real change in a couple of decades, and we wouldn't be in such dire straits today. So really, the best thing that Obama can do, in terms of energy policy, is to enact such a gradually increasing tax. Then, if it also wants to do a "crash" program, by all means - but let's have the gradual tax in there for insurance reasons. It won't do anything the first few years, but in the long-run, it will provide the proper incentives to actually solve the problem, just in case the "crash" program doesn't work.

One of my favorite stories is of the old man and his gardener. The old man wants his gardener to plant a tree. The gardener says, "But this tree will only begin to bear fruit in a hundred years." "Then," the old man replies, "plant it today."

[paine]

ndk

"Why won't anybody challenge the efficacy of Keynesian stimulus"

you are the straw man
that brakes
the back of neo-mellonism

nothin like crude blind "empericks"

willful myopia at best

btw
what possible fancy theory are you paid to over look ???

[ken melvin]

Not sure about the chicken/egg thingee, but, first you gots to have demand.

[bakho]

With all the layoffs, we are going to be spending a lot more on unemployment benefits and other benefits that are lost with the jobs. Why not pay people to do useful things rather than mail an unemployment check? Yes it costs more to pay people to work, but if what they do is useful, it can be an investment.

[ndk]

A simple review of the economic history of the United States would provide a number of vivid examples of the business cycle being driven by monetary and fiscal factors in constellations that the Keynesian framework well connects with outcomes.

Please click through to the econometric papers Mankiw references. You'll see that's not the case.

"government spending shocks crowd out both residential and non-residential investment without causing interest rates to rise"

Or Blanchard's findings:

"we find that both increases in taxes and increases in government spending have a strong negative effect on private investment spending. This effect is consistent with a neoclassical model with distortionary taxes, but more difficult to reconcile with Keynesian theory: while agnostic about the sign, Keynesian theory predicts opposite effects of tax and spending increases on private investment. This does not appear to be the case."

[ndk]

Inflation makes it less desirable to hold cash, imposes a penalty on holding cash. Inflation -- at least, steady, well-anticipated inflation -- does not do anything to prevent investment, since inflation applies as much to the real returns from investment as anything else. If the investment promises a real return of 1%, a 3% inflation rate means that a 4% nominal return is available, with which to do an investment deal.

Before you blast me, please pay attention to what I write. I didn't say a real return of 1%. I said a return of 1%. Someone may have very good visibility into the returns they can receive on an investment because they know a lot about their industry and can run the numbers very well. They may not have very good visibility into macro trends because they're not a macroeconomist. If they're told there will be 3% inflation, then they may impose a higher bar for their own investment.

I agree with inflation targeting as a concept in normal times to provide a buffer. I don't think imposing an inflation target ex post facto during deflation will help.

[godoggo]

I was curios what I'd get if I technoratied that Mankiw post (since he doesn't have comments)...I'll just note Arnold Kling (who one might expect to be inclined to question Keynes) wrote a quick response, and, although he doesn't go into any detail, he's properly skeptical of the cited studies' results.

http://econlog.econlib.org/archives/2008/12/crowding_out_or.html

[anne]

"Why won't anybody challenge the efficacy of Keynesian stimulus?"

Because most people can think, or are honest at any rate.

[Lee A. Arnold]

do not be misled by different kinds of results. If we're NOT SEEING investment spending or private consumption, then government spending is all we have remaining. I doubt whether you can jump so readily from the doubts about the Keynesian theory for the long-term to results of government spending in practice. You appear to be confusing long-term investment with fighting short-term cyclical trends.

[ndk]

Thanks for the link, godoggo. But, he writes nothing to prove or disprove the research. He just muses:

I guess we're supposed to believe that newer research is more technically sound. But, honestly, I wonder whether the new research is even less reliable than the old research.

I'd rather see an explanation of why the research is bad, or at least an admission from stimulus advocates that the track record is debatable.

I doubt whether you can jump so readily from the doubts about the Keynesian theory for the long-term to results of government spending in practice.

The first paper explicitly talks about fiscal policy shocks, which if you check out the graphs of results, is pretty immediate in terms of crowding out. It does indicate a marginally positive increase in the GDP deflator, which is good.

Because most people can think, or are honest at any rate.

I'd appreciate it if you'd at least mingle your insults with some analysis.

[ndk]

It does indicate a marginally positive increase in the GDP deflator, which is good.

Pardon me, my mistake(see figure 7). It's actually a negative impulse to both interest rates and the deflator. That would indeed worsen deflation, if the research is accurate.

[Bruce Wilder]

ndk: "I don't think imposing an inflation target ex post facto during deflation will help."

I guess I really do not understand your argument.

Mine is pretty simple: Deflation very bad. Low-rate of inflation good. Respond to deflation with policy aimed at restoring inflation. There's no ex post, in my argument; that was an alternative scenario, to highlight the differing effects of deflationary and inflationary expectations.

What's yours? To declare 75 years of Keynesian theory and analysis "a nice theory" and unproven, because of some shaky time-series analysis that even Mankiw and Kling don't believe?

[don]

BW: "And, I would press a weak dollar on China like a hot iron, as soon as fiscal stimulus had restore domestic inflation and the liquidity trap was over."
My priorities are the reverse of yours (and Paine's, from earlier posts). I question whether crowding out is a big problem (many of the studies cited by Mankiw do not cover episodes in which there was a liquidity trap), but I don't think the response of the external balance can be ignored. If we borrow most of the stimulus from abroad, then most of the stimulus will go abroad and we will be left with little to show for our troubles beyond a greater debt burden. It's not as bad as opening our doors to heat the outside, but it is certainly a questionnable stategy. I think the stimulus should be an international effort. It would be tough to wait, and foreign agreement would be hard to get, but I doubt that the current paradigm - the U.S. consumer as the bedrock support for global demand and Asian export growth - is still viable. If we continue to ignore this issue, at any reasonable rate of discount of the future, the eventual result may be worse than doing nothing now. Similar considerations lead me to believe that the policies Japan followed after their bubble may have been close to optimal.

says...

"anne says...
"Why won't anybody challenge the efficacy of Keynesian stimulus?"

Because most people can think, or are honest at any rate."

Note the brainless dismissal, the assumed superiority, the duplicitous dishonesty, the unreasoned response. No argument, no reasons, no evidence. Vicious, imperious. Typical tyranny of the midgets. Do carry on though.

[don]

I should have said "The U.S. as bedrock support for global demand" (delete "consumer").

[Bruce Wilder]

ndk, The vowel-less one, KNZN addresses what I guess may be your main concern: "as most people writing for the public acknowledge (or insist), there is more to care about than the condition of the economy. There is also the condition of the government’s finances.

As far as the government’s finances are concerned, it is not just a bad idea to do too much; it is a bad idea to do enough. . .

Once you do enough, not only does the government have to start doing real borrowing to finance its deficit; it also has to pay real interest on the outstanding debt. The government is like a monopolist facing a kinked demand curve. As long as you stay below the kink, the more you produce, the better. But as soon as you get to the kink, all Hell breaks loose. Not only are you unable to sell your marginal “new” products for a profitable price; the price of your inframarginal “old” products starts to go down too."

He does a pretty good job, as usual, in laying out the pros and cons of the Keynesian case in a straightforward fashion. KNZN, recently, has been conducting a first-rate seminar in the fundamentals of macroeconomics applied to the present situation. very much worth reading.

[OhNoNotAgain]

"Why not pay people to do useful things rather than mail an unemployment check?"

Exactly bakho, and Harry Hopkins understood this all too well as Federal Relief Administrator under FDR. His number one goal was to provide the dignity of work instead of handouts, which he thought were actually counter-productive.

[Bruce Wilder]

don: "If we borrow most of the stimulus from abroad, then most of the stimulus will go abroad and we will be left with little to show for our troubles beyond a greater debt burden. It's not as bad as opening our doors to heat the outside, but it is certainly a questionnable stategy."

It is an excellent point, and one that Dani Rodrik addresses in Some unpleasant Keynesian arithmetic

KNZN touches on it as well, in comments on the post I linked to earlier. (Both links were provided by Mark Thoma in his links post for today.)

I regard a massive fiscal stimulus as an emergency measure. It doesn't make the necessity of responding to the underlying problems of adjustment to flow imbalances go away. Having a positive household savings rate, business investment in productive domestic capital stock, changing the energy basis of the economy so we are not importing massive amounts of petroleum and fighting wars to protect what is not ours -- these and other problems are not necessarily addressed.

The U.S. is under considerable pressure to move toward a lower rate of household consumption (aka a lower standard of living), a positive savings rate, a positive rate of investment in manufacturing, a curtailment of oil imports. There's a sense in which those changes are going to be long-run in nature, but the shift in orientation has been sudden and abrupt.

If policy ends up trying to preserve or restore the status quo ante -- if, for example, a fiscal stimulus just functions to restore consumers spending from borrowed funds to buy electronic junk from China, while our so-called banks recycle petrodollars into credit card usury -- then we will have screwed ourselves and our posterity. After a two or three or five years we will back in the same economic crisis, and the government's credit will have been ruined.

The massive fiscal stimulus has to be the center of a policy that changes everything. Brad DeLong: How Are We Going to Manage to Do All This: "The Obama administration is going to be rebuilding and reconstructing five major sectors of the American t. It has no choice--there is no other option. It has to remake:

* Autos
* Housing finance
* High finance
* Energy
* And the big one—health care

On what principles and through what procedures is this extraordinary exercise in structural economic reform policy going to be accomplished? I get how to do the macroeconomics of Obama administration economic policy. I don’t get how to do the structural side…"

[don]

BW:
Thanks for the cite. I would pick one nit with DR, when he says "The good news here is that China is playing along and hopefully the Europeans will too (if they can convince Germans to get over their weird obsession with fiscal conservatism)."
But the bad news is China may buy $500 billion in foreign currency in 2009. This is an anti-stimulus to the ROW and bigger than the increase in domestic spending they are contemplating. This doesn't look to me like a very cooperative attitude on their part. I would rather have them float their currency (like the Germans).
I should also have nuanced my statement that 'crowding out' is not a problem. For an open economy, the counterpart of perfect crowding out in a closed economy is that all of the new borrowing for the stimulus will be financed by foreign lending. Same result, different mechanism.

[Lafayette]

About Mankiw

Kling: He (Mankiw) is referring to recent empirical work suggesting the government spending crowds out investment, so that spending might be less effective as a stimulus than a tax cut.

It is difficult to imagine where this "empirical work" comes from. Has Mankiw talked to any business managers, for instance?

Any government spending that sparks demand will bring forth, in a suitable time-frame, both higher employment and necessarily corporate investment. The reasons are simple and highly evident ... to anyone who went looking for them.

Empirically, corporations will, upon increases in general levels of Consumption (aka consumer Demand), strive to meet Demand by augmenting production. This occurs by either adding productivity or adding labor input and typically both. Not only, but if sufficiently assured that that enhanced demand is not transitory, they will try to expand market share.

Enhancing market share entails penetration of new markets or more occupation of existing markets (penetration and occupation entail different metrics in Business Development). Whichever of the above alternatives they decide to undertake, they will require investment funding to do so, since such an effort is likely beyond in-house resources alone.

The investment funding will derive from either internal resources (Savings), but also external debt or added equity participation in the company (increased shareholding). It is indeed rare that Corporate Savings are employed to finance investment, but not impossible.

If companies do not need external investment resources, they finance their expansion internally. Most often they prefer recapitalization for investment purposes by means of shareholding rather than debt, which requires interest-bearing repayment. Shareholders will accept price revaluation boosted by additional profits.

This above is classical business operations. Highly empirical. It is unimaginable that government spending would "crowd out" investment. Why should it?