Wednesday, October 6, 2010

The Stimulus Wasn't Big Enough

The IMF has there 2010 World Economic Outlook out and they put forth the idea that if the world economy weakens further, those nations that can afford it (say a nation who's 10 year bond rate is hovering around 2.4) should consider additional stimulus.

The IMF also makes the point in the executive summary that "fiscal consolidation in advanced economies typically detracts from short-term growth." In other words, if you cut government spending, you hurt short term growth. And as Matt Steinglass points out in Democracy in America, the IMF has concluded that fiscal consolidation to the order of 1 percent of GDP leads to a 0.5 percent decrease in real GDP and a 0.3 percent increase in unemployment.

So far we have paid out $537 billion from the original $787 billion that was authorized. That constitutes 68% of the authorized funds.

I'm not saying we pass another stimulus tomorrow. I'm saying it needs to be part of the policy conversation. Paul Krugman has been all over this here, here, & here, and clearly he has a point of view, but he's also a Nobel Prize winning economist who's research focused on the Great Depression. Maybe we should listen to him instead of waiting for him to say "I told you so." (Which has said many times in the past couple years)

UPDATE: Jan Hatzius, economist with Goldman Sachs, has a grim outlook for the U.S. economy over the next 6 to 9 months. He also notes "The reason is...the impulse from fiscal policy [is] likely to continue deteriorating through 2011."

1 comment:

Colin said...

So far we have paid out $537 billion from the original $787 billion that was authorized. That constitutes 68% of the authorized funds.

This is a good argument in favor of tax cuts, which would have immediately resulted in more money in people's pockets. That government spending would take time to distribute was widely foreseen, but dismissed by those who trust the government more with taxpayer money than the taxpayers.

[Krugman]'s research focused on the Great Depression.

That's just not true. Krugman's acknowledged area of expertise is international trade (this is the area of work that won him his Nobel prize) and international finance. If you don't believe me you can go here and check out the list of his works.

Speaking of Krugman, why is he worth listening to anyhow? This is the same guy who in 2008 called for a one year stimulus package equivalent to $600 billion, or 4% of GDP. Well, the Obama administration gave us a $800+ billion stimulus over two years that was 5% of GDP, and we've all seen how well that is going.

Should I really believe that had we just dug ourselves a few hundred billion more in the hole that everything would be fine and dandy? Look, I realize Krugman has to push this line, that the stimulus was inadequate, as the alternative is admitting he was wrong and much of his economic philosophy is bankrupt, but why should he even be part of the conversation?

As Krugman continues his prattle on about the need to spend more, it is worth considering research which has found that reductions in public spending serve to boost economic growth.

A reduction by 1 percentage point in the ratio of primary spending to GDP in the sample OECD countries leads to an immediate increase in the investment/GDP ratio by 0.16 percentage points. It leads to a cumulative increase by 0.5 percentage points after two years and by 0.8 percentage points after five years. This effect is particularly pronounced when the spending cut is achieved through lower government wages. A cut in the public wage bill of 1 percent of GDP leads to an immediate increase in the investment/GDP ratio by 0.51 percentage points, by 1.83 percentage points after two years, and by 2.77 percentage points after five years.

This would certainly seem to have more explanatory power for the US economy in recent years than anything Krugman has put forward.