Friday, 23 January 2009

FAQ: Can fiscal stimulus save us?

Q: Can all this fiscal stimulus save the US economy?
A: No. It can’t.

Q:Why’s that?
A: Because the fundamental problem is not lack of money to shore up demand, but lack of goods to pay for real demand –- that is, lack of the sort of goods that are being demanded -- and no amount of “stimulus” can fix that.  All it can do is make the production of those goods more difficult.

Read Can Fiscal Stimulus Revive the US Economy? for the details.  As Frank Shostak points out there, “not only does the increase in government outlays not raise overall output by a positive multiple; but, on the contrary, this leads to the weakening in the process of wealth generation in general.”

This is the case not just for the US, but for anyone who tries the same “stimulus” shenanigans.  Can someone please explain all this to Little Billy English, the Pink Tory Pump-Primer.

UPDATE: Further on Shostak's point quoted above, Economist Robert Barro (highly rated by the likes of Richard Salsman) points out that the idea of a positive mutiplier from government spending (i.e., the result predicted by the simple Keynesian macroeconomic model) "implicitly assumes that the government is better than the private market at marshaling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system."

In other words, any notion of a positive multiple is mistaken. As Barro argues, 

"A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one."

Read Barro's argument over at Paul Walker's Anti Dismal: Government Spending is No Free Lunch.


  1. You won't have seen Mr English's piece in today's DomPost in which he says National's stimulus package - at $9 billion - is the 5th most "stimulatory" in the OECD. How can a package be accurately called stimulatory with no knowledge of the outcome? Intent is not enough. When manufacturers make claims about what a product is intended to do, and the product fails to fulfil that promise, they are liable. If only we could hold governments to the standards they require from the private sector.

  2. "Because the fundamental problem is not lack of money to shore up demand, but lack of goods to pay for real demand –- that is, lack of the sort of goods that are being demanded -- and no amount of “stimulus” can fix that. All it can do is make the production of those goods more difficult."

    So we can never have a situation of unemployed resources where prices are unable or unwilling to more to clear the market?

    Say if wages are stuck too high, firms will hire less than the socially optimal number of workers. Now if this labour input is not used, its just wasted.

    If the government was able to use this input to create things of value (eg public goods, or goods that are currently being underprovided given sticky prices) then they are improving societies set of resources - they are using a labour input that would not have been used otherwise. That is productive capacity.

    I think the idea of government stimulus can be, and is, massively oversold - but there are certain times when "government" stimulus makes sense.

  3. According to Bernard Hickey, at roughly 3% of GDP, NZ’s stimulus package puts us third most profligate in the world’s “stimulus” stakes, right behind Iceland and Denmark.

    Good news, huh.

    If only politicians would give some thought to the production side of the equation - they might then consider that what businesses need to produce profitably is for prices to fall, and they sure as hell aren't going to do that while all that printed money is inflating the hell out of demand.

    And you surely know, Lindsay, that governments are never judged on their actual results, only on their promises.

    To them, spending is the result.

  4. Hang on. Are't there too many goods, rather than too few?

  5. MATT: Sorry, the simple and unpalatable truth that you and your confreres need to grasp is that if wages are stuck too high, and they are, then wages need to fall. And they will have to.

    It doesn't take a PhD in economics (or a re-reading of Herbert Hoover's destructive efforts to fake reality) to understand that as long as wages are set too high then unemployment is the inevitable result, but as long as all the PhDs make excuses for why they can't fall or don't need to fall then wage-earners themselves will fail to heed the message, and politicians who promise the delusion of a stimulatory (read inflationary) path out of the economic wilderness will continue to get their support instead of their approbation.

    And don't tell me that wage and salary-earners won't allow their wages and salaries to drop. When the case is put to them rationally, the evidence of at least one workplace shows that they do.

  6. Anonymous: Too many of the wrong sort of goods -- i.e., too many goods were produced in the boom that in boom conditions producers thought would be productive, but by the time they were produced it became clear the market didn't want them.

    Too many goods into which too much real capital was thrown in times of too low interest rates, and which we now have to earn back.

  7. PC,

    Yeah, I get your point. But you have to admit, they are pretty cool photos!

  8. Hi PC,

    Thats the thing - I agree that if wages are too high they need to fall. But if, for some reason, they don't fall then the government may be able to get these people to produce something of value.

    Of course, I would like it if the government could quantify what this value is - and show that they aren't also nicking off with resources from the private sector when doing it. However, it is still a plausible situation.

    Note, I am saying that wages are stuck high - for some reason they just won't fall. I am not saying that I think we should hold up wages or anything of the such. Now if it turns out that wages don't get stuck we wouldn't need to look at intervention.

    "And don't tell me that wage and salary-earners won't allow their wages and salaries to drop"

    This is a question that economists have studied in detail. Think of it this way - the majority of people in the firm would rather have someone else sacked then take a paycut, so in order to keep up morale etc the firm is more likely to sack staff instead of cutting wages.

    In this case the relationship between the employee and employer can hold up wages even in the face of rising unemployment and falling general prices.

    I agree that this is an essential assumption - and if you don't agree with it then I can completely understand why you would be 100% against intervention. However, I do believe it - so I think the case can be made for intervention in "some" circumstances. Whether we should be doing it now is a whole other question ;)

  9. Hi Matt,

    No, I don't agree it's a necessary assumption, as my example of the enlightened workplace shows.

    So first of all, I do disagree that it's an essential assumption (as Mr Keynes was so wont to insist).

    I'd suggest that reactions to any suggestions that wages must drop are predicated very much so, as all human behaviour is, by the context in which that need is explained.

    If it's made in the context I suggest in that example, a context that would be made easier by widespread publicity from more rational economists that such cuts really are essential, then yes, I would expect many workplaces to do so -- with the result that production could be maintained but at the lower cost needed to meet the market.

    But if it's made in a different context -- one for example in which both politicians and the less rational economists are suggesting there's some way for everone to get something for nothing -- then I'd expect more of them to vote to eat their cake and have it too. And why wouldn't they, since they've been told so thoroughly by those who should know better that such a thing is possible.

    But second of all, even on your own terms, there's no way that the government stimulus can get people to produce something of value that they wouldn't produce otherwise.

    As Robert Barro argues (via Paul Walker), any "multiplier" created by any such stimulus is certainly going to be less than 1.0, and probably closer to zero than it is to anything else.

    Government spending really is no free lunch.


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