Originally I was going to post this as a comment on Anti-Dismal’s blog. But then I realised that I’m probably the busiest I’ve been in my life at the moment, and I need to make anything I can into a blog post. So here is a comment on this post.
Greg Mankiw has made an implicit call that there are long lags to infrastructural policy – and therefore such policy seems difficult to justify as a short-term stimulus (Anti-Dismal and Kiwiblog also link to this approvingly).
Now this is a very fair point, however I was initially going to criticise it on the simple ground that the government promising to invest in infrastructure increases expected future income which DOES lead to stimulus now (given that we believe that expectations and confidence are key). Hell the government could pay people now to build things in the future.
However, that didn’t take very long. So instead I’m going to discuss this post on a defense of infrastructural spending.
An excellent article by Stephen Kirchner of Institutional Economics on why the paradox of thrift has to be taken in context.
Key quote for me:
But recessions are not made worse via increased saving, so long as the financial system continues to put that saving to work
As long as the financial system is working (eg credit constraints are not firing up) then there is little need for rising savings to be met with rising government spending. Even in the case where there are financial issues, government intervention should focus on the market failure – rather than arbitrary fiscal spending.
One thing I would note is that there is also a role for confidence here which has been missed – if consumers and businesses lose confidence savings increases and demand for investment falls. If this decline is sufficient, and if interest rates are bounded at zero (or are interest rates, or the price of investments are too sticky) there can then be a role for increases “public investment”.
However, the appropriate role of government in the current crisis needs to be identified and defined (and quickly) before policy is determined. Doing something for the sake of doing something is nonsense – and such policy is often defended by the term “the paradox of thrift”.
Eugene Fama has written a much maligned post on stimulus packages. As a medium-long term view there is really nothing wrong with it, but the large swath of criticisms that have appeared focus on the fact that the author appears to be implying that there is no short-term stabilisation possible from expansionary fiscal policy – namely, government investment is completely crowded out.
Given that everyone else is talking about it, I thought I would add my relatively inconsequential two cents 😉 . This is from an email I sent along to CPW.
http://gregmankiw.blogspot.com/2009/01/fama-on-fiscal-stimulus.html
I’m really with Greg Mankiw.
I think that the criticism that Brad Delong laid out – that inventory is counted as investment but is over-valued – is really a second order issue. The main issue with this is that the mix of credit rationing and a flight to quality does support the idea that there is not complete crowding out – contrary to what Fama implicitly assumes. This in turn implies that government spending can smooth the economic cycle.
How does this hold with the S=I identity? I would say that:
- Given the existence of “low risk” government investment this (an increase in government investment) would lead to an increase in savings to match the increase in investment – people are more willing to loan to government than business after all,
- Given the presumption of unemployed resources (and credit constraints) there is scope for an exogenous positive shock to invest (which government investment is) to lead to an increase in equilibrium savings and investment – given that the use of unemployed resources creates value which could not be picked up by the private sector because of credit constraints/catatonic fear.
Even if I thought that the US was at potential (which I don’t – I just think the output gap could be overestimated) the whole attitude to risk and credit rationing surely implies that complete crowding out does not hold – sure S=I always holds, but not complete crowding out.
I realise I’m not adding anything to the debate. However, this blog is a good place for me to store things the way I see them at a given point in time, and thats just what I’m doing damn it 😀
If anyone thinks I’m talking crack, feel free to tell me in the comments 😉
Note: In case it isn’t clear the first mechanism reduces consumption, so no instantaneous stimulus even in the face of no crowding out! However, it does allow for a “reallocation” from consumption to investment, if the price signal was screwy for some reason this could be optimal.
The second leads to an indeterminate change in consumption (given the first mechanism – the income effect in of itself will increase consumption), but a net stimulus.
These are important factors to note when we ask “is an increase in government investment increasing output” and furthermore “is an increase in GI increasing welfare” – which is the ultimate goal.
Note2: There is also the case where public investment is more productive than private investment. I don’t think this case is as unlikely as people say – given that the government may have easier access to some resources than the private sector (and given the possibility of increasing returns to scale, especially in a small place like New Zealand).
Over at Economists View, Mark Thoma points out and, in my opinion, rightly criticises a piece from the Cato institute on fiscal stimulus.
Now the Cato piece seems to equate a fiscal stimulus strictly with the “broken window fallacy“. I do not completely agree with this. As Thoma points out government investment should be counter-cyclical, as by investing this way they get to build public goods (which will not be provided in sufficient quantities by the market) cheaply!
However, some fiscal stimulus does fit into the broken window frame – however it does so in two different ways. First we have the case where the windows are broken and then we are wondering what to do with policy. Then we have the case where the government could break windows. Lets discuss.
There really is a pile of excellent economic discussion flooding out the the Economics blogsphere over recent months. If the collapse of Lehman brother did nothing else – it got economists arguing!
On the issue of a US “fiscal stimulus” there have been two main posts that I have found as convincing arguments against the “large stimulus” school of thought that is being sold by Paul Krugman and Mark Thoma. These posts were by Tyler Cowen at Marginal Revolution and David Henderson at Econlog (and part 2).
Ultimately, the static Keynesian analysis being sold by Krugman and Thoma misses the impact of relative prices – a factor that is important given that some of the shocks hitting the macroeconomy are structural.
Now, given the way confidence (especially business confidence) has turned south I think we can sell some scope for a stimulus. Furthermore, government CAN help improve outcomes during a structural shift in the face of asymmetric information. However, Krugman and Thoma are both ignoring any supply side shift – and treating all the decline in activity as a decline in “demand”. Such an extreme position would only lead to excessive government involvement in my mind.
The most important question in my mind is “what is potential”? I’m sorry, but we have an observable, large, permanent, negative supply side shock – but many forecasters are still assuming that “natural” growth will be unchanged. How am I supposed to trust those forecasts in these extreme circumstances?