Earlier I mentioned that Paul Walker and myself had different ideas surrounding the need for a stimulus in the US. Fundamentally I think he is completely against while I see scope for some stimulus.
Over at Brad Delong’s blog he mentions a description of the stimulus by Kevin Murphy.
The structure he describes is below:
It appears that one of President Obama’s first concerns is “currency manipulation” by China – very interesting. The administrations view seems to be:
The US has long felt that China has artificially depressed the value of its currency to boost exports – to the detriment of US business – but the Bush administration always stopped short of formally declaring China a currency manipulator.
However, I would also note who in the US it benefits: The US consumer. When China devalues their own dollar, they are making exports more cheaply for the rest of the world – including the US.
I’m all for market pricing the in the face of good information – but lets not forget that US consumers have benefited from this action.
In a recent post by Paul Krugman he laments the lack of serious arguments against a fiscal expansion. I think that this is a bit extreme on his part – but I think that his criticism of John Taylor indicates the exact value judgment that makes him feel this way:
You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks (emphasis mine)
Notice that he not only rejecting the anti fiscal stimulus policy – he is rejecting the belief that part of the current crisis is the result of a permanent shock. If the current crisis is the result of a temporary shock then fiscal stimulus could help to dampen the impact. However, if the shock is permanent any fiscal stimulus will merely be a costly way of delaying the inevitable.
Of course, we have a bit of both – there are a range of shocks, some permanent, some temporary. Given this, some type of fiscal stimulus could be seen as necessary – however, the required stimulus would be a lot smaller than the fiscal stimulus crusaders are supporting. Again, it all comes back to our forecasts of potential output …
Calculated Risk illustrates growth in US retail sales over the past 15 odd years:
Source: Calculated Risk.
Now we know that exports from Japan are plummeting. We suspect exports from China are falling. This decline in spending in the world’s largest economy would be the reason why. Very interesting …
Update: Don’t forget about trade, ick!
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?