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Open letter on stimulus

August 16th, 2010

Over Fifty Australian Economists Agree Fiscal Stimulus Prevented A Major Recession

Nobel Laureate Professor Joseph Stiglitz has stated publicly that the Australian Fiscal Stimulus was a well designed package that saved the Australian economy from a major recession that has hit almost all the other OECD economies. He argued that the Australian package was a model for other economies facing similar problems.

The attached letter was signed by over fifty academic economists. Several other academics and economists supported this view about the Fiscal Stimulus Package that prevented the Australian economy from a deep recession and prevented a massive increase in unemployment.

The Australian economy has come out of the Global Financial Crisis in surprisingly good shape thanks to this Stimulus Package.

The Australian unemployment rate is amongst the lowest of any of the OECD economies.

Unlike the US and Europe, we are not facing the possibility of a double dip recession.

The current level of government debt (the lowest in the OECD economies) is due to tax revenues falling during a slow-down in the economy, whilst social security payments increase. Most of the increase in the debt would have happened independently of the increased government expenditures associated with the Stimulus Package.

The Stimulus Package has led to an increase in infrastructure investment that would help the long-term development of the Australian Economy.

Labor’s Stimulus Package, 2010

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  1. gerard
    August 20th, 2010 at 17:14 | #1

    @jquiggin
    American faculty, especially in the social sciences and humanities, are overwhelmingly Democratic in affiliation and social-democratic in orientation.

    If ideology plays no role at all in the hard and applied sciences, what are we to make of the 2.5:1 Democratic:Republican ratio in engineering, the 4.1:1 in chemistry, 4.2:1 ratio in physics, 10.7:1 in biology, or the 13.1:1 in neurosciences?

    It seems pretty obvious what we are to make of it.

  2. August 20th, 2010 at 18:33 | #2

    @gerard

    It does, but of course, as is so often the case, one’s paradigm may constrain one from seeing the obvious.

  3. Alice
    August 20th, 2010 at 18:41 | #3

    @gerard
    What we are to make of this Gerard …is the bleeding obvious. Democrats are better educated. But conservatives can be street smart like cunning rats about furthering their own ambitions and those of like minded street smart rats (rats with gold teeth??)…
    Now are these the people we want leading for all of us? Not if we dont want to get bitten!

  4. Jim Rose
    August 20th, 2010 at 19:42 | #4

    @Alice
    I have no difficult with the proposition that left-wing parties have lost their base in the working class and no longer represent the interests of the working class. the role of progressive parties is to rent-seek for the middle class.

    the democractic primaries in 2008 were all about appealing to the middle class.

  5. sdfc
    August 20th, 2010 at 22:05 | #5

    Jim Rose :@sdfc thanks
    If there is a liquidity trap, as you hint, Auerbach and Obstfeld explored this recently in the American Economic Review in “The Case for Open-Market Purchases in a Liquidity Trap”.
    To the extent that long-term interest rates are positive now or short-term interest rates are expected to be positive in the future, trading money for interest-bearing public debt through open market operations reduces future debt-service requirements.
    A massive monetary expansion during a liquidity trap should improve welfare by reducing the taxes required in the future to service the now much smaller national debt!!!!
    A quantitative easing during a liquidity trap is, in effect, as good as or even better than a lump sum tax. Central banks perhaps should contrive liquidity traps because they can then buy back the public debt because of the unlimited demand for money. People will without limit give up bonds for non-interest bearing cash. If monetary policy is impotent near the zero bound, the Fed should buy trillions of dollars worth in federal bonds and payoff the public debt. This is a logical implication of liquidity traps for an optimal fiscal policy!!!!
    Rhetorical claims that fiscal policy worked is the usual shape shifting.1. In Australia, it worked because unemployment rates are back near the natural rate.2. In the USA, the situation would have been far worse but for fiscal policy.The perfect hypothesis – it is confirmed works not matter if things improve or worsen.
    After reading the annual reports of the Fed in the 1920s and 1930s, Milton Friedman noticed the following pattern:“In the years of prosperity, monetary policy is a potent weapon, the skilful handling of which deserves the credit for the favourable course of events; in years of adversity, other forces are the important sources of economic change, monetary policy had little leeway, and only the skilful handling of the exceedingly limited powers available prevented conditions from being even worse”
    two questions: are fiscal expansions potent in small open economies? what is the extent of exchange rate crowding out?
    I also draw your attention to the literature on expansionary fiscal contractions. Examples in addition to the EU in 1980s and 1990s are Australia and NZ in 1931. 25%+ unemployment in 1931 was below double figures by about 1935 after massive fiscal contractions combined with going off the gold standard.

    Hi Jim

    So you’re basically in favour of monetising the debt. They’re going to have to reduce their balance sheet some time. How much further do you want the money base to grow? How low do benchmark interest rates have to be?

    The money base has expanded enough. The problem’s not with the Fed it’s with the banking system. There are signs that credit in the US has become a little easier two year into the downturn.

    As for fiscal policy working in Australia The national accounts tell us that direct public spending contributed 2.8 pps to 2.7% YOY growth in the March quarter. When you add the impact of the first homebuyer grant (along with monetary policy of course), the business investment tax breaks and the cash hand outs to households it’s pretty hard to argue against.

    As for the US package, private sector credit growth has been negative for some. Government credit drives economic activity while the private sector is deleveraging. We saw the US auto industry go through a short term production boom on the back of governement credit. Household income is being heavily supported by government credit. Business activity on government credit supports private sector profits with the expectation of future profits.

    In short, given the impotence of monetary policy fiscal policy is the obvious candidate for the “recovery” in the US.

    As for the Fed in the 1920s, they were juggling a huge increase in money because of the war and its aftermath. The prvate sector was never the less debt laden and vulnerable to a shock. The Fed took a while to get its act together and the money supply began to shrink because the banking sector stopped lending.

    I’m not really familiar with NZ in the depression but one fundamental difference between here and the US is that we didn’t have a banking collapse. The depression was made more severe due to the collapse in the terms of trade. That’s not to say however that devaluation and interest rate and wages cuts had no effect.

    Fiscal policy can be effective in a small open economy under recessionary conditions because it supports demand. Financial markets aren’t frictionless and the economy is not always in equilibrium.

    As for the exchange rate, or course there is going to be some leakage, but a stronger currency is a funtction of having a stronger economy. Interest rates are higher because the strength of the economy didn’t warrant a 3% cash rate.

  6. Andre
    August 21st, 2010 at 00:32 | #6

    The economists need a little…..”attitude of epistimic humility”

    http://www.tnr.com/blog/critics/77109/stimulus-spending-confusion-whos-right

    and the democrats are smarter than the republicans/conservatives and the republicans/conservatives are smarter than the democrats and … and .. and … what a load of piffle.

  7. sdfc
    August 23rd, 2010 at 21:29 | #7

    Andre

    I take it that the author of that article would not be making such an argument if the US “recovery” had been the result of an increase in private sector spending . So why should a fiscal expansion not have an expansionary impact on economic activity? Is the flow of money from an increase in public credit somehow ineffective in promoting economic activity?

    Those who argue that the stimulus did not have an impact need to provide a coherent argument as to why it has not. The usual argument against public spending is that it crowds out the private sector, either through its draw on economic resources or the supply of loanable funds. Neither of these arguments is likely to be true given that the US currently has an abundance of idle economic resources while the general risk aversion and financial sector malaise has seen private sector credit decline for five or six quarters, depending on what sector you are looking at.

  8. Michael of Summer Hill
    August 23rd, 2010 at 23:26 | #8

    SDFC, much of the rhetoric from the business sector is bulldust for when things go wrong many so-called CEO, analysts, etc never accept responsibility for their mistakes be they present or past. Everyday you hear about closures, bankruptcies, fraud, etc but in reality much of the failures is due to incompetence, bad judgement and what is media fails to write up on ‘bad intelligence’.

  9. Andre
    August 25th, 2010 at 00:56 | #9

    @SDFC

    I agree that the Manzi may not have made this argument if the US “”recovery”" had been the result of private sector investment. He does however make a good point ..

    “…it was clear that we wouldn’t know which economists were right even after the fact. Suppose that on February 1, 2009, Famous Economist X had predicted: “In two years, unemployment will be about 8 percent if we pass the stimulus bill, but about 10 percent if we don’t.” What do you think would happen when 2011 rolled around and unemployment was still at 10 percent, despite the passage of the bill? It’s a safe bet that Professor X would say something like: “Yes, but other conditions deteriorated faster than anticipated, so if we hadn’t passed the stimulus bill, unemployment would have been more like 12 percent. So I was right: the bill reduced unemployment by about 2 percent.”
    Another way of putting the problem is that we have no reliable way to measure counterfactuals—that is, to know what would have happened had we not executed some policy—because so many other factors influence the outcome.”

    Manzi suggests that it is practically impossible to definitively measure the outcomes of the stimulus. Concluding that what is needed is some epistimic humilty (see socrates view @ http://plato.stanford.edu/entries/wisdom/). I will also be a little cynical and also point out that the letter released by the fifty economist was timed to yield maximum political capital for the party that implemented the stimulus. The consensus of fifty esteemed economist, in a bayesain sense, ” the current state of knowledge” has a sense of infallibility rather then humility.

    In regard to your questions, any “coherent argument” against the stimulus would have to be supported by conclusive evidence which like Manzi I believe is not within my grasp. I will however throw some mud at the bright light of consesnus surrounding our fifty esteemed economist.

    The basic Keynesian principle that underpins the stimulus is “the inverse relationship between interest rates and aggregate demand and that the economy “wants” negative real rates so it can hit the point where that demand curve crosses the full employment line, which is below the zero interest rate line.” (Krugman in the US)

    Briefly some of the difficult issues: There is no way of differentiating between consumption and investment or that they will move in the same direction or opposite to each other even given idle resources. There is no notion of capital or that production takes time. What about malinvestment as result of low interest rates…… .

    These results are difficult to measure. So how can I be sure that my concerns about the stimulus are realistic then ? The short answer is I cannot be sure unless perhaps I get together with fifty economist and come to a consensus.

    Consensus is ocassionally useful in politics but on shaky ground when it underpins a science. I will leave it to you to try and “morph” these two fields together.

  10. Michael of Summer Hill
    August 25th, 2010 at 07:07 | #10

    Andre, one way to measure the stimulus package is to look at the TARP program and the buy back and return on investments in dividends, interest and other incomes. You could say the government is laughing all the way to the bank.

  11. Michael of Summer Hill
    August 25th, 2010 at 21:20 | #11

    Andre, the latest reports indicate the stimulus package may have created and/or saved as many as 3.3 million jobs last quarter and lowered the unemployment rate by as much as 1.8 percentage points. Now that is a good sign.

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