Home > Economic policy, Economics - General > The big issues in macroeconomics: the fiscal multiplier

The big issues in macroeconomics: the fiscal multiplier

January 4th, 2013

The biggest theoretical issue in macroeconomics is “what causes unemployment”. As discussed in the last post, the classical answer, that unemployment is caused by problems in labor markets, is obviously wrong as an explanation of the simultaneous emergence of sustained high unemployment in many different countries. Unemployment is a macroeconomic problem.

The central macroeconomic policy issue, then, is “what, if anything, can macroeconomic policy do to move the economy back to full employment”. If you accept that, under current conditions of zero interest rates, there’s not much positive that can be done with monetary policy[1], and you stay within the bounds of mainstream policy debate, this question can be restated as “how effective is expansionary fiscal policy” or, in Keynesian terms, “how large is the fiscal multiplier in a depression”.

To restate this in more neutral terms, if the government spends more, say by employing and equipping more firefighters, what happens in the rest of the economy? The answer given by classical economics is that the newly-employed firefighters must be drawn from elsewhere in the economy, presumably in the private sector. Similarly, the production of extra firetrucks means less vehicles can be produced for other purposes. Although the exact way in which resources are reallocated can’t easily be predicted, the classical model gives the clear answer that the overall level of employment and economic activity won’t change[2]

Keynes gave a different answer. The classical solution, he said, was applicable in a situation of full employment, but that was a special case. In general, the economy might be in an equilibrium with high unemployment, with plenty of idle workers who could be hired as firefighters, and factories to produce their equipment. Not only that, but the firefighters would spend at least some of their increased incomes, leading to further growth in demand. So, aggregate employment and production would expand by more than the amount of the initial increase, leading to a ‘multiplier’ effect.

More precisely, the fiscal multiplier is the ratio of the final change in aggregate output (and therefore in employment) to the initial change in government expenditure. The traditional “Old Keynesian” view (implied by the multiplier terminology) is that, provided there are plenty of unemployed resources, the multiplier is greater than 1 (among other things the value depends on the kind of expenditure – low income households are more responsive to income changes, so expenditure that benefits them will have a higher multiplier). That view seems consistent with the evidence of, for example, Romer and Romer and, more recently, the IMF World Economic Outlook (PDF), which concluded

Research reported in previous issues of the WEO finds that fiscal multipliers have been close to 1 in a world in which many countries adjust together; the analysis here suggests that multipliers may recently have been larger than 1

The classical position may be restated as saying that the fiscal multiplier is zero. The core of New Classical economics is the reassertion of this claim. If workers are unemployed it was either because they are unwilling to work at the going wage or because some artificial barrier (unions or minimum wages) stops wages from adjusting to their equilibrium level. To the extent that Keynesian policies worked, New Classical economists like Lucas argued, it was by generating inflation and tricking workers into accepting wages that were higher in nominal terms but lower in real terms.

Before the current crisis, New Keynesians conceded a fair bit of ground to the classical view, but argued for a positive multiplier, though not necessarily greater than 1. One way of putting this is that public expenditure partially “crowds out” private spending. But most NK advocates thought fiscal policy unnecessary, since monetary policy had the same effects and was easier to manage.

I criticized the New Classical view last time, but the dominant idea in European and many US policy circles is even worse. It’s, the theory of expansionary austerity put forward by Alesina and various co-authors that the fiscal multiplier is substantial and negative. That is, cutting public expenditure will increase output.

This claim has no real theoretical basis and almost no empirical support, being based largely on anecdotal evidence and on a few studies that have not stood up to criticism. I took it apart in the paperback edition of Zombie Economics – the relevant section was published here

To sum up, despite the thousands of papers published every year in the field, macroeconomic theory is incapable of giving even a qualitative answer to the most basic questions about fiscal policy[3]; at least, not one that would not elicit dissent from a substantial, and well-credentialled group of leading experts. Worse, public policy decisions to impose austerity policies are being made on the basis of a magical theory, with almost no empirical support.

This is an appalling situation, made worse by the complacency of (the dominant group of) academic macroeconomic specialists, who seem to think that everything in the garden is rosy, or would be if outsiders like Krugman would just shut up. It really is hard for me to see how the economics profession can recover from its current rotten state, at least as regards macro (and, even worse, finance).

fn1. Some advocates of nominal GDP targeting, such as Scott Sumner say that monetary policy could work if central banks showed sufficient resolve to convince people they would tolerate inflation. I disagree, but I’ll have to leave this for another time.

fn2. On this view, welfare would decline, because governments would use resources less efficiently.

fn3. While writing this, I wondered what would happen if you put this question to a group of DSGE theorists as a pop quiz. I suspect most would give some variant of “the question is ill-posed” and the rest would be all over the place. But, if any DSGE theorists are reading, I’d be keen to get their views.

  1. Jordan
    January 4th, 2013 at 18:47 | #1

    Acctually the problem of unemployment is in the labor markets, labor is paid too low.
    Total employment wages are not too low, they are distributed very very unequally and hence can’t support consumption once the debt as a mean for Surplus Circulation stops creating demand. Debt served as transfer of nominal surplus from savers to spenders/Surplus Circulation which enabled AG and with it investment.

    The solution is in making that circulation be restarted. Fiscal multiplyer is describing succes of Surplus Circulation. Nominal Surplus Circulation.
    Marxist surplus is in real values while Nominal Surplus Circulation is in nominal values or movement of money which is used to acces real value.

    That NSC can be restarted by state action, raising the minimum wage and raising marginal tax rates. This would redistribute employee costs from managers exorbitant salaries to labor wages and possibly restart NSC by other means rather then debt as it was before the crash.
    I say “possibly” because labor is still encumbered by high debt which total has fallen to the 1980′s levels but mostly due to reduction in debt for wealthy while little reduction at labor level besides defaults.
    That debt can be repayed by time with higher wages or imidietly with debt forgivness/ debt jubilee without waiting. What’s better, to wait till debt is paid off with high unemployment or do it right away with $50T coins by debt jubille?
    Sticky debt is the problem, not sticky wages or prices.

  2. January 4th, 2013 at 20:42 | #2

    Where? might be a logical question to ask when trying to predict the effect of government stimulus packages. For example, Labor’s stimulus worked because it gave money to people on low incomes who were likely to spend the money in Australia. It would have been a failure if Turnbull had had his way and the stimulus had come in the form of tax cuts to the rich. Rich people who would probably have wasted the money on speculation and overseas trips.

    The insulation scheme stimulus also made economic (if not safety) sense because the jobs it created could be done by low skill workers. On the other hand a stimulus package that spent money in an already overstretched construction sector would have achieved little in economic terms even if a diversion of resources away form building coal mines may have been good for the planet.

  3. Bruce Bradbury
    January 4th, 2013 at 20:58 | #3

    Interestingly, the Aust govt’s initial fiscal response to the financial crisis goes beyond the fiscal policy rationale that Krugman and Co have been outlining recently. Treasury recommended that we ‘go early, go hard and go households’ in a situation where we did not (yet) have high unemployment.

    This is all about timing. Monetary policy has long lags but fiscal policy changes can be very quickly implemented – at least in Australia. (More so than in most other countries).

    In terms of the fiscal multiplier debate, then, the key issue is the time distribution of the fiscal impact, rather than simply the overall impact.

  4. John Brookes
    January 4th, 2013 at 21:48 | #4

    I agree with Jordan. We’ve seen an unexpected drop in unemployment over the last few months. I believe this is caused by the income redistribution associated with the carbon tax. Money went from high income earners to low income earners. Unemployment went down, and nobody expected it.

    We now have the opposite being tried, with a reduction in income to single mums. I’m betting that the loss of spending power will cause a rise in unemployment (the money is, after all, just being saved by the government).

    But I’m not an economist (can’t you tell?), so please explain why this interpretation is wrong.

    And why do you get such differing opinions from economists? Could it be that they profess to believe in the interests of those they identify with?

  5. Mel
    January 5th, 2013 at 00:47 | #5

    Interesting and well written. I’m trying to follow these debates but I must admit I’m too ignorant (and dense) to ever have more than superficial grasp of the subject matter. Anyway, I’ve been slowly reading Zombie Economics and it certainly sounds far more plausible than the arguments put forward by your opponents. One point- I wouldn’t mind hearing more from you on “crowding out”, which only gets a brief mention in Zombi Economics.

  6. sdfc
    January 5th, 2013 at 01:07 | #6

    What crowding out? Of labour?

  7. Katz
    January 5th, 2013 at 06:02 | #7

    If, as JQ alleges, the discipline of economics is in a state of profound epistemological crisis, how long can that situation persist before there are profound real life effects?

    Alternatively, it may not really matter very much that economists have failed to describe and to understand reality. The world continues to turn regardless of the boneheadedness of economists. Keynes himself opined that markets can remain irrational for a long time. Perhaps it is true that markets can remain irrational forever.

    The latter being the case, what earthly use are economists?

  8. Ikonoclast
    January 5th, 2013 at 06:57 | #8

    I am continually astonished that Keynes is not (and not seen as) the father of the central tradition of capitalist mixed-economy macroeconomics and its management by the democratic state. A roughly analogous situation in physics would be the rejection of Einstein and continued attempts to understand the physical cosmology of the universe with Newtonian physics.

  9. Ikonoclast
    January 5th, 2013 at 07:13 | #9

    @Katz

    1. Economics is in a state of profound crisis.

    2. There are profound real life effects happening right now. Look at Greece, look at Spain with overall unemployment rates at about 25%. Look at Australia with youth unemployment at about 25.0%. Look at the US with its politically self inflicted “fiscal cliff” dangers. The fiscal cliff is only real if they implement the defacto austerity measures implied in massively raising taxes and massively dropping expenditure in a flat economy. These real life effects have been happening ever since the Neocssicals, Monetarists, Neocons etc. took over economic and political policy in the 1970s.

    3. Bad economists (Classical, Neoclassical, Monetarist) are worse than useless. Good economists can help if only politics and society will pay heed to them. By “good economists” I mean those whose theories are actually supported by the empirical evidence. For sure, economics is not a pure science. But broad effects from the different macroeconomic approaches are clear enough in the real world evidence. It is clear what we need to do but the official political and social discourse space is taken up by those who argue ideologically not evidentially.

  10. RSP
    January 5th, 2013 at 07:46 | #10

    In the Howard era a group of neo-classical economists calling themselves “The Six Economists” proposed government subsidies to employers as way of reducing unemployment. Unacceptably high unemployment rates were interpreted as result of labour market rigidities – conditions of employment, particularly wage rates, were more generous than a free market would have dictated on the basis of the skills and prodcutivity of those available for hire. So to employers would need to be compensated for this productivity deficit. Many objected that up-skilling the unemployed would be a better policy and the idea eventually died the death – but it may return to haunt us. One member of the The Six gave a lecture at a government department. I asked him what he expected would happen to unemployment if God suddenly smote all the unemployed. His response: “Nice exam question. Next…”

  11. Katz
    January 5th, 2013 at 08:21 | #11

    @Ikonoclast

    “Bad” can either mean “incompetent” or “malign”.

    Which quality predominates among economists, in your opinion.

  12. January 5th, 2013 at 10:07 | #12

    Actually it was 5 economists.

    They wanted to boost family tax transfers and keep minimum wages constant.

    So over time minimum wages would fall but family incomes wouldn’t.

    That way NAUIRU would fall.

    SDFC, as sual, has a good question.

  13. Ikonoclast
    January 5th, 2013 at 11:02 | #13

    @Katz

    Many are poor economists (in fact not deserving of the title) because of any or all of;

    (a) they follow falsified theories;
    (b) they follow the herd;
    (c) they are bought and suborned (do what their corporate masters tell them);
    (d) they pay no attention to history or empirical outcomes (same as first point really);
    (e) they are ideologically driven while being blind to this fact.

    Some are malign economists. I would put Milton Friedman at the top of that list. I mean malign towards the working classes and the unemployed. They regard them as manipulable and disposable factory fodder, sweatshop fodder and cubicle fodder. They don’t care if people go homeless, commit sucide in despair and so on so long as they have a seat at the Oligarch’s table. Many of the malign economists are also highly intellectually dishonest. Friedman certainly was. You can’t advance views like his and frame them like he did without being intellectually dishonest or stupid and Friedman was not stupid.

    Some are possibly well-meaning but highly ideological and misguided souls like Hayek and the Austrians.

  14. Ikonoclast
    January 5th, 2013 at 11:18 | #14

    In some circles, Marxism is considered highly tainted due to its association with and presumed direct causation of Russian and Chinese “communism”.

    It would be interesting if we applied the same standards of judgement to capitalism. (Which most in the West hypocritically do not.) Capitalism is associated with imperialism, colonialism, mass murders and ethnic cleansing of natives and indigenes almost all over the world and (before labour laws in the west) child labour and grotesque exploitation of the working class.

    The slave trade (though it was not just capitalists), the despoliation of Africa, India and China (Opium Wars) before such countries gained or regained true independence are just a few more “feathers” in the cap Western bourgeois capitalism. We can add to that now the stripping of resources and the despoliation of the biosphere including the atmosphere to the extent that we now certainly face 6 degress of global warming which will devastate much of the world and civilization.

    Oh gee! Well done capitalism! What a great system you are… NOT!

  15. Happy Heyoka
    January 5th, 2013 at 12:53 | #15

    A quick comment from the peanut gallery: while I understand that the discussion is mainly aimed at generating an informed response from those in the field, the jargon can be impenetrable sometimes (nb: as an IT guy, pot, kettle etc).

    Today’s example is “NAUIRU”; previously on the unemployment post it was “E/P ratio” – that one was easy enough to decipher (intuit that “P” is maybe population –> participation) but googling for it returns either Price/Earnings or Permits/Employment; metrics not applicable to the discussion.

    Links to a decent glossary?

  16. Ikonoclast
    January 5th, 2013 at 13:18 | #16

    According to Wikipedia;

    “In monetarist economics, particularly the work of Milton Friedman, NAIRU is an acronym for non-accelerating inflation rate of unemployment, and refers to a level of unemployment below which inflation rises. It is widely used in mainstream economics.”

    In other words, being part of the work of the charlatan Milton Friedman, it is a load of bunk. You can safely ignore it.

  17. Ikonoclast
    January 5th, 2013 at 13:23 | #17

    This reader’s post in the NY Sun sums up Friedman’s legacy.

    http://www.nysun.com/comments/35236

  18. Ikonoclast
    January 5th, 2013 at 13:35 | #18

    Here are some snippets I have plagiarized from around the net. I won’t bother with attributions, this is a blog not an academic paper.

    1. Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

    “The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing.”

    2. University of Texas economist James Galbraith says Friedman’s ideology has run its course.

    “The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says.

    Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge. Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith Snr., who died in 2006, rejected mathematical models and technical analyses as divorced from reality.

    * * *

    Ok, I have posted too much. I will put the attack dogs back in the kennel. (But the Monetarists, Friedmanites and Chicago shool fill me with loathing.)

  19. January 5th, 2013 at 20:17 | #19

    Question: Presumably it’s wrong to think of the fiscal multiplier as some ‘universal constant’ like the mass of a fundamental particle, waiting to be discovered by enough empirical work? Presumably the multiplier varies depending on institutional details of particular economies, the current macroeconomic conditions of that economy, and perhaps whether the fiscal balance is going up or down (i.e. there may be hysteresis?).
    And is fiscal policy ‘fungible’? That is, does a given change in fiscal balance achieved by a reduction in tax rates produce the same multiplier as an increase in spending?

  20. Will
    January 5th, 2013 at 21:02 | #20

    @Tom Davies

    The multiplier is not constant at all; the only matter of agreement is that it is highly variable. That being said, it would be a brave economist to propose a fiscal multiplier of less than 1.0.

    At the ECON101 level, if the economy starts out at the same initial position the gain in GDP increase from a tax cut and an increase in government spending will be the same. The way I was taught it, some of the tax cut will first be saved and the remainder used for C and I, so it will take a tax cut of, say, $12b to provide the same benefit to GDP as an increase in government spending by $10b (full mathematical explanation omitted).

  21. alfred venison
    January 6th, 2013 at 07:35 | #21

    has anyone seen this from last thursday’s washington post?

    “Consider it a mea culpa submerged in a deep pool of calculus and regression analysis: The International Monetary Fund’s top economist today acknowledged that the fund blew its forecasts for Greece and other European economies because it did not fully understand how government austerity efforts would undermine economic growth.”

    “The new and highly technical paper looks again at the issue of fiscal multipliers – the impact that a rise or fall in government spending or tax collection has on a country’s economic output.”

    “ ‘Forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation,’ Blanchard and co-author Daniel Leigh, a fund economist, wrote in the paper.”

    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/01/03/an-amazing-mea-culpa-from-the-imfs-chief-economist-on-austerity/

  22. John Brookes
    January 6th, 2013 at 14:02 | #22

    @alfred venison

    Which is what Krugman and many others said.

    It’s almost as if economics is like climate science, except that the “fake skeptics” of the climate wars translate into respected/influential economists. They are wrong, obviously wrong, pushing a barrow, and yet taken seriously.

    Of course, the problem with economics is that you can’t prepare two identical economies and then do experiments on them and confirm the result. Which is precisely the problem faced by climate science. What you can do is look at the many accidental experiments conducted, like Greece, and draw conclusions from the weight of evidence.

  23. TerjeP
    January 6th, 2013 at 19:50 | #23

    As discussed in the last post, the classical answer, that unemployment is caused by problems in labor markets, is obviously wrong as an explanation of the simultaneous emergence of sustained high unemployment in many different countries.

    However malinvestment isn’t. Nor are trade barriers. They may be wrong but not obviously so. IMHO.

  24. January 6th, 2013 at 20:23 | #24

    @John Brookes

    One of the problems is that the economic orthodoxy of the day makes it hard for countries to try different approaches. This problem is is made worse by collective long term memory loss.

    For example, free market orthodoxy is supposed to be based on the idea that free markets allow the best ideas to emerge. The irony of course is that free market bullies such as the WTO and its allies make it very difficult for a country to try something different to free market orthodoxy.
    The irony of course was that countries like Australia had very healthy growth and low unemployment in the bad old protectionist days.

  25. rog
    January 7th, 2013 at 06:04 | #25

    Joseph Stiglitz argues that pursuing employment over inflation is cost effective and that Central banks need to have their wings clipped The economic analysis of Clinton’s Council of Economic Advisers turned out to be right; the models of the IMF (and the Fed) were wrong. America secured a much lower rate of unemployment without inflation–eventually unemployment fell to below 4% Stiglitz contends that the Fed has been captured by Wall St.

    http://www.project-syndicate.org/commentary/big-lies-about-central-banking#198EZ3iOlDmMiTB6.99

  26. Jim Rose
    January 7th, 2013 at 17:59 | #26

    see http://www.dimensional.com/famafrench/2009/01/bailouts-and-stimulus-plans.html for a concise discussion of the points raised by Fama:

    bailouts and stimulus plans seem attractive when there are idle resources – unemployment:
    1. Bailouts and stimulus plans must be financed.
    2. If the financing takes the form of additional government debt, the added debt displaces other uses of the funds.
    3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.

  27. Chris Warren
    January 7th, 2013 at 19:54 | #27

    @Jim Rose

    This doesn’t make sense.

    IF:

    there are idle resources – unemployment

    THEN:

    How does:

    added debt displaces other uses of the funds.

    .

    The real problem with adding debt, is that it solves a short-term problem but without remedying whatever caused the original underutilisation. So debt ratchets.

  28. Graeme Bird
    January 7th, 2013 at 21:51 | #28

    There is no fiscal multiplier nor any evidence for a fiscal multiplier. Such evidence as exists comes from mixing up “spending” or “aggregate demand” with GDP or national income. Well we know that fiscal policy will increase NOMINAL GDP. That is very clear. Because it redirects spending from categories outside of GDP to categories that GDP picks up. But there is no evidence now or in the past that fiscal policy increases spending in total. Nor is there a good apriori case for such an idea. I don’t deny that it COULD happen. But its a matter of pure serendipity and if we found out it COULD happen this would be utterly useless for public policy.

    Because we already know that we can hit any level of nominal business revenue we want to by way of increasing the reserve asset ratio, and new cash creation. So what is fiscal policy for?

  29. January 8th, 2013 at 11:11 | #29

    Fama like most of the lovers of Classical economics always assumes full employment or no output gap.

    If he was right we would see crowding out. We are not seeing that.

  30. Jim Rose
    January 8th, 2013 at 12:22 | #30

    nottrampis, Fama specifically discussed unemployment in his post saying that
    “Even when there are lots of idle workers, government bailouts and stimulus plans are not likely to add to employment. The reason is that bailouts and stimulus plans must be financed.

    The additional government debt means that existing current resources just move from one use to another, from private investment to government investment or from investment to consumption, with no effect on total current resources in the system or on total employment. “

  31. BilB
    January 8th, 2013 at 13:25 | #31

    There is no doubt that diligent application of fiscal resources can have a multiplier effect.

    “She defended the $6.3 million cost of the firework display, saying it equated to $4 for every person who watched the event around the harbour, and the fireworks generated $156 million for the local economy”

    …..for example. The GST on the expenditure put the cash back in the government coffers and a good time was had by all.

    Australia’s stingiest attempt at a fiscal multiplier came from John Howard who offered support funds to small businesses in country communities during the worst of the last drought. The problem was that there were so many strings attached to the funds that virtually nothing of what was on offer was taken up. This exercise proved in the end to simply be a Political Multiplier, and provided to be no stimulus at all.

  32. January 8th, 2013 at 13:56 | #32

    Jim,

    If resources are idle then there is a surfeit of funds as Savings is greater than Investment.

    They do not move at all. They are not being used.

    Fama is simply being silly.

    It seems as though the GFC has led a number of vocal academics to show they do not have the faintest idea of basic economics.

  33. January 8th, 2013 at 18:16 | #33

    Interesting (and very brief) article by Yglesias: http://www.slate.com/blogs/moneybox/2013/01/06/fiscal_stimulus_debate_endless_frustration.html

    Provocative quote “If you listen carefully to Krugman, he’s saying that fiscal stimulus will almost never be a good idea.”

  34. Jim Rose
    January 9th, 2013 at 16:30 | #34

    @nottrampis There must have been an excess of savings in the 1930s depression in Australia but it was a fiscal contraction in 1931 that sparked the recovery from unemployment rates of 25%+

    • Australia came out of the Depression earlier than most other countries because of the approach that was made under the Premiers’ Plan.
    • By the mid-1930s, their unemployment rates were in mid-to-high single digits.

    The premiers’ plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans. The plan was complementary to the Arbitration Court’s 10 per cent wage cut of January 1931 and the devaluation of the Australian pound.

    While MacLaurin (1936) dated the economic recovery from the last months of 1932, it was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during the 1920s.

    What was the fiscal multiplier on the premiers’ plan?

  35. BilB
    January 9th, 2013 at 17:09 | #35

    More importantly, Jim Rose, what were the consequences

    “Throughout Scullin’s term, commodity prices continued to fall, unemployment rose, and Australia’s big cities were depopulated as thousands of unemployed men took to the countryside in search of menial agricultural work. The stagnant economy had reduced economic activity and therefore tax revenues. However, the debt commitments of both state and federal governments remained the same. Australia became severely at risk of defaulting on its foreign debt which had been accumulated during the relative prosperity and infrastructure-building frenzy of the 1920s.”

    Do you think that we have these options in today’s world?

  36. Jim Rose
    January 10th, 2013 at 16:14 | #36

    Sovereign defaults are rather common especially implicitly through surprise inflations. Those 1920s hyperinflations in Europe were fiscally motivated.

    Hyperinflation and moderate inflations are ended through fiscal consolidations backing the new monetary police rule. Tom Sargent wrote on this in the 1980s. His 1981 paper on Thatcher is very good.

    Are you saying that the merits of a fiscal contraction or stimulus depend on whether there is pleasant or unpleasant monetary arithmetic and the risk of default?

    If you are constrained by default risks and default premium, the case for s stimulus collapses into the case for tax smoothing advocated by Barro.

    Many countries and states have been downgraded recently because of default risks.

  37. Katz
    January 10th, 2013 at 16:46 | #37

    @Jim Rose

    There must have been an excess of savings in the 1930s depression in Australia but it was a fiscal contraction in 1931 that sparked the recovery from unemployment rates of 25%+

    This had some minor effect.

    Much more important was the >30% devaluation of the A£ at the end of 1931. Australia’s recovery was export-led under the aegis of Empire Preference.

    Little noticed has been the deflationary effect of the repatriation of government debt by means of a series of huge bond issues. By these means foreign debt was retired and hundreds of millions of A£ was tied up in government bonds whose interest was paid by means of tax increases.

  38. BilB
    January 10th, 2013 at 20:13 | #38

    What I was referring to, Jim Rose, was

    “Australia’s big cities were depopulated as thousands of unemployed men took to the countryside in search of menial agricultural work”

    effectively a huge chunk of the population just disappeared, ……..no social wellfare burden, no stimulus required.

  39. Jim Rose
    January 11th, 2013 at 18:18 | #39

    @Katz Everyone was devaluing and going of the gold standard at that time. Devaluation without a fiscal consolation might mean unpleasant monetary arithmetic will take hold. The UK went off gold in 1931 as well.

    For example, Greasley and Oxley (2002) suggested that devaluation was also behind the recovery from the depression in NZ and promoted a remarkable recovery.

    New Zealand differed sharply Australia in that devaluation was chosen rather than forced, and eventually associated with a new inflationary regime.

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