Posted by: Tobias | December 12, 2008


Peer Steinbrück, the German Minister of Finance, gave an interview to Newsweek today in which he defends the caution the German government has displayed in the face of a Europe-wide efforts to put together a stimulus package for the ailing world economy:

What is wrong with the stimulus proposals?
The speed at which proposals are put together under pressure that don’t even pass an economic test is breathtaking and depressing. Our British friends are now cutting their value-added tax. We have no idea how much of that stores will pass on to customers. Are you really going to buy a DVD player because it now costs £39.10 instead of £39.90? All this will do is raise Britain’s debt to a level that will take a whole generation to work off. The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking. […]

Doesn’t an unprecedented crisis call for unprecedented measures?
It’s the yearning for the Great Rescue Plan. It doesn’t exist. It doesn’t exist! Dealing with an unprecedented crisis is a puzzle, a trial-and-error. Honestly, I don’t know. I tend to be skeptical because it is human nature to see the crisis as even worse than it is. I don’t want to downplay anything; 2009 looks like it will be a very difficult year. But we are not about to collapse. We are just about to ratify our €31 billion stimulus in Parliament. As long as we haven’t even given that a chance to work, I am not going to participate in this bidding war over who can do the most. I try to exude a little steadiness and continuity instead.

What entails the greater risk to the economy: not acting now before the pain gets worse or the negative consequences of overspending now?
I don’t think anyone knows. Making political decisions means taking responsibility in an environment of uncertainty. When in doubt, I’d say the risk is greater of burning money without significant effects and in the end having a budget weighed down with even more debt. For me the only stimulus measures that make sense are those that create jobs and have a positive structural effect beyond the economic cycle. One should wait to see how what we have agreed on now works before one thinks about readjusting.

In a blog post entitled The economic consequences of Herr Steinbrueck (an allusion to a similarly critical essay Keynes wrote on “The economic consequences of Mr. Churchill”) Paul Krugman, the newly minted Nobel laureate in economics lays into Steinbrück pretty hard:

Here’s the issue: we’re rapidly heading toward a world in which monetary policy has little or no traction: T-bill rates in the US are already zero, and near-zero rate will prevail in the euro zone quite soon. Fiscal policy is all that’s left. But in Europe it’s very hard to do a fiscal expansion unless it’s coordinated.

The reason is that the European economy is so integrated: European countries on average spend around a quarter of their GDP on imports from each other. Since imports tend to rise or fall faster than GDP during a business cycle, this probably means that something like 40 percent of any change in final demand “leaks” across borders within Europe. As a result, the multiplier on fiscal policy within any given European country is much less than the multiplier on a coordinated fiscal expansion. And that in turn means that the tradeoff between deficits and supporting the economy in a time of trouble is much less favorable for any one European country than for Europe as a whole.

It is, in short, a classic example of the kind of situation in which policy coordination is essential — but you won’t get coordination if policymakers in the biggest European economy refuse to go along.

And if Germany prevents an effective European response, this adds significantly to the severity of the global downturn.

In short, there’s a huge multiplier effect at work; unfortunately, what it’s doing is multiplying the impact of the current German government’s boneheadedness.

Color me unconvinced. It’s not that I’m a crazed supply sider. I’m not. I do not believe that Ricardian equivalence or complete fiscal impotence for countries the size of Germany are empirically correct (or even theoretically very convincing in the former case). I do think that the state can play a useful role in a recession by stimulating aggregate demand. In theory.

In the Macroeconomics 101 version of theory these things sound fairly simple: the government recognizes an output gap – idle resources, whether they be capital, land or labor – and starts spending money to put these idle resources back to work. And not only do you get this direct effect, the money you spend becomes someone else’s income and that person will spend it in turn. Your initial spending impulse is thus amplified via the so-called Keynesian multiplier and you get quite a bit of bang for the buck

The real world, however, is much messier. Not only is the multiplier often quite small, much smaller than the Keynesians of old often imagined, it also varies from sector to sector, even from one recession to the next and it’s tough to get the mix or even the size and the timing of the stimulus right.

What strikes me is that level of the discussion on the US stimulus package that will undoubtedly be put together even before Barack Obama takes office hasn’t been exactly stellar and the little I have read about stimulus plans in Europe doesn’t sound any more convincing. I see loads of highly respectable and respected economists using arguments and methods which are essentially 70 years old and what starts out as a back-of-the-envelope calculation soon becomes the anchor for actual policy discussions. I cannot believe that we have made so little progress since the days of Keynes himself.

And these are the economists speaking. Everyone else seems even crazier. “Let’s spend the money on infrastructure investment, which we’ll need sooner or later anyway,” I hear all the time, never mind that “projects that are “shovel-ready” are probably only a few tens of billions worth” (and some were planned anyway and therefore wouldn’t provide any stimulus, one might add). A lot of environmentalists, meanwhile, are proposing, nay demanding, that we see this recession not as a danger for resolving the climate change issue but as an opportunity by ‘stimulating’ all sorts of green technologies (see the numerous posts on Climate Progress, for example), never mind that there is only so much research we can do, only so many solar panels we can manufacture and so many hybrids to build over the next year or so.

Every day I open the paper (well, the web site of a paper) I find yet another idea for what we could spend money on, now that we’re spending. Any old idea, however stupid, seems to get a second life if you repackage it and label it with the magic word ‘stimulus’. A case of false advertisement if there ever was one.

So, it’s not that I think this can’t work, it’s that I’m immensely skeptical that we have the knowledge about how much, how, when and where to spend and even if we did, whether a stimulus plan that could pass the legislature would still resemble the optimal policy in any meaningful way. There’s a saying about laws and sausages that comes to mind. And how we spent the last 350 billion dollars, the ones we spent to rescue the American financial system via the TARP doesn’t exactly instill confidence in the people that will have to carry this out in the end:

This report makes a clear-eyed and compelling case that Treasury really has no idea what it’s been doing so far; that policy decisions have been ad hoc and ill-thought-through; and that no one has spent much in the way of time or effort in terms of thinking seriously about what the ultimate purpose of the TARP is, and how best to achieve that end.

I look forward to the US stimulus package to be signed into law shortly after 20 January. At the very least it’ll be another valuable piece of data for my friend the macroeconometrician. About everything else, we’ll see; or not.


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