When you spend less, the economy contracts

[^_^ 5,021]

Last week the IMF published its 2010 World Economic Outlook, which focuses in large measure on the fact that lots of countries that engaged in stimulus spending in 2008-09 are now getting ready to retrench. Chapter 3, "Will It Hurt? Macroeconomic Effects of Fiscal Consolidation", takes up the question of whether government spending cutbacks will shrink GDP and raise unemployment in the near to medium term. Yes, the IMF finds with a weary sigh, they will.

This is a question that, before the spring of 2009, very few people thought was really a question. The general opinion held by people across the political spectrum (Ben Bernanke, Greg Mankiw, Martin Feldstein, Christina Romer, Paul Krugman and what have you) was that when governments start unwrapping packs of 100-dollar bills and blowing them into the street with giant fans, spending and economic activity goes up. In the long run economic activity will probably end up a bit lower as the bills come due. Or it may not. In some cases the economic destruction caused by a contraction may be so severe that you wind up with lower GDP forever if you don't engage in stimulus. Anyway, when you're facing a severe recession, you want to take that bargain and smooth things out, because cyclical volatility causes suffering.

Yet because a Democratic president passed a stimulus bill in 2009, because economic conditions are still lousy, and because the American media-political system is currently capable of generating arguments about literally anything, an argument is now circulating that the stimulus didn't do anything at all to raise GDP or employment. This is a view that virtually no economist holds. Ezra Klein yesterday reported the remarks of Martin Feldstein, former chairman of Ronald Reagan's Council of Economic Advisers, at yesterday's Fiscal Choices conference:

Before the election, I wrote an op-ed saying it doesn't matter who's going to win. Whoever it is needs to get the ball rolling on stimulus. I didn't recognize how big the hole was going to be yet. But when it finally got rolling, instead of asking what annual level of spending they needed, they asked themselves how big the number could be politically, and they decided it needed to be in the billions rather than the trillions. For all sorts of reasons, it was poorly designed, but in the end, it just wasn't big enough, and I think we all recognize that now.

The IMF takes up a few serious papers from the 1990s that marshalled evidence that government spending cuts could raise growth and lower unemployment, but they dismiss them as irrelevant to the current situation. Those papers dealt with situations in which large government debt had driven up interest rates, choking off credit to business. This has little bearing on a world in which the Bank of Japan drops its interest rates to 0% as part of pledge to stimulate more inflation. Fiscal retrenchment in the 1990s created growth by lowering interest rates, the IMF says; it can't do that when interest rates are hitting the zero bound. It's a familiar point that Paul Krugman has been trying to make relentlessly for almost two years now, but politics have moved relentlessly in the opposite direction, and the policy is constrained by the politics. As a result, Mr Krugman is becoming resigned to disaster.

There's a trap, and it's the same thing that happened with fiscal stimulus. You do something in the right direction that's inadequate, and then people say, well, that didn't work, and instead of increasing the dosage and proving it right, you give the thing up altogether.

All of this is very familiar if you studied Japan in the '90s. In fact, we're doing worse than the Japanese did. Our monetary policy is a bit more aggressive, but our fiscal policy has been less aggressive. We have a larger output gap than they did, and we've had a surge in unemployment that they never had, and our political will to act has been exhausted much faster than theirs was. On the current track, we're going to look at Japan's lost decade as a success story compared to us.

http://www.economist.com/blogs/democracyinamerica/2010/10/politics_and_economy?fsrc=scn/fb/wl/bl/spendless

[Heracles 417]

Derr no brianer, hence why taxation is essential during such a time, as it allows the government to stimulating spending by means of various projects. Projects that will benefit the community for years and decades to income.

This whole tax break rubbish, is just that - rubbish. People will simply hoard the tax break, which defeats the rationale behind the tax break.

[Obama 2012 1,714]

Derr no brianer, hence why taxation is essential during such a time, as it allows the government to stimulating spending by means of various projects. Projects that will benefit the community for years and decades to income.

This whole tax break rubbish, is just that - rubbish. People will simply hoard the tax break, which defeats the rationale behind the tax break.

Actually you need a fine balance.

Part of our problem today is we've had this 'spend, spend, spend' mentality without saving.

You need to balance spending and saving to have a successful economy. Otherwise you end up in a heap of trouble like we've seen the past few years.

A 'credit based' economy like we've been on since World War II cannot be maintained.

[Heracles 417]

Actually you need a fine balance.

Part of our problem today is we've had this 'spend, spend, spend' mentality without saving.

You need to balance spending and saving to have a successful economy. Otherwise you end up in a heap of trouble like we've seen the past few years.

A 'credit based' economy like we've been on since World War II cannot be maintained.

Agreed, on the savings part. The credit rise here was fueled because they have been allowed to do whatever they want. Go try get a credit card in AUS and you will see why they don't have the same issues. The industry is heavily regulated, also why less than like 0.5% of their mortgages are subprime.

Were we strongly disagree is regarding government investments on things like service and more importantly desperately needed infrastructure. Government expenditure on things like infrastructure is an investment for the country. The lack of such investments following the Reagan years is why the US is decades behind the rest of the OECD in so many areas. You have mentioned Texas before but while it might be doing well versus the rest of the states, it's still pale compared to numerous other first world countries. Look at the Goliath projects the Chinese are working on, versus simply wasting it on Military rubbish.

In terms of savings I was shocked to read the other day that the Chinese [communist] now have over $2 trillion USD in personal private savings versus the $454 billion of Americans.

Edited October 12, 2010 by Heracles

[Obama 2012 1,714]

Agreed, on the savings part. The credit rise here was fueled because they have been allowed to do whatever they want. Go try get a credit card in AUS and you will see why they don't have the same issues. The industry is heavily regulated, also why less than like 0.5% of their mortgages are subprime.

Were we strongly disagree is regarding government investments on things like service and more importantly desperately needed infrastructure. Government expenditure on things like infrastructure is an investment for the country. The lack of such investments following the Reagan years is why the US is decades behind the rest of the OECD in so many areas. You have mentioned Texas before but while it might be doing well versus the rest of the states, it's still pale compared to numerous other first world countries. Look at the Goliath projects the Chinese are working on, versus simply wasting it on Military rubbish.

In terms of savings I was shocked to read the other day that the Chinese [communist] now have over $2 trillion USD in personal private savings versus the $454 billion of Americans.

The United States would not be the nation we are today without our military power. Now with that being said though, we could save a lot of money if we weren't galloping around the middle east. That we can agree on.

As far as infrastructure spending goes, that's tossed down the crapper until the value of the dollar can be brought back up somehow. The only way we are ever going to do that is to raise interest rates and pull some cash out of the economy. Which many would argue against as it's harmful initially, but better off in the long run.

The price of steel in through the roof right now. Concrete is not in full supply and alot of the American industry that procudes other tools/materials needed has moved offshore to countries in the middle-east and in China who are buying up the materials are the premium prices because they can.

Obama saying we only need $50 billion is a joke. He has still stimulus money at his fingertips that never got used allegedly (or misused to begin with). For us to build on infrastructure and give it a good solid investment, we'd have to spend hundreds of billions of dollars right now if not more with the current prices and value of the dollar. Inflation is not only a ###### for you and me, it's a big burden on government spending as well.

So until we get certain things fixed economically where items can be more affordable, I wouldn't expect much change....

[Heracles 417]

The United States would not be the nation we are today without our military power. Now with that being said though, we could save a lot of money if we weren't galloping around the middle east. That we can agree on.

Winding the US spending back and off from the status-quo approach of pre-signed blank checks is what I am talking about here. Just the other day I posted that ~$577 billion goes into operation and personnel costs versus $150 billion for R&D and intelligence. The $577 billion for one year is basically piss-farted around for things like the unnecessary bases all over the world.

So yes, it's funny to hear the same people who hate government and wastage, turn a complete blind eye to the biggest wasters of them all - the US military. A place any expense is no problem.

As far as infrastructure spending goes, that's tossed down the crapper until the value of the dollar can be brought back up somehow. The only way we are ever going to do that is to raise interest rates and pull some cash out of the economy. Which many would argue against as it's harmful initially, but better off in the long run.

The price of steel in through the roof right now. Concrete is not in full supply and alot of the American industry that procudes other tools/materials needed has moved offshore to countries in the middle-east and in China who are buying up the materials are the premium prices because they can.

Obama saying we only need $50 billion is a joke. He has still stimulus money at his fingertips that never got used allegedly (or misused to begin with). For us to build on infrastructure and give it a good solid investment, we'd have to spend hundreds of billions of dollars right now if not more with the current prices and value of the dollar. Inflation is not only a ###### for you and me, it's a big burden on government spending as well.

So until we get certain things fixed economically where items can be more affordable, I wouldn't expect much change....

Actually these things are something that cannot be exported and would created hundreds of thousands of jobs. America desperately needs its infrastructure brought into the 21st century, at a cost estimated by Engineers to be over $2.5 trillion. It should be less than that but the country is clearly that behind and in need of repair.

No brainer though, whatever you neglect now, ends up costing 15 fold down the track to fix. The Regan years started the neglect because most of the infrastructure had been built during the roaring 40's to late 60s and was still basically new. It's been nearly 30 years since then and the chickens have most certainly come home to roost, the neglect can be seen everywhere. I know people joke about my reference to streetview, but out of all the countries now available (inc South Africa), excluding Brazil and parts of Mexico, the US has the worst of the lot - it's embarrassing actually.

Edited October 12, 2010 by Heracles