Download Stimulus and the great recession

Stimulus and the great recession
Sinclair Davidson
On the use of language
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Adam Smith on Government
• The statesman who should attempt to direct private people in what manner
they ought to employ their capitals, would … assume an authority which could
safely be trusted, not only to no single person, but to no council or senate
whatever, and which would nowhere be so dangerous as in the hands of a
many who had folly and presumption enough to fancy himself fit to exercise it.
(Book IV, Chapter II)
• It is the highest impertinence and presumption, therefore, in kings and
ministers, to pretend to watch over the œconomy of private people….
They are themselves always, and without any exception, the greatest
spendthrifts in the society. Let them look well after their own expence, and
they may safely trust private people with theirs. If their own extravagance
does not ruin the state, that of their subjects never will. (Book II, Chapter III)
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Adam Smith on Economic Growth
• Great nations are never impoverished by private, though they sometimes
are by publick prodigality and misconduct. The whole, or almost the whole
publick revenue, is in most countries employed in maintaining unproductive
hands. Such are the people who compose a numerous and splendid court, a
great ecclesiastical establishment, great fleets and armies, who in time of
peace produce nothing, and in time of war acquire nothing which can
compensate the expence of maintaining them, even while the war lasts. Such
people, as they themselves produce nothing, are all maintained by the
produce of other men's labour. … Those unproductive hands, who should be
maintained by a part only of the spare revenue of the people, may consume
so great a share of their whole revenue, and thereby oblige so great a
number to encroach upon their capitals, upon the funds destined for the
maintenance of productive labour, that all the frugality and good conduct of
individuals may not be able to compensate the waste and degradation of
produce occasioned by this violent and forced encroachment. … (Book II,
Chapter III)
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Adam Smith on Economic Growth
• The annual produce of the land and labour of any nation can be increased in
its value by no other means, but by increasing either the number of its
productive labourers, or the productive powers of those labourers who
had before been employed. The number of its productive labourers, it is
evident, can never be much increased, but in consequence of an increase of
capital, or of the funds destined for maintaining them. The productive powers
of the same number of labourers cannot be increased, but in consequence
either of some addition and improvement to those machines and instruments
which facilitate and abridge labour; or of a more proper division and
distribution of employment. In either case an additional capital is almost
always required. (Book II, Chapter III)
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The role of fiscal policy
• Fiscal policy represents the spending and taxation (including borrowing)
decisions taken by government.
– Provision of public goods.
– Provision of merit goods.
– Redistribution.
• Question: should fiscal policy be used as a tool to manage the economy?
– Can fiscal policy be used for counter-cyclical policy?
– Yes.
– Keynesian theory suggests that government can successfully
intervene in the economy.
– No.
– Ricardian equivalence suggests that government cannot
successfully intervene in the economy.
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A digression on the Great Depression
• Popular Understanding of the Great Depression
– Capitalism lead to excesses in the 1920s.
– Economic growth was unsustainable.
– Stock Market crash of 1929 started the depression.
– Irresponsible application of orthodox policy worsened the depression.
– FDR saved the world by spending.
– A slightly more sophisticated view would have FDR and JM Keynes
saving the world.
– When FDR did try to balance the budget he made things worse.
– WWII ended the Great Depression.
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Popular Understanding of the Great Depression
• This is a very American view of the Great Depression.
• Probably exported to the world by popular culture and Hollywood.
• But even as a history of the US it is misleading.
• Amity Shlaes in The Forgotten Man: A New History of the Great Depression
has a far more nuanced view of the Great Depression (pg. 392).
– ‘But what really stands out when you step back from the 1930s picture is
not how much the New Deal public works achieved. It is how little. … The
story of the mid-1930s is the story of a heroic economy struggling to
recuperate but failing to do so because of perverse federal policy. The
worst factor was Roosevelt’s war on business. But one can also make the
argument that lawmakers’ pre-occupation with public works got in the way
of allowing productive business to expand and pull the rest forward.’
• In February 1931 Ludwig von Mises had written
– ‘All attempts to emerge from the crisis by new interventionalist measures
are completely misguided. There is only one way out of the crisis: Forgo
every attempt to prevent the impact of market prices on production.’
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The Great Depression in America
1938
1939
1937
1935
1936
1934
1932
1933
1931
1929
1930
1928
1926
1927
1925
1923
1924
1922
140
120
100
80
60
40
20
0
1920
1921
US GDP (per capita) Index 1920 = 100
Source: Angus Maddison. 1990 International Geary-Khamis dollars
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What Happened to Government Spending?
US Expenditure % GDP
18
16
14
12
10
8
6
4
2
0
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941
• Source: Bureau of Economic Analysis
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What happened in 1936-37?
• Randall Kroszner “In 1936-37, the
Federal Reserve made a colossal
mistake in its “exit strategy”. This time
round it is crucial that central banks get
their timing right.
• Source: FT August 11 2009
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Seventy-three years ago, fearing the
large accumulation of reserves held by
the banks at the Fed could result in an
“uncontrollable expansion of credit in the
future” if the banks decided to lend out
those reserves, the Fed raised reserve
requirements to absorb them. This sharp
tightening of monetary policy stopped
the robust recovery that had been in
train since 1933, precipitating a “doubledip” contraction in 1937-38, which
according to Milton Friedman and Anna
Schwartz in their 1963 book A Monetary
History of the United States, 1867–1960
“was one of the sharpest on record”.”
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Causes of the Great Depression
• Stock standard recession.
– Amplified by monetary policy mistakes.
• Incorrect application of Gold Standard leading to US and UK inflation.
• Animal spirits.
• Excesses of capitalism.
• Austrian Theory.
• Both the Monetary theory and the Austrian Theory posit that policy errors lead
to the Depression.
– Increasing Tariffs etc. exacerbated a bad situation.
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An Austrian Explanation of the Great Depression
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An Austrian Explanation of the Great Depression
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An Austrian Explanation of the Great Depression
• Putting the model through its paces
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Australia in the Great Depression
1938
1939
1937
1935
1936
1934
1932
1933
1931
1929
1930
1928
1926
1927
1925
1923
1924
1922
130
120
110
100
90
80
70
60
1920
1921
Australian GDP (per capita) Index 1920 = 100
• Source: Angus Maddison. 1990 International Geary-Khamis dollars
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Australia in the Great Depression
• Australia and the US Compared
GDP per capitia Index (1919=100)
130
120
110
100
90
80
70
Australia
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1939
1938
1937
1936
1935
1934
1933
1932
1931
1930
1929
1928
1927
1926
1925
1924
1923
1922
1921
1920
1919
60
United States
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Australia in the Great Depression
35
30
%
25
20
15
10
5
0
1928 1929 1930 1931 1932 1933 1934 1935 1936 1937
Trade Union
Everyone
• Source: Steve Kates, ABS
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Australia in the Great Depression
• Unemployment Compared to US
Unemployment
30
25
20
15
10
5
0
1929
1930
1931
1932
1933
Australia
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1934
1935
1936
1937
1938
United States
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Australia in the Great Depression
• You’ll notice the Australian turning point is very marked.
• What Happened in 1931?
– Australia went off the Gold Standard.
– Australia adopted the ‘Premiers’ Plan’.
• Kevin Rudd on the Premiers’ Plan
– ‘The alternatives [to the stimulus packages] were to do nothing or, worse,
effectively replicate the Premiers' Plan of 1931 when governments cut
expenditure, thereby compounding the problems created by a private
sector already in retreat. The result, of course, was an economic rout,
appalling unemployment and a decade of negligible growth through the
1930s.’
– This statement is completely at odds with Australian economic history but
not political history – the ALP government was thrown out of office.
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Australia in the Great Depression
• The Premiers’ Plan
– Reduction in government spending of 20 percent.
– Increase in Commonwealth income tax and sales tax.
– Reduction in interest Rates.
– Spending cuts were deeper that tax rises.
– Commonwealth ran a budget surplus from ‘ordinary transactions’ for
the period 1931/2 onwards.
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Australia in the Great Depression
• Is the turning point (just) due to going off gold?
Australia
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New Zealand
Canada
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1939
1938
1937
1936
1935
1934
1933
1932
1931
1930
1929
1928
1927
1926
1925
1924
1923
1922
1921
1920
1919
140
130
120
110
100
90
80
70
60
United Kingdom
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Lessons learned from the Great Depression
• Lesson learned from the Great Depression:
– Keynes’ contribution: Replace the decline in private aggregate demand
with increased public spending (and debt).
– Friedman’s contribution: Keep the stock of money in circulation from
declining to ensure that monetary liquidity is maintained.
• Are those good lessons to have learned?
• What about these lessons? (Gwartney)
– Avoid these policies:
– Monetary contraction.
– Trade restrictions.
– Tax increases.
– Constant changes in policy; this merely creates uncertainty and delays
private sector recovery.
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The Global Financial Crisis or Great Recession
• The GFC began in mid to late 2007.
– August 7, 2007 Banque Paribus freezes two hedge fund accounts.
– September 6, 2007 Northern Rock bailout.
– March 15, 2008 Bear Sterns Rescue.
– September 7, 2008 US government seizes control of Fannie Mae and
Freddie Mac.
– September 15, 2008 Lehman Brothers files for bankruptcy.
– September 16, 2008 AIG bailout.
– September 21, 2008 TARP proposed.
– September 23, 2008 TARP rejected.
– September 24, 2008 Ben Bernanke appears before Congress; President
Bush on national prime time television.
– October 3, 2008 TARP Legislation passed.
– February 17, 2009 American Recovery and Reinvestment Act passed.
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Bernanke to Congress September 24, 2008
• “Despite the efforts of the Federal Reserve, the Treasury, and other agencies,
global financial markets remain under extraordinary stress. Action by the
Congress is urgently required to stabilize the situation and avert what
otherwise could be very serious consequences for our financial markets
and for our economy. In this regard, the Federal Reserve supports the
Treasury's proposal to buy illiquid assets from financial
institutions. Purchasing impaired assets will create liquidity and promote
price discovery in the markets for these assets, while reducing investor
uncertainty about the current value and prospects of financial
institutions. More generally, removing these assets from institutions’ balance
sheets will help to restore confidence in our financial markets and enable
banks and other institutions to raise capital and to expand credit to support
economic growth.”
– No wonder markets panicked.
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Was all this necessary?
• Roger Congleton (2009)
– Much of the data associated with the recession of 2008, however,
suggests that the term “crisis” was overused in mid-2008, although that
term did trigger rapid, although not necessarily well-considered, responses
from government. The first year of the present recession was caused by
routine responses of consumers to wealth reductions associated with the
end of the real estate and stock bubbles, and by the usual adjustment of
firms to reduced consumer demand. Two of the three major U.S. markets
for credit performed more or less normally. Moreover, much of the policy
response also has been fairly routine. The Federal Reserve reduced
interest rates and expanded the monetary base. Congress extended
benefits for the unemployed and increased government spending (and
deficits). Many bank failures were addressed by the FDIC through
mergers, some of which were subsidized with FDIC reserves.
– There is some evidence that the “Great Depression” rhetoric used to
secure passage of the bailout bill exacerbated the credit problem and the
recession. Because individual investors and firms naturally assume that
Treasury experts have the very best data, the risk of another Great
Depression apparently was “new news” to many of them.
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Shitstorm – the Australian experience
• January 10, 2008 Wayne Swan becomes aware of crisis after call from Hank
Paulson.
• January 21, 2008 Kevin Rudd identifies financial crisis as problem, but less
so than inflation.
• February 6, 2008 RBA raises interest rates.
• February 29, 2009 Rudd asks Ken Henry for some worst case scenario
planning.
• March 5, 2008 RBA raises interest rates.
• August 5, 2008 Rudd organises meeting of gang of 4 to discuss fiscal
stimulus.
• September 3, 2008 RBA cuts interest rate.
• September 21, 2008 Government bans short selling.
• October 7, 2008 Gang of 4 meet in Brisbane to discuss stimulus
– Gillard and Tanner learn of advanced plans
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Shitstorm – the Australian experience
• October 8, 2008 RBA drops interest rate by 100 basis points.
• October 9, 2008 Tanner is told stimulus plan will go ahead by his department
secretary.
• October 11 – 12, 2008 Gang of 4 and bureaucrats discuss Stimulus I (Swan
from US and Tanner from Melbourne).
• October 12, 2008 Government guarantees bank deposits.
• October 14, 2008 $10.4 billion stimulus package announced.
• November 5, 2008 RBA drops interest rate by 75 basis points.
• February 3, 2009 $42 billion stimulus package.
• February 4, 2009 RBA drops interest rate by 100 basis points.
• February 9, 2009 Senate Inquiry into Stimulus package – 3 economists
appear for 10 minutes each.
• April 8, 2009 RBA drops interest rate by 25 basis points
• October 7, 2009 RBA raises interest rate by 25 basis points.
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Doing the Time Warp
• Richard M. Salsman
– If there is anything more tragic than our current banking crisis, it is that the
crisis is being blamed on the wrong group, on the bankers, instead of on
the primary culprit, government intervention. The tragedy lies in failing to
identify the fundamental cause of the problem, thereby ensuring its
continuance. Bankers are not entirely innocent of wrongdoing in the
present debacle, but to the extent that bankers have been irresponsible, it
has been primarily government intervention that has encouraged them to
be so. … Government has created these banking crises – by making it
nearly impossible to practice prudent banking. Having done so,
government has then pointed to bad banking practices as sufficient cause
for still further interventions in the industry.
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Doing the Time Warp
• Richard M. Salsman
– If there is anything more tragic than our current banking crisis, it is that the
crisis is being blamed on the wrong group, on the bankers, instead of on
the primary culprit, government intervention. The tragedy lies in failing to
identify the fundamental cause of the problem, thereby ensuring its
continuance. Bankers are not entirely innocent of wrongdoing in the
present debacle, but to the extent that bankers have been irresponsible, it
has been primarily government intervention that has encouraged them to
be so. … Government has created these banking crises – by making it
nearly impossible to practice prudent banking. Having done so,
government has then pointed to bad banking practices as sufficient cause
for still further interventions in the industry.
• These words were written in 1991!
• They could have been written to describe the current crisis.
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The Global Financial Crisis
• Causes of the Global Financial Crisis
– Bubbles: Very unsatisfactory explanation.
– The Krugman Hypothesis: ‘Alan Greenspan needs to create a housing
bubble to replace the Nasdaq bubble.’
– Imbalances: It is true that there are various imbalances in the international
economy, many of these are due to various government interventions to
prevent prices from fully reflecting economic conditions.
– Financial Deregulation: The idea that the financial system is very
deregulated has taken hold. Financial deregulation is a mythical beast.
– Minsky moment:
– The Efficient Market Hypothesis: Very confused explanation.
– Greed: Trivially true, yet what is lacking is an explanation for the sudden
outbreak of greed. ‘Greed’ is a constant.
– Government intervention: A perverse incentives argument is likely to be
able to explain much of origins of the crisis.
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The Global Financial Crisis
• Inappropriate Monetary Policy
• Inappropriate Housing Policy
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The deterioration in lending standards
• In the 1970s US social justice activists alleged that banks and other financial
institutions were discriminating against minorities – usually African Americans
and Hispanics – in a practice known as ‘redlining’.
– The Home Mortgage Disclosure Act (HMDA) required banks and financial
institutions to collect and report data on their mortgage applicants.
– The Community Reinvestment Act (CRA) of 1977 required banks and
financial institutions to conduct business over the entire geographic region
where they operated.
• In 1992, the Boston Federal Reserve produced a working paper,
subsequently published in the prestigious peer-reviewed American Economic
Review that provided empirical evidence showing that banks were
discriminating against minorities.
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The deterioration in lending standards
• Banks were directed by government policy choice to make loans they
otherwise would not make and were able to on-sell the loans.
• This type of government action assumes that politicians and bureaucrats can
better understand and manage financial institutions than the management of
those organisations.
– It also makes the assumption that lenders dislike minorities more than they
like making profit.
– Financial markets have historically been very competitive so this form of
discrimination would be very unprofitable and would likely not survive long.
– Those individuals making the redlining argument have never explained
how and why it survives.
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The deterioration in lending standards
• It subsequently transpired that the data used in the 1992 Boston Fed paper
was deeply and fundamentally flawed.
• Unfortunately they never made their entire data set public. There was a
series of academic papers that criticised the Fed report.
– One 1994 study looked at a very small sub-sample of the data yet found
that more than half the observations contained serious errors.
– The definitive study the Boston Fed report was conducted by Theodore
Day and Stan Liebowitz and was published in the 1998 Economic Inquiry –
also a peer reviewed journal.
– That study found that after correcting the most severe data errors that no
evidence of racial discrimination could be found – banks and other
financial institutions had not engaged in redlining.
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The deterioration in lending standards
• The Boston Fed had published a document in 1993 entitled ‘Closing the gap:
A guide to equal opportunity lending’; it is still available on their website.
– ‘Even the most determined lending institution will have difficulty cultivating
business from minority customers if its underwriting standards contain
arbitrary or unreasonable measures of creditworthiness.’
– ‘Policies regarding applicants with no credit history or problem credit
history should be reviewed. Lack of credit history should not be seen as a
negative factor.’
• Stan Liebowitz
– Those “outdated” standards existed to limit defaults. But bank regulators
required the loosened underwriting standards, with approval by politicians
and the chattering class. … It also let community activists intervene at
yearly bank reviews, shaking the banks down for large pots of money.
Banks that got poor reviews were punished; some saw their merger plans
frustrated; others faced direct legal challenges by the Justice Department.
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Partial mea culpa
• Lawrence Lindsey, former member of the Federal Board of Governors
– The regulatory community was placed under intense political pressure to
come up with ways of providing access to credit for those populations, and
did so, most notably with new rules under the Community Reinvestment
Act. I was involved in that process and am proud of what was
accomplished. In fact, most of those individuals could be and did turn out
to be responsible borrowers and homeowners. But there can also be little
doubt that in hindsight the new regulations did contribute to some of the
excessive expansion in credit that has occurred. I note this mainly to
provide a cautionary tale. Even very well intentioned and largely
successful regulations can have unintended consequences.
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Round up the usual suspects
• Government Senators’ Minority Report (October 2009)
– From the middle of 2007, financial markets began showing signs of
considerable turmoil as the realities of trade in exotic financial
derivatives and the explosion in sub-prime lending that had
characterised the finance market boom became clear.
As subsequent events would reveal, inadequate regulation and greed on
the part of financial market players would set in train a sequence of events
in the United States, the United Kingdom and Europe that would culminate
in the collapse, nationalisation or government bailout of major banks,
insurers and credit providers. These included Citigroup, American
International Group, Northern Rock, Fannie Mae, Freddie Mac, Bank of
America, Goldman Sachs, Morgan Stanley, Royal Bank of Scotland,
Lloyds TSB, HBOS and a number of major continental European financial
institutions. The list of institutions involved reads like a veritable Who’s
Who of those who only months earlier would have considered themselves
“masters of the universe”. As we now know, these emperors had no
clothes.
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Round up the usual suspects
• Peter Wallison in a dissenting report to the US Financial Crisis Inquiry
Commission
– Like Congress and the Administration, the Commission’s majority erred in
assuming that it knew the causes of the financial crisis. Instead of pursuing
a thorough study, the Commission’s majority used its extensive statutory
investigative authority to seek only the facts that supported its initial
assumptions—that the crisis was caused by “deregulation” or lax
regulation, greed and recklessness on Wall Street, predatory lending in the
mortgage market, unregulated derivatives and a financial system addicted
to excessive risk-taking. The Commission did not seriously investigate any
other cause, and did not effectively connect the factors it investigated to
the financial crisis. The majority’s report covers in detail many elements of
the economy before the financial crisis that the authors did not like, but
generally failed to show how practices that had gone on for many years
suddenly caused a world-wide financial crisis. In the end, the majority’s
report turned out to be a just so story about the financial crisis, rather than
a report on what caused the financial crisis.
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Making excuses
• A minority report in the US Financial Crisis Inquiry Commission did argue that
contentious regulatory failures in the US could be justified.
• Regulator behaviour
– “The government should not have bailed out _____”.
– For a policymaker, the calculus is simple: if you bail out AIG and you’re
wrong, you will have wasted taxpayer money and provoked public
outrage. If you don’t bail out AIG and you’re wrong, the global financial
system collapses.
– Regulators follow a mini-max rule – they minimize their maximum
regret.
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Making excuses
– “Bernanke, Geithner, and Paulson should not have chosen to let Lehman
fail”.
– To make this case one must argue:
– Bernanke, Geithner, and Paulson had a legal and viable option
available to them other than Lehman filing bankruptcy.
– They knew they had this option, considered it, and rejected it.
– They were wrong to do so.
– They had a reason for choosing to allow Lehman to fail.
– These conditions were not met – unlike many of the other firms there
was no credible buyer for Lehman.
– It wasn’t just the failure of Lehman Brothers that intensified the crisis.
– In quick succession in September 2008, the failure, near-failure, or
restructuring of ten firms triggered a global financial panic.
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Sensible Commentary I
• Wall Street Journal Asia (November 2009)
– The idea that bankers caused the financial crisis is only credible with
politicians and unaccountable bureaucrats. It’s especially seductive in
the U.S., where Wall Street firms leveraged up to their necks and then
took taxpayer money when they were bailed out. But no such crisis
happened in Hong Kong, where banks more prudently managed their
balance sheets.
The idea, too, that a public-sector bureaucrat can better align banker
incentives than a competitive marketplace is laughable. In its draft
proposal the HKMA didn't define what “excessive risk” is because it
doesn’t know. Only a private-sector banker competing to hire talent away
from a rival can make that judgment.
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Sensible Commentary II
• Wall Street Journal Europe (November 2009)
– Whether banks benefit from the explicit guarantees of deposit insurance or
the implicit protection of being too-big-to-fail, or both, governments have a
right to demand that banks not ride free on the backs of taxpayers.
But whether it's less leverage, more capital, or restrictions on banking
activities, no one should be under any illusion that the same people who
failed to detect the last bubble and crash will be able to design a system
capable of catching the next one in time. The relative risks of being too lax
or too restrictive may be hard to gauge, but either way the odds of getting
it wrong are substantial if not overwhelming.
This is why putting the risk of failure back into the system should be the
sine qua non of any effort at reform. If regulators around the world get
nothing else right, the final backstop has to be bankruptcy and/or
dissolution for firms that have earned it.
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What do Banks do?
• The business of banking is well-described by Ludwig von Mises (1912, 1981)
– Banks borrow money in order to lend it; the difference between the rate
of interest that is paid to them and the rate that they pay, less their working
expenses, constitutes their profit on this kind of transaction.
– Imprudent granting of credit is bound to prove just as ruinous to a
bank as to any other merchant. That follows from the legal structure of
their business; there is no legal connection between their credit
transactions and their debit transactions, and their obligation to pay back
the money they have borrowed is not affected by the fate of their
investments; the obligation continues even if the investments prove dead
losses.
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The Logic of Stimulus
• David Gruen: Australian Business Economists Conference (December 2008).
– The first, and most obvious, benefit is that involuntary unemployment is
lower than it would otherwise be. …
– But there are further benefits to avoiding a recession that would need to be
taken into account in a realistic cost-benefit analysis of discretionary fiscal
stimulus. Recessions break productive links between firms, and between
firms and workers, when firms that would otherwise be viable over the
long-term are driven into bankruptcy by a recession. In other words, plenty
of the destruction that occurs in a recession is not creative destruction.
Finally, recessions do long-lasting damage, particularly to that cohort of
people entering the labour market at the time the recession hits. Thus, for
example, university graduates entering the labour market in a recession
suffer sizeable initial earnings losses, losses that persist for a period
estimated at between eight and fifteen years – that is, long after the
recession has ended (Oreopoulos et al., 2006, Kahn 2009).
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The Logic of Stimulus
• Robert Reich believes government spending is self-financing
– "The huge debts we're wracking up will cause your taxes to rise!" Wrong
again. When it comes to the national debt, as I've said before, the relevant
statistic is the ratio of debt to the gross domestic product. The only sure
way to bring that debt down and make it manageable in future years is to
get the economy growing again -- which requires that, in the short term,
the government spend a lot of money (because consumers and
businesses won't).
• Lateral Economics
– So for every dollar the government spent, tax revenue to Australia’s
governments rose by around 22.5 cents, leaving just 77.5 cents to be
repaid. The total windfall to the budget – and to the community – of the
additional tax revenue from the cash transfers is around $6.7 billion. This
money and the production of all those people and all that capital kept in
employment are the riches of good economic management – the only kind
of free lunch we know of.
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The logic of the stimulus
Suppose I walk up to you and forcibly take from your wallet $3636. That is
roughly about the amount of the Federal Government's combined stimulus
programs per head of population.
I immediately give you back $900 of this for you to spend on anything you
want - cigarettes, clothing, computer games, fridges, handbags, mobile
phones, tattoos, anything you care to buy. You could even deposit it straight
back into your own bank account.
I then spend $2227 of your money on things that take my fancy.
Some lobbyist told me that throwing some of the money I've taken from you
(let's call it what it is, a tax) towards housing insulation batts would somehow
save the Earth. Someone else whispered in my ear that spending a fraction of
the $2227 tax take on school gyms, at inflated rates, would help kids read,
write, add and subtract. In fact, so many people are lobbying me to spend
your money that I need more cash from elsewhere. I resolve this by
borrowing even more currency, on top of your taxes.
I forgot to mention at the outset that 14 cents out of every dollar I spend is on
my own administration costs.
Julie Novak - The Courier Mail 23rd September, 2009
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Stimulus Package I
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Stimulus Package II
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Other Spending
• December 2008: Nation Building Package $4.7 billion
• May 2009: Nation Building Infrastructure $22.5 billion
• Total: $79.1 billion
– Stimulus I: $10.4 billion
– Stimulus II: $41.5 billion
– Nation Building: $4.7 billion
– Budget: $22.5 billion
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What I said in February 2009
In summary, it is my view that the Senate should reject the fiscal stimulus
package in its current format.
– The package contains a lot of spending and little actual stimulus.
– The proposed spending is poor quality expenditure of Federal funding.
– Discretionary fiscal policy has a poor track record of success.
– While the government needs to respond to the current economic down
turn in a timely manner, there is no immediate urgent need to rush the
package. Rather a better quality package should be designed and
implemented.
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What I said in February 2009
• Government policy should establish conditions whereby living standards can
improve.
• Fiscal policy should be prudent and conservative. That implies balanced
budgets, and low taxes.
• Public debt should be used sparingly, if at all.
• Government should target Ken Henry’s 3Ps when making policy.
Participation, Productivity and Population.
• Government should also consider Glenn Stevens advice – a good project last
year is probably still a good project, whereas a bad project last year remains
a bad project now. ‘Shovel ready’ is not now, nor has it ever been, an
appropriate criteria for public spending.
• To the extent that the federal government wishes to pursue an activist fiscal
policy it should target tax cuts. In particular, the federal government should
consider payroll tax relief and a GST holiday.
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What I said in February 2009
Objections to the Proposed Policy
• Spending multipliers are low.
– “The classic argument for fiscal stimulus presumes that the central cause
of our current economic problems is this: We, the people and our
government, are not doing nearly enough borrowing and spending on
consumer goods. The government must step in force us all to borrow and
spend more. This diagnosis is tragically comic once said aloud.” John
Cochrane
– “It is easy to ‘Australianise’ this comment, ‘Australians have not been
borrowing and spending enough on alcohol, pokies and tobacco and there
are not nearly enough plasma televisions around. The government should
borrow and spend more to ensure that more consumer spending occurs’. I
invite Senators to read that statement out loud and wonder whether it
sounds plausible or responsible.”
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What I said in February 2009
• When stimuli do work
– Kevin M Murphy - Stimuli are likely to work when the economic value of
the output from the stimulus is greater than the costs of the inputs and
deadweight losses.
– The economic returns of federal investment in school halls etc. are likely to
be low.
– This makes very little, if any, contribution to productivity, participation or
population.
– This is primarily expenditure that should occur at the local level. This
expenditure rewards State and Territory governments for past neglect
of school infrastructure needs and re-enforces perverse incentives.
– It is possible that a properly designed scheme could see federal
funding that augments local community and State funding, but this
should not be primarily funded at federal level.
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What I said in February 2009
– The economic returns of home insulation are likely to be low.
– Are there really under-utilised resources in the home insulation sector?
– Are the skills developed in this sector generic or specific? What will
happen to workers after all homes have been insulated?
– How will this policy interact with the Climate Change Policy?
– To the extent that this policy is useful and valuable, an open
question, it is better that it be considered as part of the Climate
Change policy.
– The economic returns to a $950 hand-out based on having been a
taxpayer in 2007-08 likely to be low.
– This is a retrospective tax refund that cannot lead people to change
their behaviour – i.e. it has no incentive effects.
– Consequently, this money has no impact on productivity, participation
or population.
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What I said in February 2009
• While the economic benefits of the Fiscal Package are low, the costs are
likely to be high.
– The project choices are rushed and more likely to be less efficient.
– The objective to spend more money faster is likely to lead to poor project
choice.
– Public sector spending tends to be less efficient than private spending
anyway.
• The Fiscal Stimulus is funded by public debt.
– Public debt is associated with intergenerational burdens.
– Public debt has a history of rising very rapidly to high levels.
– Public debt is associated with irresponsible fiscal behaviour.
– Public debt implies that future taxes will be higher than they otherwise
would have been.
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What I said in February 2009
• The government is not doing nothing! (sorry about the double negative).
– RBA, an operationally independent arm of government, has lowered rates
by 4 per cent over six months.
– The ‘automatic stabilisers’ are operating to put money into the economy
already.
• Spending versus saving is a false dichotomy.
• Keynesian strategies are less likely to work in small, open economies.
• Economists tend to over-estimate the benefits of fiscal policy.
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Did the Stimulus work? Australian evidence
Figure Eleven: Household Income and Household Expenditure
200,000
$million
180,000
160,000
Gross Disposable Household Income (sa)
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
140,000
Household Final Consumption Expenditure (sa)
Source: ABS cat. 5206.0
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US Experience
•
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Source: John B Taylor (2010)
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Did the Rudd Stimulus Packages work?
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Did the Rudd Stimulus Packages work?
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Have the Rudd Stimulus Packages worked?
• No.
• If our package worked, why did everyone else fail?
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Did the Rudd Stimulus Packages work?
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Was it ever going to work?
• No.
• Australia is a small open economy.
•
http://www.cepr.org/pubs/PolicyInsights/PolicyInsight39.pdf
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Was it ever going to work?
• No.
• Australia has a floating exchange rate.
•
http://www.cepr.org/pubs/PolicyInsights/PolicyInsight39.pdf
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Waste of Money
• Source: The Cairns Post
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Waste of Money
• Gary Banks ‘said that poorly conceived or executed infrastructure projects
imposed a double burden on the economy, “with future generations having to
service higher debts from incomes that are lower than they would otherwise
be”.’ The Australian (November 6)
• ‘A plumber friend of mine has recently tendered for a number of jobs created
via the government school hall scheme. Despite having quoted 3 times his
normal price he has won 85 percent of the tenders. However, in each of these
tenders he has not included the cost of plumbing required to get to the actual
hall. So once his job is complete no water will be able to travel to or from the
building unless they engage him to do more work. He believes this will add an
additional cost of 100 %.’ email communication
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Waste of Money
• ‘When the school guttering needed replacing, with about 60m of gutter, Mr
Mayne obtained a quote from an independent builder for about $1800
including materials. The bill the school received from the department for the
work is $11,000 plus materials. When Mr Mayne queried the disparity in
costs, he was told he didn't understand that's the way the system works and it
couldn't be changed.’ The Australian (June 16)
• ‘AN undercover playground with concrete floors and no doors costs
$1.8 million under the Rudd Government's schools stimulus funding,
the State Opposition says.
And it says that's just one example of how schools are being ripped off.
Other documents obtained by The Courier-Mail showed Mulgildie State
School west of Bundaberg received $250,000 to build a basic 60sq m shed,
after receiving a $29,000 quote from a local shed builder for a similar
structure.’ Courier-Mail (June 16)
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Waste of Money
• ‘EIGHT tiny schools have been handed $400,000 in taxpayer funds for new
fencing, spruced-up classrooms and playground upgrades this year - even
though the Queensland government has shortlisted them for closure’. The
Australian (August 3)
• ‘The decision to rob high schools of science labs and language centres to
help pay for the blowout in the cost of sheds in primary schools has left high
school principals furious, and betrayed the Prime Minister's stated priorities of
improving science and language education.
The only program in the $16billion Building the Education Revolution to have
real educational merit was the smallest, the $1bn - reduced last week to
$800million - to build sciences and language centres in high schools.
The remaining $15bn was handed to schools regardless of their existing
facilities, their community's resources, or whether they even needed a hall or
library.’ The Australian (September 2)
• ‘AN outback school with one student is among nine tiny schools handed
$2.25 million in federal grants to build new halls, libraries and classrooms,
even though they face closure.’ The Australian (September 3)
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Loss of Life and Property Damage
• ‘THE electrocution of a second Queenslander has cast further doubt over the
adequacy of training for workers fitting insulation under the Federal
Government's controversial rebate scheme.
The 16-year-old youth was electrocuted in a home near Stanwell, southwest
of Rockhampton, while installing batts.’ Courier Mail (November 18)
• ‘Mr Wilson was the third insulation installer to die as operators rush to cash in
on the Federal Government's rebate scheme.’ Daily Telegraph (November
25)
• ‘DOZENS of NSW homes have been destroyed or damaged by fires which
erupted when badly installed ceiling insulation came into contact with
downlights.’ Daily Telegraph (September 21)
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What was promised in the US
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US Experience
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Saved or Spent?
• Treasury relied on a paper by Christian Broda and Jonathan Parker to argue
that the stimulus would be spent, not saved.
– US$950 handout
– Consumption higher is households that had received the handout
– Did not test how much was spent
• David Johnson, Jonathan Parker, and Nicholas Souleles. 2006
– 2001 rebate: 2/3 spent over six months
• Sumit Agarwal, Chunlin Liu, and Nicholas Souleles, 2007
– 40 spent spent over six months
• Andrew Leigh – Survey data indicates that Australians spent the money twice
as fast as US consumers spent 2001 tax rebate
• David Gruen – Treasury estimate – 2/3 spent in six months (T&U 208)
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Saved or Spent?
• Broda and Parker (2012) argue that households increased their spending by
ten per cent in the week the cash handout arrived – while that sounds quite
large, the US dollar amount was just $14 in that week.
• Over the next seven weeks US consumers in receipt of the cash handout
spent an addition US$30 – US$50.
• Aisbett, Brueckner, Steinhauser, and Wilcox (2012)
– Australian replication of Broda and Parker.
– households' consumption of non-durables did not react significantly during
or after the one-time, preannounced transfer.
– the average household, which received a payment of $900, spent in the
week upon receipt of the payment an additional $1 on non-durables.
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Saved or Spent?
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Saved or Spent?
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Thoughts on Ricardian Equivalence etc.
• Barro-Ricardo view: Deficits don’t matter because individuals save in order to
pay future taxes.
– Large literature – does not hold perfectly.
– Does this mean that deficit spending can stimulate economy?
• Buchanan view: Deficits matter because Ricardian equivalence fails to hold.
– Some people do not save to offset government dissaving.
– Excess consumption occurs and crowds out private investment.
– Future generations inherit a small capital base.
– Deficits expropriate wealth from future generations.
• Just because Ricardian equivalence doesn’t hold doesn’t mean that stimulus
can work.
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Was it worth it?
But it is hard to resist the conclusion that the government spent more than
was needed, no matter how reasonable its actions appeared at the time. The
stimulus spending was designed for an economy that was expected to be
shrinking at a rate of 1 per cent, not one that was growing at a pretty normal
rate of 2.7 percent, which is what happened in 2009.
The government and Treasury had expected collapsing businesses to drag
the economy into a long recession, but instead the shock caused by the
collapse in world trade and the panic in financial markets passed after a few
month, leaving the corporate sector largely intact. The government was left
completing large stimulus projects that were no longer really needed.
…
It is the opportunity cost – the things that cannot be accomplished by either
this government or the next – that weighs heaviest as a result of the
government’s spending more than was needed. Had the economy behaved
anything like Treasury’s forecasts for it, no-one would have begrudged the
money spent. But now $75 billion has gone, with a negligible addition to
Australia’s productive capacity. The debt must be serviced and in due course
paid back. In the context of a $1 trillion economy, it is not a crippling burden,
but there is depressingly little to show for it.
Taylor and Uren (2010)
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Conclusions
• Vulgar Keynesianism failed. Again.
– This theory has been tried again and again and always fails.
• Government spending needs to be restrained.
• Economists have known this for a long time.
• Adam Smith
– Great nations are never impoverished by private, though they sometimes
are by publick prodigality and misconduct.
– It is the highest impertinence and presumption, therefore, in kings and
ministers, to pretend to watch over the œconomy of private people….
They are themselves always, and without any exception, the greatest
spendthrifts in the society. Let them look well after their own expence, and
they may safely trust private people with theirs. If their own extravagance
does not ruin the state, that of their subjects never will.
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