Tuesday, August 31, 2010

"Proof" that the "Stimulus" Worked?

In an August 27 post, Paul Krugman shows a graph that supposedly is "proof" that the "Stimulus" actually worked, but also constitutes "proof" that the "Stimulus" was "not big enough." Krugman's post hoc ergo propter hoc world, of course, is full of this stuff, but I believe it will do us well to take a brief look.

The post deals with the following two graphs, the first being Mark Zandi's prediction and the second being the actual GDP numbers (or at least what the government says are the GDP numbers). First, the Zandi graph:


Now, for the post-stimulus graph:



The graphs are what they are. However, Krugman's comment about them is most illuminating:
It’s not a perfect correspondence, nor would you expect one — other factors, especially inventory swings, were bound to make the timing of actual growth different from that of stimulus. Still, the two pictures support the view that stimulus worked as long as it lasted, boosting the economy — which is the same conclusion Adam Posen drew from Japan’s experience in the 1990s (pdf): Fiscal policy works when it is tried. (Emphasis mine)

But the stimulus wasn’t nearly big enough to restore full employment — as I warned from the beginning. And it was set up to fade out in the second half of 2010.
Most important, a new injection of money into a moribund economy (especially if it is an early injection) ALWAYS will bring about more economic activity. In his classic "Fiat Money Inflation in France," Andrew Dickson White points out that during the French Revolution, the first round distribution of Assignats brought new life to the French economy, a "stimulus," if you will.

However, with further injections, the economy responded less and less to the new money and new spending until finally all that was left was the inflation. In this case, I am not surprised at the numbers, but one has to remember that the stimulus was about SPENDING and nothing else. The new money for projects ended up in the hands of people who spent it, clearing existing inventories and the like.

What Krugman wants us to believe is that had there been more money made available through "fiscal" policies (more borrowing by the government), somehow that extra money would have given the economy "traction," which then would have allowed it to move along on its own. There is no real causality as to WHY this would happen; he just wants us to believe that this is what would have occurred.

Actually, what would have happened would have been bigger numbers (as Krugman claims) at the beginning, and then a steeper fall, as there would have been nothing to have SUSTAINED that earlier activity. In the Keynesian paradigm, the economy is a homogeneous mass driven only by spending; Austrians understand that there has to be long-term capital investment that can be sustained by economic activity, and that makes all of the difference.

10 comments:

Anonymous said...

However, with further injections, the economy responded less and less to the new money and new spending until finally all that was left was the inflation.

Yes, on the back end of the curve (on the decline), it takes more and more inputs to achieve the same result, and eventually, no amount of stimulus can achieve anything. Please see the two late July interviews with James Rickards on King World News.

AP Lerner said...

“I am not surprised at the numbers, but one has to remember that the stimulus was about SPENDING and nothing else”

Talk about rewriting history. Please go back and check the facts. 40% of the stimulus was in tax cuts, not spending. And you call Krugman dishonest?

“What Krugman wants us to believe is that had there been more money made available through "fiscal" policies (more borrowing by the government), somehow that extra money would have given the economy "traction," “

Of course, a government like the US does not borrow. Debt issuance is just a monetary operation. I’ll let a real economist that actually understands monetary operations and what deficits really mean explain.

http://bilbo.economicoutlook.net/blog/?p=332

and of course, “more money made available through "fiscal" policies” does increase the surpluses of the private sector. This is accounting 101. Could you please point me in the direction of some research that debunks this accounting identity since you so often chose to ignore it?

http://images.creditwritedowns.com/wp-content/uploads/2010/07/Pimcos_double_entry_bookkeeping.gif

Maybe you could try authoring a post that explains this chart? This time, do not enlist the help of Guido Hulsmann because his response on why bond rates are falling (and even lower from the time he attempted to respond) was embarrassing.

http://krugman-in-wonderland.blogspot.com/2010/06/commentary-on-current-bond-rates.html

“Actually, what would have happened would have been bigger numbers (as Krugman claims) at the beginning, and then a steeper fall,”

This is of course nonsense. If the stimulus has been bigger and better targeted towards the indebted private sector as opposed to encouraging more private sector debt by offering silly cash for clunkers and first home buyer tax credits, then this chart would have improved.

http://static.seekingalpha.com/uploads/2009/12/3/saupload_debttoincome.jpg

And once this chart normalizes, a real recovery can begin.

“Austrians understand that there has to be long-term capital investment that can be sustained by economic activity”

Too bad they do not understand how that long term capital investment gets funded. Fortunately, MMT’ers do.

bill said...

"...then this chart would have improved... And once this chart normalizes, a real recovery can begin."

So basically the prerequisite for economic recovery is, uh, an improved chart? Uh, Okay...

Anonymous said...

AP Lerner:

Now that you've given me an entirely different way of looking at public debt (and thank you), do you have sources that tell you optimal ways to manage the level of public debt/private savings, hopefully with some historical back testing?

I have ordered but not yet received Wray's Understanding Modern Money.

Thanks ...

(apologize for the fat fingered cross post on the wrong thread)

AP Lerner said...

I would start with some of Abba Lerner’s work, like Functional Finance and the Federal Debt, or Economics of Unemployment. Lerner’s work is kind of like the foundation for MMT.

Monetary Economics by Godley is good. I would also suggest The State, the Market and the Euro by Bell and Nell. This essay is by Bell is may be helpful.

http://129.3.20.41/eps/mac/papers/9808/9808008.pdf

not sure any of these get to your specific question on public debt and private savings, since the optimal level is ultimately determined by the demands of the private sector, but many of these essays/books focus on the relationship between private and public sector balances.

I would check out William Mitchells blog as well. Lengthy essays, but he shreds the neo liberals and Austrians (including Krugman – except without the childish remarks and distortions) on a daily basis.

http://bilbo.economicoutlook.net/blog/

Thanks for the post!

Joe the Plummer said...

"In the Keynesian paradigm, the economy is a homogeneous mass driven only by spending;"

Keynes does not believe this. An increase in aggregate demand is something only necessary in very specific circumstances (I can't drive this point into your head enough) of depression to avoid the effects of "secondary deflation" that Hayek warned about.

Providing employment through public works is something even Mr Hayek though was appropriate in very specific circumstances. (gotta hammer this into you)

"[B]ut that one measure to offset secondary depression [deflation] would be to provide ‘employment through public works at relatively low wages so that workers will wish to move as soon as they can to other and better paid occupations."
-Hayek

Here's a couple of notable quotes from Keynes you might find interesting seeing how you keep on repeating the same strawmen over and over ago.

"One has to be constantly on guard against treating the material as constant and homogeneous. It is as though the fall of the apple to the ground depended on the apple’s motives, on whether it is worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on the mistaken calculations on the part of the apple as to how far it was from the center of the earth.”

"The object of our analysis is, not to provide a machine, or method of blind manipulation, which will furnish an infallible answer, but to provide ourselves with an organized and orderly method of thinking about particular problems; and, after we have reached a provisional conclusion by isolating the complicating factors one by one, we then have to go back on ourselves and allow, as well as we can, for the probable interactions of the factors themselves. This is the nature of economic thinking"

Anonymous said...

Those of you refuting the argument of this post are wrong and it can be explained very simply. The only economic policy to a sustainable, productive economy is to let individuals come together and trade voluntarily w/o gov spending, here's why. Peter knows what he wants, eggs, so Paul supplies eggs. They trade money for eggs and both are better off. Now the gov comes and takes Peter's money and borrows money from Japan to spend it on soy b/c nobody's buying soy and the gov wants to help the soy farmers. Peter doesn't want soy he wants eggs but now he doesn't have enough money to buy as many eggs as he wants, so he's worse off. Paul loses money since fewer eggs are being bought and has to layoff workers. The soy farmers are doing good though and the soy employees keep their jobs and will continue to do well as long as the gov continues to take money from Peter and borrow it from Japan. At some point though Japan will stop loaning the gov money so the only way for them to continue to pay soy farmers to farm soy that nobody wants is to raise taxes ( print money ) until Peter no longer has enough money for any eggs or milk, but the soy farmers are doing well. Now the milk producers have to layoff workers too, but the soy workers are happy to be producing a product nobody wants. This will continue until the economy is in ruin. If the gov were to ever stop this ridiculous policy then Peter would buy eggs and milk again, the soy farmers resrouces would be rightly reallocated to more productive means and productivity would increase.

Anonymous said...

...cont the soy farmer wouldn't have been in trouble if people wanted to buy what he was selling. The fact that the gov comes in and taxes, and borrows and prints and forces people to pay for something they don't want solves nothing. As soon as the gov stops doing that they will go back to buying what they want because only they know what that is, the gov does not. That is econ 101.

Anonymous said...

For MMT fallacies, see:

http://www.zerohedge.com/article/guest-post-termite-riddled-house-treasury-bonds

burkll13 said...

"If people no longer trust dollars as a medium of exchange and Treasuries as stores of value, where will they go? They will leave both and go to something else—commodities (remember i have provided a real world example of people doing this in Iraq), as I have argued. And when that day comes, people will do anything to get out of the dollar and Treasuries, and into something that is stable in terms of value storage and medium of exchange.

MMT doesn’t see this—it just sees spread-sheets and board-games. This story here, which giddily, girlishly describes Federal Reserve drones “printing money”—and how wonderful and magical that process is—is pretty indicative of the fundamental detachment from reality of this world-view.

It’s why MMT fails at describing both reality, and predicting the future."

nice link 6:51 anon.