Source
r/NeutralPolitics•
circularfish

Does Keynesian Stimulus Actually Work

Ok, NeutralPolitics, if there was ever a topic that is at once (a) timely, (b) controversial, and (c) at least in theory, subject to empirical input, this is it.

The basic idea beyind Keynesian pump priming is simple - government stimulus is supposed to boost aggregate consumption in certain recessionary situations as a function of Keynesian multiplier which is, in turn, a declining function of a marginal propensity to save as expenditures are cycled.

Others are not so convinced this actually works. Or, for the more easily entertained: this.

This is probably the single most controversial theoretical issue in politics today, underlying a whole host of other policy arguments. To be honest, most of the economists I know believe that stimulus spending is - tautologically - stimulative. But, they might be wrong, and what I know/believe is irrelevant.

So, how about it? I have an undergraduate degree in economics, but am basically a finance/law type guy and would consider it pure bliss to see knowledgeable people discuss this in a calm fashion, preferably with citations to peer-reviewed papers so that we can follow along.

Are we up to it?

Edit: typos, clarity. Edit#2: made sure to remove appeal to authority.

Posted Feb 17, 2012, 2:34 PM UTC · edited

5299
staythepathMODI might be wrong.•

Now, as a moderator I'd like to say this is one type of posts we are looking for. The only thing that could make it better would be to add a suggestion to refer to the sources in the wiki article if the wiki is not deemed sufficient for someone. If your "appeal to authority" was a request for specific moderation, PM me and I'll see if it's something I can help with, no promises though. Well done!

27
GRANITO•

Currently doing a masters in econ. From what I learned in my american ecnomic history class, it works, but not how politicians want to make you think it works. Most "stimulus" spending comes in too late to have a real impact because by the time it gets passed it's not really needed any more. The most effective boosts are automatic stabilizers like unemployment insurance because they start to kick in right as things start to get bad. The book is http://www.amazon.com/New-Economic-View-American-History/dp/0393963152/ref=sr_1_6?s=books&ie=UTF8&qid=1329504971&sr=1-6. I don't know if it was exactly the book or my professor that talked about it. But yea, "stimulus spending" isn't really necessary, they just need to quit gutting programs that help the unemployed.

26
rjhelms•

Wouldn't that still mean that there's some benefit to stimulus spending, in the case of a long recession?

It makes sense that the lags make stimulus spending ineffective at preventing a downturn, as by the time it made any difference it would be far too late, but to me that doesn't necessarily mean it's useless, so long as it's effects are seen before the return to long-term GDP trends.

11
GRANITO•

True but then it also becomes a question of how big the stimulus should be and what to stimulate. Those sorts of automatic stabilizers help right as it becomes needed and right at the sector that needs it. I'm hoping eventually they'll start linking unemployment and education assistance so people can wait out the downturn learning new skills ready to take advantage of the new upturn.

Most recessions last 1-3 years so by the time the political will is wrangled most of the bad stuff has already gone by. For this downturn and for the great depression it probably makes sense to go on a big infrastructure building or rebuilding thing but it becomes very political what it's spent on (the book also had a thing showing how congressmen used stimulus funds for their constituencies).

12
James_GAF•

I'm hoping eventually they'll start linking unemployment and education assistance so people can wait out the downturn learning new skills ready to take advantage of the new upturn.

Absolutely agree with you on that one.

I've had this idea floating in my head for some time it may be useful to actually put those drawing unemployment to work in some way. Perhaps as labor in local public works projects. Though, I'd really like to see private sector temp to hire transitional training programs where unemployment insurance helps span the skills gap of training costs. That way a business is helped filling a hole, the worker gains new skills and the employment gap is hopefully much less significant to long term employment prospects.

3
twinarteriesflow•

Now what if the stimulus is something large yet related to a specific measure? Meaning that, would it be possible to create a stimulus bill that puts unemployed workers into agriculture, so that they have an income while still providing for the overall economy? Because I can't see how Congressional delay could really alter the effect of such a hypothetucal stimulus.

1
GRANITO•

It gets super hard picking the "right" thing to put money into (example: http://en.wikipedia.org/wiki/Solyndra). I guess general infrastructure projects could be good (roads, internet access, etc) since large portions of the economy would use them but it'd have to be a major recession like what we have now.

5
aqaspecification•

Just to point out this is quite a controversial viewpoint, I'm studying economics at Oxford uni and I have yet to meet a lecturer who doesn't openly support stimulus spending of some kind in the right circumstances (i.e. a long protracted recession like the previous one), and a lot of these guys are leaders in their field.

2
GRANITO•

This is true, I think I may have been too blunt in my phrasing. I'm not necessarily against government stimulus, but because of the political process it usually becomes a political calculation rather than an economic one. Usually the details of the right circumstances get fought over until the opportune time has passed or to the point that the stimulus is too small (like TARP).

2
FuggleyBrew•

But yea, "stimulus spending" isn't really necessary, they just need to quit gutting programs that help the unemployed.

In a regular recession you're absolutely correct, automatic stabilizers and an expansionary monetary policy are of the most responsive and effective measures.

However, automatic stabilizers on their own cannot end a recession, merely slow down its impact. AD will still decrease even in the presence of strong stabilizers (e.g. unemployment insurance will always be a fraction of employment)

In a severe recession, akin to the American Depression, or our current mess, the hit to AD is already severe enough that we cannot expect the free market to recover on its own, and simultaneously they are severe enough that monetary policy reaches the limit of its efficacy.

At this point we need stimulus spending, and I think the idea that projects necessarily need to be shovel ready is a misconception. We've been a recession now for roughly four years, and we are likely to be in a recession for another two or three years at the very least. Had we implemented a major infrastructure project back in 2008/2009 we could have been breaking ground on it by now and it could actually be driving employment down at this point.

2
GRANITO•

I agree that had they started making plans 08/09 we'd have solid projects going now that would stimulate the economy. The downside is that we did not know how long or how deep this was going to get at the time (McCain: The fundamentals are still solid). Had it turned out to be another 1-2 year recession then the money would have been "wasted." I put it in quotation marks because the US does still need an infrastructure overhaul so it wouldn't be wasted in that sense but the opportunity cost of the money spent on it that could be spent on something else.

3
FuggleyBrew•

I think it was mostly naive optimism that this recession was going to be short lived. Basically we were looking at a banking system which couldn't determine good debt from bad, this tends to result in a long recession, Japan suffered largely through this scenario and it was hardly quick.

Many people assailed the stimulus from the start for being too timid and too watered down, not only was it not particularly large, it completely shied away from any major investments, preferring instead to focus the majority of money towards tax cuts and towards investments which did not have very large multipliers.

The issue was fundamentally that Obama felt he couldn't pound the table on the stimulus because he wanted to save that for later, as a result he gave in to special interest groups on both sides. For example, the National Organization of Women lobbied quite hard against spending money on construction, arguing it should go towards healthcare and education, despite the fact that neither were suffering the impacts of the recession at the time. Obama reasoned that he could appease these groups and the republicans, and that as a result when it came to healthcare he'd be able use his political capital at that point, to focus exclusively on healthcare.

This isn't a case of Obama not having the political power, at the time the stimulus was written the facts and the public were on his side. Obama made a political calculation and chose not to support the stimulus he campaigned for, his decision turned out to be an unmitigated failure. Had he gone the other way things would have been far better, in fact it would have been better even for Obama's other policy initiatives because he wouldn't have been so vulnerable on the economy.

2
GRANITO•

Actually, I feel this is a good example of why I don't like it when politicians talk about a "stimulus." It's always a political subject and not an economic subject so the "stimulus" goes towards fulfilling their political objectives rather than economic objectives. Another example is Bush's tax cuts that were meant to stimulate the economy but mostly just gave rich people a lot of money. Obama used it to further clean energy and infrastructure (great goals) but he did it for political rather than economic reasons so his stimulus was smaller than what was needed.

The big problem (I feel) with whether to use stimulus or not is pro-cyclical vs counter-cyclical government activity. If government spends money when we are out of a recession it's a pro-cyclical move that can affect its ability to act during a downturn (for example the Bush tax cuts adding to the debt which made spending during this downturn much harder). Since political will seems to be pro-cyclical (we're good? spend like there's no tomorrow. We're bad? Sorry guys, no unemployment insurance for you) my feeling is that we should stop letting them get away with it and instead focus on those kinds of automatic stabilizers that don't require a vote like unemployment services. If I could count on politicians to make sound economic decisions I would not be against stimulus packages in general but unfortunately high level economics classes are not required to become a congressperson ;_;.

1
Sharlach•

That depends a lot on how you define success, but I would argue that it does work. Putting unemployed people to work most certainly does boost aggregate demand, and it's impossible to argue otherwise. That said, I feel that the real issue is the kind of work these newly hired workers will be doing. Are they producing something tangible or simply wasting resources by pushing around paper in a govt office? A stimulus package that (re)builds infrastructure, subsidizes workers at privately owned factories, or produces new research will be far more effective in the long run than most other types of work.

Addendum: Stimulus works for the same reasons investing works. The role of stimulus should be that of an investment, by the govt, in industries and areas that benefit society but would be left undeveloped by private interests. And of course the best time to make these investments is during a recession, so as to flatten out the business cycle.

18
Elephantom_Fanon•

There is certainly real work available to the unemployed if we are ambitious enough as a nation.

  • I'm talking about vanguard design/architecture development in the many miles of arid dessert within the Tex-Mex states

  • Repairing and Reforming antiquated schools in low-income neighborhoods (like the one I live in in North Philadelphia)

  • A resurgence of novel American Industry (this would probably take legislative coercion given the farce of a national debate we have about bringing industry back to America)

  • R&D for sustainable design like the Scandinavian countries are doing.

  • Prepping and Maintaining massive Mono-crop fields of hemp for various industries from textiles and hemp plastic composite to biofuels and animal feed

The list can go on, but the point being, there is definitely the potential for meaningful Keynsian stimulus in our current economy if we're ambitious enough.

13
craneomotor•

•A resurgence of novel American Industry (this would probably take legislative coercion given the farce of a national debate we have about bringing industry back to America)

Legislative coercion and then some. People always talk about the flight of American industry as if it was a choice someone made, as if there were not overwhelmingly powerful economic forces at work that are more akin to natural law than policies that we have any control over.

5
Elephantom_Fanon•

It wasn't a choice someone made, it was a paradigm designed by many mutual beneficiaries of skewed globalized trade agreements. It came about through the domination of third world policy through subversive methods while expanding models of industry based on exporting costs and internalizing revenue by any means necessary.

7
JB_UK•

What's the alternative? Slap tarriffs on the import of products? You can bet any such move would lead to retaliation, which would lock any country that attempted it out of markets elsewhere, while leaving that country's consumers with inferior goods.

3
twinarteriesflow•

So essentially, applying Keynesian economics can work in our current economy if it's applied to agriculture and infrastructure development? Or am I missing something about your post?

2
Elephantom_Fanon•

Essentially, my hypothesis is that maybe if we were to apply basic Keynesian principles of surgical gov't spending and subsidization with a balanced interest in innovation, pragmatic industries, agricultural integrity, societal welfare, and civil rights(education, freedom of information, freedom to explore within the bounds of altruism, etc) The economy would play a supporting role in our cultural growth as opposed to the current state of affairs in which our economy limits the capacity of cultural progress.

Maybe projects like the James Webb Telescope or advanced robotics, bioengineering and nano tech could be explored without being compromised by political and economic tension.

7
Sizergh•

This. Governments purpose should be to maintain zero unemployment, not for the sake of do gooding to unemployed people, but for advantage of everyone in getting new technologies via R&D, and improving infrastructure. As private employment rises government employment should be free to fall, depending exclusively on private business when it is in recession (has made a mistake) prolongs the recession punishing those within private business who have not made a mistake.

2
nosecohnPartially impartial•

I appreciate your perspective and partly agree, but I take issue with this one statement:

Putting unemployed people to work most certainly does boost aggregate demand, and it's impossible to argue otherwise.

It's impossible to argue otherwise? I could quite easily argue otherwise. My argument might be wrong, but making that argument is well within the realm of possibility. Here's an example...

If the government employs people, it has to pay for that employment through increased taxes (by either transferring the revenue directly to the new workforce, or more likely, borrowing the funds and taxing to pay the interest). The taxpayers then have reduced buying power and the newly employed, having been out of work for a while and needing to get back on their feet, cannot replace that buying power quickly. Therefore, in the short term, you have not boosted aggregate demand.

Now, as I've said, I could be completely wrong here, but I have proven that it is possible to argue otherwise.

I'll admit that, on the surface, this point seems semantic. But I think it's important to bring up because this subreddit is in its infancy and is trying to set a particularly neutral tone. Using verbage that implies whoever disagrees with your assertion is wrong does not mesh with that tone. Sorry for making you an example, but I thought it needed to be said.

3
tlydon007•

And of course the best time to make these investments is during a recession, so as to flatten out the business cycle.

I'd like to add that I think it's also the best time because we get the infrastructure at a discount. It would seem to me that building(or rebuilding) necessary infrastructure while the private sector is booming would cost much more.

1
[deleted]•

That said, I feel that the real issue is the kind of work these newly hired workers will be doing.

The most important aspect of putting unemployed people to work, is to maintain them in working condition trough the bad times. Workers who are unemployed for long time, don't just bounce back when times get better. Their families have broken, their kids did not get into college, they may have been sick without insurance, etc. Unemployment destroys more than it builds motivation.

When you account the effect of stimulus, you should count in the future earning capacity (that can be 10-40 years long) that those people have as taxpayers and GDP contributors in the future with and without stimulus. Then you should account in the effect the stimulus had to the future earning capacity of their children and spouse.

Stimulus works for the same reasons investing works.

This investment should be also seen as investment for the human resource. If you have expensive machine that you must start every morning to keep it going for 20-50 years, you will invest money to keep it in working condition trough the years there is not enough demand. If you can find something useful to make, even better.

1
Swederman•

When Keynes brought it up I think it was efficient, I'm far from being an expert but I've never heard critics of the New Deal.

One of the problem is it isn't really relevant as an economic policy anymore, because the objective if the stimulus is to create national growth, but nowadays with the globalization the investment is dilluted through the world.

So the stimulus might work, but will profit for other countries more than the origin country itself

11
AwesomeTed•

It's funny you bring that up, because it reminds me of the debate around the supply-side "trickle down" theory, and how many of its detractors (Keynsian champions) say that ever since we adopted the trickle down model, the middle class has been getting progressively worse. And while the argument can easily be made that the middle-class no longer is what it used to be, it's not necessarily because "nothing trickled down" so much as "it trickled down to the wrong place". China and India have seen rapid growth, as our middle class has declined. And all the wealth concentrated at the top being trickled down outside the country thanks to globalization would certainly help explain the unprecedented growing income gap.

IANAE, but I personally prefer the Keynsian demand-side model just because, to me, it just logically makes more sense. A strong middle class has jobs, buys goods, businesses need to produce more to meet demand, hires people, and so on and so forth. Plus that whole New Deal thing did work out pretty nicely. Of course, none of this works without raising taxes to offset the deficits caused by the stimulus, which essentially means in today's political climate it won't happen.

5
dkey1983•

But you're missing the real model - a model that views supply & demand as equally important. That is what Austrian economics is about.

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twinarteriesflow•

Could you please go into more detail? I'm curious as to how the Austrians apply this model compared to the US

5
dkey1983•

It's such a broad topic, but basically Austrian economics believes in no government interference in the economy at all - including controlling the value of the currency. In an Austrian economic model, currency is just another commodity. Its value, along with every other commodity is based solely off of supply & demand. In a Keynesian model, currency is fully set and controlled by the government via the printing of money and manipulation of interest rates. Think about what manipulating the value of a currency actually does - government literally interferes with half of every single transaction that occurs. It completely distorts the market. With that being the case, the Keynesian system never allows for supply & demand to fully take effect...in other words, the value of goods are never reflected accurately and it leads to disaster after disaster as resources are not allocated properly.

edit: I should put in here that I don't claim to be an expert. There is so much I do not know.

5
johneeleemiller•

I often wonder why people debate Keynes vs. Hayek.

Keynes never even lived to see the invention of the computer, and Hayek died just as the internet was coming to a rise. I doubt that either of these brilliant men would apply their policies verbatim to the world today.

4
Gradath•

I doubt that either of these brilliant men would apply their policies verbatim to the world today.

Why not? What has the computer changed about the fundamentals of economics? The details have changed, but the principals are the same.

11
nosecohnPartially impartial•

I often wonder why people debate Keynes vs. Hayek.

They debated each other. Hayek critiqued Keynes' work publicly and was basically brought to the LSE as a counter to the dominance of Keynes' worldview. Although Keynes died relatively young, he was only 17 years older than Hayek and their rivalry was quite widely known in London.

3
Erinaceous•

Part of the problem is that many of the assumptions of this form of stimulus is that it relies on an assumption of growth. In the neo-classical model growth is exogenous. However, Ayres-Warr show that growth is endogenous and results from the exergy efficiency of conversion of primary energy into useful work. When you see growth from this perspective energy cannot be assumed as a constant and knowing that demand for energy resources will overshoot supply by a range of about 500 EJ/a the ability of the economy to absorb debt through growth is highly questionable (although some kind of debt jubilee could occur). The Keynesian multiplier to my mind is a product of the fossil fuel era and a bit dangerous if misapplied in an era of fossil fuel constraint.

That being said stimulus spending to prepare the economy for higher exergy efficiency, lower energy requirements and a return to a more localized infrastructure would be a good development (not growth) investment and would satisfy the requirements of the Ayres-Warr model. This is very similar to the approach of Germany with regards to renewables and I suspect that along with strong manufacturing is a reason why their economy is much more robust than their european counterparts.

11
rjhelms•

Getting a bit off topic, when I was doing my undergrad, there was another student who consistently argued that money was not a very good unit for economic analysis, and that the kilojoule was likely a better thing to use.

It's very interesting to see that he was thinking along the same lines as serious economic research that was taking place at that time.

7
Erinaceous•

I've seen similar arguments in some old energy economics but I don't think that energy is a good direct proxy for money. Money is created and has no physical dimension (unless you count the negligible quantities of paper or metal or bits). Money only has a physical dimension with respect to commodities; what Marx would have called the M-C-M cycle (don't hate me because I cite Marx; he's just one of the few who talk about this relationship). Energy and entropy have a direct relationship to production which is constrained by the 2nd law of Thermodynamics. Growth has a direct relationship to useful work and the degree to which energy can be multiplied by technological innovation. Increases in credit money allow for greater amounts of consumption which in turn allows for greater production. So there is a relationship between money and energy but they are not proxies for each other and it's not what Ayres-Warr are saying.

5
islamicatheist•

The President before passing his stimulus bill explained how unemployment would not peak past 8 percent if the stimulus was passed. By setting that standard, by definition, the stimulus has failed. I'm no expert in this field but a few questions are begged. If, say, a politician proclaimed the urgency to pump 700 billion dollars for a chance to ameliorate our economy, where does this number come from, and is it simply arbitrary? If 700 billion dollars could offer a chance to speed things up, why not print two or three trillion to guarantee it? If the amount of money was not arbitrary and formulated by economic data and projections, then in this instance it has not worked. If it was arbitrary, then I would have a difficult time further taking economics seriously as a science.

(I'm not saying all government spending is bad.)

6
rjhelms•

The better standard to evaluate the stimulus is: "Would unemployment be higher without the stimulus? Is the reduction in unemployment worth the money we're spending on it?" That, of course, is much harder to sell politically.

Pretty much all economists agree the answer to the first question is "Yes". The second one is a lot more complicated.

5
islamicatheist•

Unfortunately, we'd have to wait years to see if our economy grows to the point where much of our debt becomes marginalized. Some are hopeful, but personally I don't share that optimism. Many cite WWII as a case study, but some leave out externalities such as our global monopolization on the sale of industry.

2
brainpower4•

Unfortunately, the whole "wait and see what the history books write about it" concept is very common in economics. We can probably start looking back at the data from the beginning of the recession, before the stimulus and draw up models of how it would progress, and how long it would last. Then we can compare the real world numbers to the models to judge how well the stimulus worked. That sort of study is probably several years off though.

1
Elephantom_Fanon•

Would it be wrong to postulate that the recent economic stimulus is not the same type of stimulus that would be endorsed by Keynes?

1
rjhelms•

I don't know the American stimulus in great detail, so I can't really answer.

The bank and auto bailouts, specifically, were not Keynesian stimulus as I understand it, as Keynesian stimulus is government spending pure and simple: infrastructure investments, increased welfare payments, make-work projects, etc etc. The idea is that the recipients of that government spending would then go and spend the money they received, and it's that ripple effect (the multiplier) that makes it effective.

7
mind_grapes•

I sense the outlines of a common misconception: the bank and auto bailouts were under a different program (TARP) than the stimulus (ARRA). You often see them conflated, but the bailouts had nothing to do with the stimulus package, nor were they designed as Keynesian stimulus. (In that respect, you're spot on).

3
[deleted]•

I would say that the 2008 stimulus was not like Keynes would have wanted. Taking a look at the allocation of the money for the stimulus ( http://projects.nytimes.com/44th_president/stimulus ). We see that most go to programs that either directly give money to the people or essentially provide aid grants to state programs that would have been slashed when the states were forced to balance their budgets. Now this certainly helped, the stimulus beefed up the safety net so it could handle the recession, better, but that's not stimulus. Alot of economists call them automatic stabilizers, they don't lift us back up from a recession, but they steady the fall and smooth our path back up.

Stimulus I would say is stuff like the shovel-ready stuff you heard about, but that is actually comparatively little of the stimulus. The reason for this rational is not so much "lets a dig a hole and fill it back up and pay people to do it", but more like "here are all these displaced construction workers and the lowest interest rates in a decade, lets put these people back to work, and invest in our shitty infrastructre.

The important distinction is that the second example is directly creating value for the citizen in better roads, rail, new schools, etc AND the previously unemployed will now buy new goods boosting aggregate demand.

So to generalize the transfer payments of the first example provide X benefits to GDP in the form of reducing uncertainty, keeping demand up for goods, helping the unemplyed, but the infrastructure style stimulus provdes the X benefits in addition Y benefits in the form of whatever we decided to build or do with their labor. Needless to say X+Y>X

This is all dependent on how effective the govt administers the money (either by itself or through contractors) and whether the work being done is actually helpful. I'd say alot of the disagreement between liberals and conservatives, is not about whether it is technically possible to stimulate the economy, but could congress in tandem with the executive branch actually pull it off.

6
astrobeen•

By way of clarification, this (warning PDF) is the paper upon which Obama and Congress based some of their predictive numbers.

edit: grammar

3
iantheaardvark•

I remember seeing something about how if a politician "wanted a penny more, they were socialists, a penny less, and they were idiots." I can't recall if that was for political reasons or founded in solid economics.

I wonder if Obama intentionally overestimated the effect of the stimulus given how much investment can be dependent on how people feel about the state of the economy? Maybe he helped by giving people hope? Or maybe it hurt because now people don't take any optimism seriously?

Regardless, what I've heard from most economists is that the stimulus definitely helped, just not as much as it could have. A lot of them point to slowness, mis-allocation of resources, and other minor factors that added up to general disappointment.

1
rjhelms•

Good question - I also have an econ undergrad degree so this is the sort of topic that interests me. I can't give citations, but can give a rundown of the theory as to why it works or doesn't. This probably won't be new to a student of economics but may get the discussion rolling.

The theory behind Keynesian stimulus is pretty sound - ceteris paribus it does cause an increase in GDP greater than the increase in government expenditure, thanks to the multiplier effect. Of course, as with just about every economic theory the reality is quite a bit more complicated, and there are other effects of fiscal stimulus that work against it's effectiveness.

One is the fact that it will result in a government running a deficit, or a larger deficit than they would otherwise. Any action the government can take to reduce the deficit will have contractionary effects, which were pretty well summarized in the articles you linked to:

Raising taxes will reduce consumption and/or investment, although the Keynesian multiplier suggests that, for most reasonable values, the increase in output resulting from the stimulus will be larger than the reduction in output resulting from the tax increase. All the same, a tax increase will make Keynesian stimulus less effective in the short run.

In the long run, if the deficit spending continues, the government's budget becomes increasingly constrained by debt service payments. This means that, for a given level of tax income, there is less and less money available for stimulus with each passing year unless the deficit gets bigger. In the Keynesian model, this isn't an issue as once the economy enters an expansionary period on it's own the stimulus can stop and the government will run a surplus, but the amount of debt held by many of the major economies suggests that in reality that doesn't work as well.

The other major complication is that Keynesian stimulus only really works in a closed economy, where all of the multiplier effect goes to domestic consumption. In an open economy, some or all of that multiplier consumption will "leak" in the form of spending on imports, which reduces GDP, rather than spending on domestic production.

There are also monetary effects which I don't feel capable of explaining well, but it's the classic "crowding out" effect of fiscal stimulus. The short version is that the effects of fiscal stimulus on the monetary side of the economy work to reduce GDP, though changes in inflation, interest rate, and exchange rate.

tl;dr: Keynesian stimulus works as long as you don't finance it by raising taxes or running a deficit, and have a relatively closed economy. The less that's the case, the less effective it gets.

5
Erinaceous•

The theory behind Keynesian stimulus is pretty sound - ceteris paribus it does cause an increase in GDP greater than the increase in government expenditure, thanks to the multiplier effect. Of course, as with just about every economic theory the reality is quite a bit more complicated, and there are other effects of fiscal stimulus that work against it's effectiveness.

I don't think that is Keynes. That sounds much closer to John Hicks who claimed to be representing Keynes but later admitted that he came up with idea before reading Keynes General Theory. Steve Keen discusses this debate at length here.

The money multiplier effect is highly questionable as a concept since most money is created and then deposits are found. You can see this quite easily in looking at recent Banking stress tests. When forced to show capital reserves Banks often (usually) don't have those assets on their balance sheets and instead have to go looking for Capital requirements. If the money multiplier effect held money would the causal result of those Capital requirements.

Also according to Keen, Keynes was more on the side of endogenous money than exogenous money, although because of Keynes style of writing you can find ways of supporting both concepts. Keen, however, states that in Keynes later writing you can find him clearly supporting an endogenous money theory. So a Keynesian multiplier probably has very little to do with Keynes but instead is a neo-classical application of his theory than may not actually be based on his thinking.

3
rjhelms•

You could be right that it's Hicks instead of Keynes, I'm not sure. I was using the word "Keynesian" to refer to the broader school of economic thought rather than Keynes' work itself, though you're right to bring up the fact that Keynes wouldn't agree with everything we call Keynesian today.

Thanks for the link to that video, it looks very interesting. I don't have the time to watch it all now but will definitely be doing so.

1
Sharlach•

Crowding out is a farce. There are plenty of fields that would receive little to no attention from private interests regardless of whether or not the govt was pumping money into it. Which leaves plenty of room for govt spending to benefit society.

1
rjhelms•

True, but if you're targeting specific areas of government spending you've gone a bit beyond what's typically understood as Keynesian stimulus.

Keynesian stimulus is generally seen as government spending just for the sake of government spending and it's following effects. If it's not targeted, some of that spending would get crowded out.

What sorts of areas of the economy are you thinking of, where crowding out doesn't happen? (or is insignificant)

2
Sharlach•

Well, I think we can both agree that any industry that's in recession won't be negatively affected by govt spending as those firms will already be pulling back due to other reasons. But there are pretty important things such as infrastructure and research that private interests never touch or can always benefit from increased spending regardless of where it comes from.

I'd also like to say that the new deal was itself fairly targeted and the only reason that what's typically understood as Keynesian stimulus isn't thought of as "smart stimulus" is because the narrative has been hijacked by partisans over the last 30 years. Just because people's understanding of the concept has deteriorated doesn't mean that we should give up on it entirely or stop tweaking it to make it more effective.

Edit: you can scroll down to see my original post and another members contribution for more areas that should be considered common sense investments with little to no risk of crowding out private firms.

1
[deleted]•

There are plenty of fields that would receive little to no attention from private interests regardless of whether or not the govt was pumping money into it.

That's precisely the point of "crowding out." It's that the government uses real resources, such as people's labor, on things that otherwise wouldn't be demanded.

2
Sharlach•

No, "crowding out" states that [government investments will result in reduced private investments](http://en.wikipedia.org/wiki/Crowding_out_(economics). And just because markets aren't able to provide a good or service doesn't mean that there isn't any demand for it or that providing it wouldn't be beneficial to society in one way or another. Free markets don't provide effective policing or fire departments, but that doesn't mean there's no demand for it or that we shouldn't have police departments and fire stations.

4
rjhelms•

Crowding out generally wouldn't result in reduced investment total, however - more that, because of how the private sector responds, the increase in total investment is smaller than the increase in government investment. Whether that's a good use of government money depends on the magnitude of the crowding-out effect vs the magnitude of the multiplier effect, and what could be gained by spending that money elsewhere.

Police and fire service are a little different, in that those are public goods. The reason for government investment in those areas isn't that they are places where crowding out isn't an issue, but rather because the private sector will drastically under-provide those goods and services. It doesn't necessarily follow, for example, increased police spending is good Keynesian stimulus - stimulus isn't the reason that governments' provide police.

3
[deleted]•

Sorry for not spelling out the last step. The people's labor that is used by the government spending is no longer free for other uses, such as hypothetical investments.

What you initially described, the government taking resources and using them on investments that the market wouldn't have made, is crowding out.

And just because markets aren't able to provide a good or service doesn't mean that there isn't any demand for it or that providing it wouldn't be beneficial to society in one way or another.

That's a great argument that some crowding out should happen. It's not an argument that crowding out doesn't exist, which was your initial claim. Unless you believe that policemen and firefighters never, ever would work ever again for any private sector company, then the hiring of policemen and firefighters is crowding out.

1
bogeythrim•

I think to get an understanding of why stimulus doesn't work you need to start with just a few underlying ideas.

  1. What is the best way for the capital in an economy to be distributed? Why is good A preferred to good B? How do you know when an investment is a good idea or a bad one? In a capitalist economy profits are the answer. When you are making profits I'll bet you a pound to a penny that the consumer is demanding this good/service. In a planned economy an appointed board decides what should be built where when and by whom. The US is a capitalist economy. There may be some debate on that point but I digress.

  2. Government takes everything it has from its subjects. Period. Whether through taxation or inflation. This is to me, axiomatic.

Ok, so to address the original question. Government is not subject to the abject uncertainty that the investor faces. The projects they fund are not chosen by profit motive, but by the bureaucratic process. It follows that the money will be spent in a manner that is more wasteful than the other uses it could have been put to, because the decision makers have no personal skin in the game.

I often see folks talk about government works incompletely. Its important I think to examine not only what a specific work does, but also the other things that could have been done with that money had it not been taxed or inflated to government. I'm sure with an Econ degree the OP has a depth of knowledge about opportunity cost. Yet time and again we fail to consider it when thinking about things such as this.

So all that considered I'd like to leave with an open ended question to invite debate.

Why when considering the projects is only the bridge to be built considered? Why not consider also how that money might otherwise have been spent directly or invested?

4
iantheaardvark•

I think you bring up a good point here, but part of the problem is that there are worthwhile endeavors that just aren't profitable. That, to me, is (in part), the role of government spending in a capitalist economy, because I don't buy into the idea that the market will always provide.

You mention building a bridge - for whom would this be profitable, normally? Unless you're going to charge a toll, or can convince a group of people to voluntarily fund it, I can't imagine why any private institution would build one; if anyone can think of a reason why they might I'd love to know.

But I think you're very right that opportunity cost is not something often considered with government spending. The government likely could use it's money in a much more efficient (and sometimes "profitable") manner, rather than concerning themselves only with the tangible result.

Perhaps that's the future of government spending. Rather than the liberal or libertarian model, a focus on efficiency and perhaps even profitability, using taxation and excess revenue to fund non-profitable but necessary projects. I really don't know what I'm talking about though.

3
seunosewa•

What's wrong with charging a toll for a bridge? If its valuable, people will pay.

1
iantheaardvark•

I don't think there's anything necessarily wrong with charging a toll, that was just the provided example.

I'm just pointing out that there are valuable endeavors that may not be profitable. In other words, I feel that economic worth isn't (or shouldn't be) the sole determinant of value.

1
bogeythrim•

Interesting final paragraph.

It seems clear to me that government spending is always going to be inefficient, because the pressure of competition is not a factor.

Think about the decision making process at a large company and how projects are decided on, and how money is allocated. Now think about how is done by the state.

1
iantheaardvark•

It seems clear to me that government spending is always going to be inefficient, because the pressure of competition is not a factor.

I think that you're partially right - government spending will never be as efficient as business. But I think that there is also a mounting push to turn our focus from what government should and should not do and instead concern ourselves with how efficiently what it does do is done. This political pressure will not magically cure the failings of bureaucracy, but this demonization of corruption and inefficiency could certainly point us in the right direction.

Think about the decision making process at a large company and how projects are decided on, and how money is allocated. Now think about how is done by the state.

I understand that, but the reason why business is so efficient is because it serves only it's own interests. When everyone is either directly (high level management, shareholders) or indirectly (less involved employees who are pressured/incentivized by management) concerned with profits above all else, this creates a highly competitive and efficient environment both within the business and without.

This is great, and has resulted in all sorts of innovation and abundance, but again - not all valuable endeavors are profitable or economically feasible. The problem is that sometimes when government then tries to pursue such endeavors, the combination of governmental inefficiency and inherent unprofitability result in excessive waste. What options does that leave? Abandon such endeavors entirely (I'm not yet so pessimistic to think this the correct path), increase profitability of a given pursuit (unlikely or impossible in many situations - if it's profitable the market will likely provide it), increase revenue elsewhere (seems wasteful to say "well, this is super inefficient but we need to keep throwing money at it"), or try to combat inefficiency.

I'm not saying that there is certainly some event that will cause a dramatic, sudden shift towards hyper-efficient government. But I think that in some ways, it is a central issue of contemporary political discourse. The tea party was not exactly my cup of tea (no pun intended), but while their platform was half "government shouldn't do x and y," the other half was, "government is incredibly inefficient at doing z."

I may disagree with the tea party, libertarians, and others opposed to most government spending for the simple fact that I don't feel that economic value is the sole determinate in how things ought to be. I do, however, think that they are bringing an important issue to light in a way that most liberals are too blind or afraid to do.

Efficiency will not be significant to government in the same way it is for a business, but as the public becomes increasingly fed up with waste and corruption, it becomes more and more politically profitable to point out the failings of x and y that your opponent supports. The result? Politicians who are, by necessity, concerned with the efficiency of the programs they support. Perhaps I just have too much faith in the system - which I recognize as exceptionally slow - or perhaps I am seeing notable backlash to waste where there isn't any beyond regular background levels - it's hard to say because any such change will be exceptionally gradual, as is often the case in pluralistic, democratic societies.

1
FuggleyBrew•

Why when considering the projects is only the bridge to be built considered? Why not consider also how that money might otherwise have been spent directly or invested?

We're in a recession. The money is not being spent or invested. The money is being hoarded away, either in US treasuries, or in gold.

The opportunity cost for investing during a recession is the lowest it will ever be. Financing the project is incredibly cheap to do, the workers would not otherwise be working, the capital would not otherwise be invested. There is no crowding out that can occur.

Stimulus spending is quite frankly a pareto improvement.

1
bogeythrim•

Treasuries are investment in government, no? Very few people are storing wealth in assets like gold. Most people only significant savings in some form of retirement account. Retirement accounts are essentially investment in a wide range of stocks, bonds, and commodities.

Back to the gold thing for a minute. Have you ever seen a chart where the value of the dollar is expressed in terms of a fraction of an ounce of gold? Interesting stuff.

1
tweedboltmegacorp•

http://www.econtalk.org/archives/2011/09/garett_jones_on_1.html http://www.econtalk.org/archives/2011/01/fazzari_on_stim.html http://www.econtalk.org/archives/2011/10/ramey_on_stimul.html

These are some really great interviews that go into some of the literature on the effectiveness of stimulus. This is from GMU, which is more free-market leaning than most econ programs, but I think Russ Roberts does a pretty good job of keeping things intellectually honest. Anyway, most of what I have read indicates that stimulus has very little effect either way. It neither crowds out private investment as much as the right claims nor stimulates as much as the left claims. Assuming this is the case, I see little reason to pursue large scale stimulus efforts. Small, targeted ones, maybe, but I think we'll probably always run into implementation problems when we start talking about anything in the range of the ARRA.

3
mywan•

Though I'm fairly limited in economic theory, I have repeatedly gone over the fundamentals on occasion. My take on it falls basically in line with Steve Keen.

http://www.debtdeflation.com/blogs/

This is Keen's 2012 Google Talks video outlining the modeling and causal factors on a macroeconomic scale:

http://www.youtube.com/watch?v=BPRdyVabiQk

Before talking about Keynesian priming the fundamentals need to be roughly laid out. In fact Keen's makes a point of the the fact that Keynesian models as presently used do not fully conform to Keynes model. In watching this video, if you mistake his debt argument as a first order derivative effect, it falsely looks like an anti-banking argument in which banks end up owning everything. This debt effect he speaks of is a second order derivative effect that's not about the fractional reserve system specifically, or the growth rate of the money supply, but the rate the acceleration of growth increases. A second order effect. For those that understand this is a critically important point. Keen model, as demonstrated in the video, shows the effect of the paradox of thrift and that even with the growth in the money supply debts can still be fully payable. Contrary to a lot of fringe economic theories.

Now, the important features is that debt levels are critically important, which includes both public and private debt. With private debt generally dwarfing government debt. Also important is is the level of loans that go to creating income producing production. Thus borrowing for price speculation, personal consumption, and such fall under the category of ponzi investments. Though how you separate the two in a regulatory environment is a problem.

The basics start at low debt with tight lending policy. As successful loans are issued to income producing projects showing very low risk it creates money to be loaned for more risky less income growth oriented loans. This growth money then starts feeding on its own growth to produce bubbles. A far more complete picture is available by watching the video and downloading the computer models available on his blog.

This means that so long as debt cost remains high the Keynesian priming is only setting us up for a new bounce followed another crash even sooner. Priming is undeniably valuable given one of two conditions. Either it isn't paid by more debt, or the debt that is created is used to create more income producing, or more efficient, production. That makes the GM bailout (investment) worthwhile, even with more debt, but is a negative indicator for bank bailouts. Banking is merely a necessary overhead cost of capitalism, the growth of which, at least relative to the total GDP, is counter to the growth of capitalism.

I'm nowhere near the caliber of keen, but I'll defend his model to the best of my ability for debate purposes here.

There's another model I like, that is geared more toward econophysics involving agent based, rather than Keen's macroeconomic approach, that roughly justifies this debt effect.

https://www.unifr.ch/econophysics/paper/show/id/1105.2123

http://arxiv.org/abs/1105.2123

This indicates the the Bowley ratio, the ratio of capital to labor returns behind the income distribution, is the product of debt levels. Note that, in this respect, consumer credit is a far bigger culprit than government debt, though government debt is not exempt.

2
Erinaceous•

That was a pretty great summation. It's hard to put Keen into a couple paragraphs because his thinking runs contrary to so much of standard economics. You end up losing much of the short hand and having to redefine everything as you go.

One quibble. I think it would be more accurate to say that stimulus is effective on the demand side not necessarily the production side. Not dropping money from helicopters which would just fuel a bubble but in terms of employment. Some of that would obviously have to go to simulating production (or at least it's much easier to target stimulus that way) but then the choice of industries is important. Stimulating the whale oil industry around the time when kerosene was being widely adopted would not make good economic sense. There needs to be a bit of a Schumpeterian sense of technology. So GM = terrible stimulus for every reason other than scale. Green technology stimulus = great but not nearly enough.

If I were in charge of stimulus spending I would focus on relocalization and food security on a transition towns food forest model. Basically,I would have people dig ditches and fill them back up again with saplings. Not only does this provide a hedge for the poor and unemployed against rising commodity prices, reduces the percentage of income spent on food etc but it's a long term investment that adds resilience to a system that is going to be made more fragile by tightening liquid fuel resources.

1
mywan•

Your one quibble is where I would disagree the most. Though it is a demand side shortfall in the present economy, the opposite of what we had in the late 70s producing stagflation that propelled Reagan into office, simple priming the economy is not sufficient or effective under Keen's model. Unless that priming goes directly to reducing personal debt loads.

Consumption spending can reduce unemployment and increase total GDP in the short term. The problem, under keens, with trying to spend out of the recession is that it does nothing for the income to debt ratio. Watch the periodic mini-recessions that start moderating just prior to a market breakdown in his model, and in the historical data. This was the key indicator that had Keens predicting the recession, pre 2008, when standard standard economist were marveling at the Great Moderation. So long as this debt ratio, primary made of of private household consumption debt even if government debt also counts, remains so high any significant growth built on debt spending will only set us up for another recession quicker.

Think about the income inequality that is the highest since the great depression. If some percentage of your paycheck go to interest payments on your debt, then this money never passed through any material purchases of goods and services. Thus, even though it's counted as labor income it also gets immediately relinquished as capital income to the debt holder, offering the laborer zero effective buying power. Both consumption demand is decreased, in market that are meaningful to lower incomes, while capital returns grow.

In Keen's model the only real effective solution is to reduce the debt burden of individuals, even at the cost of new consumption. Once those debt cost are low enough both the income inequality and the economy has lots of room to grow consumption and the economy. Merely spending debt money, consumption priming through debt, may give us some short term positive indicators, but will ultimately land us in worse condition with the next crash it is driving us toward.

I would like to see an argument to the contrary that doesn't simply ignore this effect. Or give reasons why it should be ignored that's not so easy to counter.

1
Erinaceous•

Right. Personal debt is a huge issue. The largest percentage of debt for most people is housing. Which brings us back to the housing crisis.

This probably one of the biggest missed opportunities in the Housing Crisis was not stabilizing the demand side of the housing crisis. The government having effecitively taken over the debt of much of the foreclosed houses was in a position where it could have been the lender of last resort to a large percentage of affected home owners. Instead of vanishing debt through QE it could have vanished debt through mortgage restructuring (mortgage debt jubilee).

1
staythepathI might be wrong.•

Now, this looks interesting. Give me some time to learn a bit about this stuff and I'll get back to you. I honestly don't know much about this, but I feel I should therefore I will. I do have a question. This seems to go against basic principles of capitalism (to my knowledge at least) and the Constitution of the U.S. Am I a correct to assume that discussion is meant to be about Keynesian pump priming and not about bail outs the U.S. government has given out? I can see how it could lead to that, but I don't think that would be a good starting point as it skips the intended conversation.

1
silverpaw1786•

What part of the Constitution do Keynesian economics violate? -Law student

11
staythepathI might be wrong.•

I don't know what you are talking about. :p

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[deleted]•

[deleted]

1
Elephantom_Fanon•

Unfortunately, I don't know much about Hayek's economic theory other than it reinforces the classical liberalism paradigm in the global economy.

Would it be safe to say that Hayek's economic theories were similar in nature to the ideas of Milton Friedman? (How are the two similar or different in both domestic and foreign economic policy?)

1
greginnj•

most of the economists I know believe that stimulus spending is - tautologically - stimulative

Perhaps I'm quibbling with a side issue here, but this isn't quite a tautology. Proponents call it stimulus spending because they believe that's the consequence; them calling it that is a matter of marketing the idea. It's like saying "opponents of excessive taxation believe that it is - tautologically - excessive". You're not really deriving a conclusion, so much as echoing their question-begging.

1
circularfishOP•

I absolutely hate it when two internet Nazis go after some utterly irrelevant point, but damn it, you've got me intrigued!

I can see why this isn't a [logical tautology](http://en.wikipedia.org/wiki/Tautology_(logic), but why isn't the statement "Stimulus spending is stimulative" a [rhetorical tautology](http://en.wikipedia.org/wiki/Tautology_(rhetoric)?

A rhetorical tautology can also be defined as a series of statements that comprise an argument, whereby the statements are constructed in such a way that the truth of the proposition is guaranteed or that the truth of the proposition cannot be disputed by defining a dissimilar or synonymous term in terms of another self-referentially. Consequently, the statement conveys no useful information regardless of its length or complexity making it unfalsifiable.

Again, I'm not staking out a position of honor here - I may well be misusing the term. School me!

Edit: fixed links.

Edit#2: Ahhhh... thinking it through, if "stimulus spending" is a label and not a truth assertion then it isn't really an independent argument such that it can be tautological. Is that what you're getting at?

1
greginnj•

Exactly! Your edit #2 captures what I was saying. (Thanks for honoring my geekiness with your own!) If we're going to get into rhetoric, I would say that "stimulus spending is stimulative" is begging the question - the first instance of 'stimulus' is just the label for the kind of spending we're talking about (a label applied by the proponents); the second occurrence is a substantive claim about the effects of that spending, which is exactly the claim at issue.

It's certainly not the case that the spending is stimulative merely because we call it that -- so it can't be a tautology of either type (and it isn't a rhetorical tautology because the label and the substantive claim are two different things, even though they're the same root word), so it's a case of question-begging - basically assuming what you set out to prove.

So we can escape the perils of Godwin's law, how about we replace 'two internet Nazis' with 'two mutually reinforcing obsessive compulsives'? Cheers!

1
armozel•

From what I've read about government stimulus like the work of Christina Romer suggests expectations generally trump their intended effects, be it tax cuts or governments funding projects or expanding contracts for existing public works. It all seems to me that it indicates there's more to an economy than simply offsetting spending in the nominal sense (via stimulus, inflation, tax cuts, and the like). So, I have to wonder if caution on this matter is more worthwhile than running around "doing something."

1
MuffinMopper•

I mean obviously stimulus does something. You are paying people to do stuff, thus GDP goes up. Also, they have money to spend, so demand for goods and services of government payment receivers goes up.

The question could be better stated as such:

"Do the benefits of a government stimulus program outweigh the costs?"

I think the benefits would be increased economic activity, while the costs would be the government borrowing money. You could probably come up with additional pros/cons as well. Whether a program is a net gain or a net loss is a more difficult question.

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[deleted]•

[deleted]

1
sexual_in_your_end_o•

For me it's always been a question about whether or not Keynesian stimulus is the best way to go about it. Sure Keynesian stimulus can work, but it can also fail. It's prone, like any other market force, to what Hayek called malinvestment. Here's an interesting article about how this is currently playing out in China. Does this look like a good way to stimulate an economy? The question then, is whether or not Keynesian stimulus exacerbates failures that would otherwise have been either isolated incidents or nonexistent. The reasons are twofold. First, central government, like anything, is susceptible to corruption, but with the added problem that taxpayers are paying for this corruption. If some private firm is corrupt or inept, at least I can take solace in the fact that no one was forced to buy stock in that failure. Politicians are accountable to the voters, but how many people honestly track where exactly all the money is going and how it is being spent. Second, even if there is no corruption and all investment were honestly made with good intentions purely to help people, central government planning still puts all our eggs into one basket so to speak and so a failure is spread to all taxpayers, instead of being localized to the investors.

To sum up, I feel like Keynesian stimulus can't magically do better than any free market investment in my mind. I reject the notion that politicians and people in government somehow know how to better allocate money than your average investor. They can only do as good, but on the flipside, they can do worse by spreading the losses out to everyone either by malice or ignorance.

Also perhaps someone could help me better understand, but the idea of Keynesian stimulus boosting aggregate demand seems logically flawed to me. It would make sense if the money were evenly applied or "helicoptered" in as Friedman said, to everyone. Why do construction workers and teachers get the special privilege of having the taxpayer subsidize their work? Why does the local restaurant owner not get a break? Is the idea that the stimulus paid workers will then be more inclined to eat at the restaurant thus indirectly subsidizing all industries?

1
Fineyouwin•

No Keynesianism relies on bogus statistics and intellectually dishonest calculations to account for growth where there is none. If you would like to see how many of these statistics are manipulated to show unbridled growth when the opposite is true I would point you to a source that discusses it intimately.

The book is called "Confessions of an Economic Hitman" by John Perkins.

He describes how the IMF and world bank use statistics lauded by Keynesians to trap poor countries into debt and refinance programs they clearly can not afford.

Some examples that relate to the U.S economy which are very clearly being manipulated are GDP, the inflation rate, the unemployment rate. Numbers are fudgy. Keynesians start with an objective and use these statistics to achieve stated goal. This should not be acceptable if economics wants to be considered anything more than a social science.

1
Fineyouwin•

I would also like to add that the current Federal Reserve which vehemently believes in Keynesian stimulus lists the inflation rate at 2%. Anyone who has been to the grocery store knows prices have gone up more than 2 %. The old statistic CPI is at 9%. But we to elaborate on my previous point. They use calculations that give them their predetermined answer. which in this case is the inflation rate is 2% when it is clearly higher

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[deleted]•

[deleted]

1