We Told You So

June 13, 2011

by Mario Rizzo  

In recent months – or has it been years? – Paul Krugman and Brad DeLong have been saying, in effect, “We told you so – the stimulus was not enough. Look at the sluggish economy and high unemployment rate.”

They are arguing that the problem with the fiscal stimulus is that it was not enough. The idea was right but the quantity was wrong.

Let it pass that at ThinkMarkets it was predicted that this is what the stimulus advocates would say in the event that the economy did not improve as much as they wanted.   

The basic problem with the quantitative claim is that it skirts some real problems in the analysis.

  1. What was supposed to happen when the lines of spending actualized by the stimulus were exhausted?
  2. How was the stimulus supposed to jump start private spending? Even the advocates of fiscal stimulus were not saying that the government stimulus had to be permanent .

The reader should use the search function on this blog with the word “stimulus” to see what we have said as early as the beginning of 2009.

The essential argument is here from January 21, 2009

This in a nutshell is also the problem with both fiscal stimulus and “forced lending.” The stimulus is likely to stimulate lines of production that are not sustainable.  

In some cases, it will restore depressed markets to their previous condition when that previous condition was an over expansion. In other cases, it will prop up certain sectors like “infrastructure” and whatever else the near-trillion dollars will be spent on. Assuming, as we are told, these expenditures are temporary, what happens when the resources shift out of these previously-favored areas? More importantly, will lenders and related businesses know when the stimulus will end or shift? If not, policy uncertainty will take the place of the current uncertainty, (In fact, the current uncertainty is to a certain extent derived from the policy uncertainty about the future.) In still other cases, banks will be cajoled into lending to borrowers whose industries are experiencing sectoral decline since they may be hurting the most. Furthermore, if banks are urged to operate contrary to their own risk assessments of borrowers, what standards will be substituted?  

The stimulus advocates don’t know the answers to these questions. They will simply try to get the housing market, other similar interest-sensitive markets and credit markets (plus the auto industry!) to such a point where general production and employment are considered non-recessionary. The standard, practically speaking, will be the status-quo ante. But the status-quo ante produced the status quo.  

The root of the policy problem is that the “Keynesian” solution takes the simple aggregate demand model too seriously. It proceeds as though sectoral imbalances don’t matter. In this view, the current situation is not a coordination problem but some kind of confidence problem that leads to a deficiency of demand in general. The theory is inadequate and thus so is the solution.  

The stimulus should not have been expected to stimulate private spending. Most of the effect of stimulus is in the areas in which the government spends. Less than a third on private spending

In addition,  we predicted that Fed policy will not be helpful in equilibrating the housing market. Thanks to recent Fed policy the housing market has yet to reach its new equilibrium.

In sum: Obama stimulus won’t work.

I was not unique in the Hayekian camp in making these claims. I urge other Hayekians to join in with their own “We told you so.”

Obviously this is all in the new spirit of blogosphere self-promotion. In a previous age (not so long ago) I would have been less direct. Sigh.

27 Responses to “We Told You So”

  1. Daniel Kuehn Says:

    And this is what Krugman said you’d say too.

    We can argue this till the cows come home. The assessment is no different now than it was in 2009. In late 2010/early 2011 the stimulus was set to recede in a big way, and they said in 2009 that in early 2011 we’ll start to see problems and we’ll start to see those against stimulus saying precisely what you’re saying here. This isn’t some sort of apologetics after the fact – they said we would run into trouble at this point.

    None of the empirical or theoretical questions have changed. None of the problems with finding a counter-factual have changed. All of these “I told you so’s” on both sides are justified insofar as both sides DID tell each other this was going to happen a year and a half or two years ago. You said Krugman would say this and he said you would say this and he said HE would say this because he said it would peter out early on.

    Unfortunately, none of this solves anything and none of this improves the terrible economy.

  2. Mario Rizzo Says:

    What I am saying is that we have our own reasons for predicting that the fiscal stimulus would not work. And these reasons, I should say, are more interesting (and I suggest more accurate) than the Parrot’s reasons: Aggregate demand failure. Yes, you are right this post doesn’t solve the problem of the current “recession” (NBER says it is over). Yes, you are right that it doesn’t “prove” my points. But then again: Krugman and DeLong are wonderful self-promoters. I think Hayekians should learn from them. Most of all, I enjoyed posting this!

  3. Daniel Kuehn Says:

    Oh definitely.

    And if nothing else – it sorts out the wheat from the chaff on both sides. Even among Hayekians, some made more notable predictions than others.

    More interesting? I don’t know. A liquidity trap is pretty darned interesting dynamics. I think I’d take that over the pinacle of obviousness in pointing out the fact of relative government inefficiency or the inscruitible “everyone is scared of what Obama will do next”.

    Out of curiosity – who is the Parrot?

  4. The parrot is aggregate demand failure. It keeps being repeated over and over and over.

  5. Larry Summers, ‘explaining’ that over confidence (you know, those animal spirits), caused all the troubles, now demands even more stimulus.
    When all your thinking is made up by a hammer, the rest of the world are just nails.


  6. As Mario noted, we’ve all offered reasons for why we predicted that stimulus would be counter-productive. So there is a way to resolve issues through intellectual discussion. It is not just a matter of opinion.

    Among other things, we analyzed how monetary stimulus — easy credit and very low interest rates –would produce new bubbles. The existence of such bubbles is now widely acknowledged. Even Chairman Bernanke has admitted there is too much risk of inflation for QE3.

    Inflation is here and growth is sluggish. That is reminiscent of the stagflation of the 1970s. We also predicted that outcome. Keynesians never came to grips with stagflation, which is the reason for the triumph of monetarism.

    As a former Fed colleague recently emailed me, the one sure outcome of the recent crisis will be a new economic paradigm. As happened in the 1930s and again in the 1970s.

  7. Jeff Harding Says:

    OK, I’ll brag: The Daily Capitalist has been saying this from the get go. But, I’m rather Misean.

  8. @ Jerry

    Let us hope this new paradigm does involve capital controls to make national monetary policies more effective

  9. Of course they say that. It’s what they always have said. It’s the only response they can say while saving face. I wouldn’t expect any less of them. But of course, when you point out the problems with their theories, expect a barrage of personal attacks without a drop of substance.

  10. @Andreas,

    Austrians have not had a better oppostunity in two decades to get some traction on a major public policy issue.

  11. Bill Sardinha Says:

    Apologize for the length

    Given history and development of the Keynesian theory on which Krugman bases his analysis he certainly can make a case for his Stimulus spending policy. However how Noble it seems he is basing his analysis on old world economics.

    The world has changed and Krugman and DeLong do not seem to have changed with it. There are many factors of course but it seems these two characters are trying to apply an theory previously operated in vacuum to a complicated and inter-related world economy.

    If the US companies only operated in the US, if the US sold more products then it purchased from other countries, if the US companies retained all their profits in the US and reinvested in US companies, if the workers for those US companies were the only employees for those US companies, if the US employees and US consumers only purchased products from US companies the Keynesian theory would have a chance to succeed. Many believe that this is not the case.

    1) US companies do not only operate in the US
    To remain competitive (and higher profits) US companies have set up shop outside the US for lower taxes, less restrictions, less stringent environmental laws, less regulated labor laws and cheaper labor.
    2) US companies do not retain or reinvest the majority of their profits in the US. Their profits are reinvested outside the US for the reasons given in #1
    3) For the most part US companies are using less and less US employees because of the less labor regulation, lower employee benefits and payroll taxes and lower wages.
    4) The US employees and consumers buy more and use more products and services from non-US companies based outside the US as the quality of such products and services are comparable or in some cases better for a better price and value.

    The US stimulus package gives (they are really loans as US does not have the money to give) money to people when in fact they did not fully earn the money. To compound the problem the money that is placed the hands of these companies and consumers is used to purchase products and services outside the US which in fact does stimulate the economy, but unfortunately not the economy of the US.

    In the old days if the economy of a developing country was propped up it was for the benefit of the US as the developing country would be buying quality goods and services from the US. The US companies and more importantly US employees made desirable products such as cars, planes, TVs, refrigerators, stoves, the electronic appliances. The US and US employees pumped oil, built US oil refineries and produced much of their own gas. The developed world also realized during this time a US product represented quality at a fair price. There was a world demand and the world was willing to pay the price for US products and services.

    Things have changed. The US has a trade deficit and no longer is the king of manufactured consumer goods for the world. The US no longer has the reputation of a quality product at a fair price. A simple example is that at one time 90% of all the cars purchased in the US were manufactured in the US. Now the Japanese, Koreans and Germans are selling more cars in the US. And as for the US big 3, most of the actual production and manufacturing of a US car is performed outside the US by foreign employees. In addition to cars, the US consumer also now buys most of their consumer products, TVs, refrigerators, stoves, and appliances from companies operating outside the US.

    — Stimulus money does not help the US economy when the majority of these stimulus funds end up in the hands of overseas companies and foreign employees. It certainly does not help when US employees and consumers spend their stimulus money on products and services produced outside the US, and this includes gas and oils. Krugman and DeLong are correct, stimulus does help the economy. Unfortunately it is sad that Krugman and DeLong may have ineptly advocated borrowing funds and putting the Federal government in debt to promote investment that ends up outside the US. I would like to believe that Krugman and DeLong made an error in judgment, and that they unknowingly advocated this misguided policy; versus intentionally pushing a policy that supports their personal philosophy on how wealth should be distributed amongst the world.

    Please do not take my thinking to heart, I find this subject of interest, just another view from a different perspective.

  12. David Hoopes Says:

    Here is a dreadfully poor rationalization for government spending. Perhaps some ThinkMarkets, Coordination Problem, or OranganizationandMarkets bloggers should write a reply to the WSJ. I suppose I could do it. But, this is pretty far outside my area of expertise. Whereas, it seems right up your alley.


  13. Obviously, $1 of stimulus is too little. $2 is too little. $2 million is too little. There exists a line, somewhere, that stimulus produces a positive effect.

    Krugman applied a rule towards how much he thought. He thought 1.5 trillion, with no tax cuts, was the correct amount, following this rule. He came to a conclusion. He believed a recovery would happen, but a slow, painful one, Japan style. That’s exactly what we’re looking at.

    Obviously there’s a line where Krugman thinks a solid economic recovery can spring from. Krugman predicted a sluggish recovery, based on the stimulus size. He was right. Right-wingers say it didn’t work. The moment was stalled. This is somewhat of an achievement.

  14. Stephan Says:

    @Daniel Kuehn
    What I don’t understand is why somebody looses its cool about this post by a lonely Austrian economists. I mean they write this stuff since at least 75 years and will write it again in the future. No mystery here. Luckily nobody with notably rare exceptions cares. If Mr. Rizzo feels better after repeating age old nonsense I would say that is a good thing (at least for him).

  15. Full Employment Hawk Says:

    “Let it pass that at ThinkMarkets it was predicted that this is what the stimulus advocates would say in the event that the economy did not improve as much as they wanted.”

    The stimulus advocates said the stimulus was too small EVEN BEFORE THE STIMULUS WAS PASSED. So this is not after the fact rationalization, but, rather correct preditions.

  16. Full Employment Hawk Says:

    “1.What was supposed to happen when the lines of spending actualized by the stimulus were exhausted?”

    The purpose of the stimulus was to maintain spending until the deleveraging by the households and firms, brought on by the financial collapse, had been completed. After that private spending would take over.

  17. Full Employment Hawk Says:

    “2.How was the stimulus supposed to jump start private spending?”

    When the government buys more, firms sell more, therefore they produce more. Therefore they hire more workers, increasing their income. The workers therefore buy more, so that firms sell more and produce more, etc. The additional production increases capacity utilization, so that firms increase their physical investment, which means that firms sell more capital goods to other firms, produce more, hire more workers, etc.

  18. Full Employment Hawk Says:

    “The stimulus is likely to stimulate lines of production that are not sustainable.”

    So what? The stimulus by causing firms to produced more will both put additional workers to work and increase their speding and the increased output will increase capacity utilization and increase phisical investment in products the firms consider sustainable.

  19. Full Employment Hawk Says:

    “I mean they write this stuff since at least 75 years and will write it again in the future.”

    The Austrians have not had any major original idea since the 1930s, at which time they were wrong and fortunately society did not listen to them.

  20. Matt Says:

    The nation’s infrastructure is still historically dilapidated. Arguments about inefficient sectoral shifts would ring truer if there was any evidence of an overabundance in stimulated areas of the economy. If you want to talk about infrastructure, can you answer the following: A) should the government provide such infrastructure B) is the current infrastructure overbuild or under built, and finally C) whether there is any macro reason spending shouldn’t be adjusted in one direction or another.

    Dealing more broadly with stimulus, states governments are contracting harder than the fed ever stimulated. Dade county hasn’t hired any new teachers for years, only temps. The teachers from the 1-2 years prior to that are bounced around from school to school, surplussed every year, solely on the basis of seniority.

    If over funding the construction of infrastructure can be so counter-productive, what effects would you predict arise from under-funding education..? Replacing teachers with temps, and attracting only the leftover sort willing to put up with low pay, uncertain employment, and a shitty work environment? I’d hope any real answer to this question would address BOTH the demand-side effects of shifting such a large profession from middle-class salary w/benefits to part-time hourly w/o benefits, as well as the long-term consequences of driving the smartest workers out of education.

  21. Stephan Says:

    @Full Employment Hawk
    Correct. But no need to get worked up about it. They didn’t get it then, they don’t get it now and they won’t get it in the future. Why the US government is feeding these anti-government anti-people asocial academic vultures is beyond me. But that is a question for another day.

  22. [...] att bortförklara de uteblivna effekterna av stimulanspaketen (Stewart kanske fick sin inspiration här?), och Fox News får sig som vanligt en släng av [...]

  23. James Says:

    I honestly don’t understand this editorial post. I consider myself a fiscal conservative. I am a fan of the Austrian school. I don’t support big government in general, but the entire premise of this post is flatly contradicted by the empirical record. How can one argue that stimulus advocates are retroactively inventing a defense of their policy when stimulus advocates stated AT THE ORIGINAL TIME that the stimulus was insufficient in size and would likely not deliver the boost needed to the economy? Listen, I don’t want government spending to be the answer to any problem, but if you want to be honest and want to argue about it then you need to stick to the facts and not invent alternate realities in which your ideological foes act differently than they do in real life.

    When politicians and economists were originally debating how to get the economy on track a large group of economists, both liberal and conservative, Krugman included, argued that a stimulus of a certain size was required to counteract the lack of aggregate demand in the economy. Due to political considerations, the stimulus that was hashed out in Congress was roughly one half the size recommended by those economists. At that time many economists and politicians registered into to public domain (in the form of written editorials, TV interviews, radio interviews, etc.) their disappointment about the insufficient size of the stimulus. Krugman went out on a limb and got more specific than most economists, not only predicting the shortfall in stimulus but also predicting a rough timeline over which the stimulus would lose steam and after which the economy would once again fall into a crater of low aggregate demand. And since then he seems to have been howling, week after week, in his NYT editorials about how the policy put into place was insufficient and doomed to failure.

    I am in disbelief that the author of this post (a) doesn’t know what happened when the stimulus was originally hashed out, and (b) hasn’t followed the public pronouncements of the very same people being reprimanded in the post. I find it highly unusual to criticize someone for a flip-flop that clearly didn’t happen according to the factual record. To me, that wreaks of dishonesty. I am left to wonder whether the author of the post is misinformed or purposely spreading lies about his ideological foes.

    I want Krugman to be wrong in the grand scheme of things. I don’t want government spending to be the answer. But what happens when the little information available to us through the soft science of economics plus the predictions of people like Krugman basically come true? I hardly think that allows us to declare victory. I just don’t get it. Posts like this article are not helping the situation. They muddy the water and make it even harder for pragmatic folks to come to grasps with the true situation at hand.

  24. Bill Sardinha Says:

    Honestly I do not get it either.

    Full Employment Hawk says “When the government buys more, firms sell more, therefore they produce more. Therefore they hire more workers, increasing their income. The workers therefore buy more, so that firms sell more and produce more, etc. The additional production increases capacity utilization, so that firms increase their physical investment, which means that firms sell more capital goods to other firms, produce more, hire more workers, etc.”

    The problem is that the US no longer produces or manufactures much of anything. And it is sad to say that a big portion of the stimulus money that ended up in the US workers hands were spent in China. i.e. cars, computers, appliances, TVs, electronics home items etc. etc.

    Our stimulus benefited China with more jobs, These Chinese workers therefore buy more Chinese items, so that Chinese firms sold more to the US and China produced more, etc. The additional production increases the Chinese capacity utilization, so that Chinese firms increase their physical investment, which means that Chinese firms sell more capital goods to the firms outside of China, which allows them to produce more, hire more Chinese workers, etc. etc.

    The US economy is no longer that of our grandfathers. We do not operate in a vacuum. Only when we return to manufacturing and exporting more than we import will things get better. If you say it will never return to once it was; well there is your answer on when things will get better – it is not. I feel your frustration, but let’s be realistic, in today’s real world doubling or tripling the stimulus will not help the US produce more. It will help stimulate the Chinese or other major manufacturing countries with the US citizen providing the stimulus as the buyer.

    Unfortunately I do not see anything in the horizon that indicates that the US will have unemployment under 8%, but I do see in the next year or two, lower average wages and unemployment exceeding 12%. There are solutions, but like the people of Greece, the people of the US are not willing to accept reality, nor are they willing to make the necessary sacrifices. God help our grandchildren.

  25. dhlii Says:

    another argument being made is that little of it was of the type actually needed.

    I think Hayek would haves responded with – and why would you have expected any differently ?

    Even if the problem was fixable by government stimulus, The fact that the stimulus had to come from government pretty much guarantees it will be designed according to the needs and wants of politicians not the economy.

  26. [...] other policy responses that have had at best an ephemeral effect, click the highlighted text for Mario Rizzo on fiscal stimulus and Jerry O’Driscoll on the Federal [...]

  27. [...] plenty that the man himself foresaw. Besides the question of the effectiveness of such programs – click for one of the posts on the subject by Mario Rizzo –  there is the matter of runaway government spending.  Keynes himself favored budget surpluses [...]

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