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