Federal reserve implements its own stimulus

Great Debates
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Actually, Cochrane and Fama took a more flexible view towards the efficient markets theory. Fama wrote papers debunking CAPM, offering a 3-5 factor models in their place. Cochrane authored a work explaining that returns in fact were predictable. Sure they liked the efficient markets hypothesis, but they weren’t wed to it. Now it seems to me that they weren’t sufficiently skeptical: see my DeLong quote above. But heck, neither were lots of people, including myself.

Another obseration:
If we can get 2.5% growth, enough to keep unemployment where it is, that should repress wages but may not be all that bad for profits – after all the top line is growing while costs would be constrained. That’s what happened during the 2000-2001 era, IIRC. The problem is continued disinflation will drive up real interest rates – leading to inadvertently tighter monetary policy, regardless of what the Fed does.

Today’s news:
Core inflation just dropped to 0.6% today (year on year). I’m wondering when the business community will start to fear deflation. Warren Buffet thanked Uncle Sam for his muscular approach to the financial crisis. Indeed: policy makers prevented depression 18-24 months ago: many Congressmen voted courageously. Others, of course, did not.

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I think educated people on the other side of the debate understand crowding out and the concept of applying fiscal stimulus to under-utilized resources to avoid crowding out. The argument is actually more nuanced than that. At least, mine is.

My argument is that statements like yours still rely on aggregate measures and treat the economy as if its uniform in its response to stimulus. My argument is that in the real world, where stimulus funds are apportioned by politicians who are in turn influenced by special interests, there is no way that the fiscal stimulus will make its way purely to under-utilized resources.

Also, when the stimulus money isn’t handed out like a helicopter drop randomly across the economy but instead is targeted to special programs such as green technology, high speed rail, and other infrastructure projects, it’s even less likely that it will be targeted at under-utilized resources. Therefore, there will be significant crowding out, and it will affect the theoretical multiplier substantially.

There is plenty of evidence that this in fact has happened. Some of the stimulus money went to giving raises to public employees, for example. These were not under-utilized resources. There is also evidence that the states that accepted stimulus funds used the money to fund existing operations that they would otherwise have had to borrow their own money to continue. If so, there would be zero multiplier from that, because the money would have made its way to those projects in any event. All the stimulus did in those cases was federalize state debt.

I have personal experience with crowding out effects from the stimulus. My company got a lot of stimulus funds, and used it to fund lucrative projects at high profit. The problem is that there is no glut of engineers, so the company simply killed lower-margin projects and reallocated those engineers to the new projects. I’m sure they reported ‘net jobs created’ on those projects, but they didn’t have to report the jobs lost on the other projects.

The other argument ‘my’ side makes is that this stimulus money distorts markets and makes them less efficient, and it prevents the corrections necessary to get rid of the misallocations that already exist. Japan’s decade long stimulus has resulted in ‘zombie’ companies that produce little value to the economy, but stay alive on government stimulus money. They tie up resources and expertise that could be applied where it would do more good.

Or take the case of my company and those projects that were killed. Those projects were creating products the market was demanding. They were killed so that resources could be funneled to projects that chased easy government money, which is not the same thing. And, we actually laid off people. For example, salesmen and customer engineers who had expertise in the vertical market we abandoned. That’s real capability that my company has lost. When the stimulus money has dried up and the market reasserts itself, we will have less capacity than we would have had without the stimulus. Real productive capacity and real wealth was destroyed because of crowding out. But the pure Keynesian aggregate models simply don’t consider these effects.

This might be part of the reason why so many new papers this year are finding much lower multipliers than the stimulus advocates promised.

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Sam -
I’m not familiar with those papers reporting lower multipliers. Please pass on a cite or if that’s not possible your recollections on the source.

I see no evidence that Cochrane or Fama were presenting Sam’s argument: they phrased it in the form of an identity, an economic truth after all.
Sam’s argument is worth serious treatment, in my view: perhaps one day a researcher will investigate his concerns and report some empirical measurements. In the meantime, let me make some observations:

a) Even if you hire a guy to build pyramids, only part of the additional demand will be in the form of this pointless project, assuming the multiplier is greater than one. For the newly employed worker will himself spend his funds on things he would not have otherwise, and this other source of added spending will have no discretionary component. (We can measure this part by taking the multiplier and subtracting one.)

b) “There is also evidence that the states that accepted stimulus funds used the money to fund existing operations that they would otherwise have had to borrow their own money to continue.” That doesn’t sound right. The states have tighter effective budgetary constraints than the federal government. Aid given to the states should reduce their need to raise taxes or cut spending. It appears that Sam is misapplying an argument typically applied to corporate welfare-style tax breaks.

c) Typically the story about Japan’s zombie companies is made with respect to banks, and not big guv, AFAIK. We hear about marginal light manufacturing concerns, not marginal public construction companies.

d) Sam’s story about his company was pretty interesting, IMHO. That said, I find it likely that employment in his company was higher with the stimulus than without it, assuming that I understand him correctly. In other words, in aggregate there probably has been “Crowding in”, or higher total investment due to enhanced aggregate demand. The problem is that potentially Sam’s company switched to lower value-added activities. That’s a possible cost. It deserves scrutiny, but I think it’s fair to say that we shouldn’t simply assume that net social welfare losses ensued. After all, green energy, roads, rails, police, fireman and even high speed rail surely have some value. And the freight rail investments are terrific: the US has a number of bottlenecks that need clearing. [1]

e) Monetary policy, alas, also has some distorting consequences. Its effects tend to get concentrated in residential housing. Then again, the added demand from refinancing home mortgages presumably is pretty well distributed across the economy.

f) To be clear, I’m calling for substantially higher short run federal deficits as well as expansionary monetary policy, as the costs of lost decades and unemployment north of 8% (assuming a NAIRU of 5.5-6.0) are pretty high. My favored form of stimulus is to write checks to the states. They are broke and postponing state budget cuts and tax increases is wise during recession. They are also self-limiting, as Congressional Representatives in Washington don’t really like handing money over to potential challengers in their home states.
[1] … the most notorious being in Chicago. Incredibly, the US doesn’t have a continuous East - West rail line: goods have to be offloaded on the West side of Chicago, trucked to the East side, and reloaded on Eastbound trains. Goods take as long to cross the windy city as they do to travel from Chicago to New York. So yes, there are productive activities that the government can and does undertake.

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Measure For Measure:

Here are some examples:

New Keynesian versus Old Keynesian Government Spending Multipliers

How Big(Small) are Fiscal Multipliers?

There’s a more detailed but gated version of this paper I can’t link to. However, here’s their Powerpoint deck containing the data.

This paper contains new analysis of fiscal and monetary policy in the 1930’s, and suggests multipliers were lower than others have claimed for the time: U.S. Monetary and Fiscal Policy in the 1930’s

NBER Working Paper 15369 - Macroeconomic Effects from Government Purchases and Taxes

This is a gated paper I can’t link to, but here’s the abstract:

Robert Barro (Professor of Economics at Harvard) Editorial in the Wall Street Journal:

There are a number of other papers out there that are finding lower multipliers as well. This is just a representative sample. There’s an IMF study that suggested U.S. multipliers were in the range of (if I recall correctly) .2 to 1.2, depending on where the money was spent.

Finally, I think the recent Romer and Romer paper which attempted to understand the effects of tax changes by looking at ‘exogenous’ taxes, has a lot of implications that have yet to fully work their way through the economic literature. For example, their finding that tax increases of 1% of GDP can result in as much as 3% of GDP growth rate reduction is a much higher effect than they or anyone else had thought. But even more interesting was that they found that tax increases used to pay down government debt had no negative GDP impact at all. This implies that public debt exerts a bigger drag on the economy than was previously thought, and that has big implications for borrowing money for fiscal stimulus - Implications that are not considered in the models used earlier by Romer and by the CBO.

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Sam: thanks for linking to that set of papers.

Here’s my biggest comment: generally speaking, the less effective fiscal policy is, the more effective monetary policy becomes. Indeed, a number of centrist and liberal economists leaned towards fighting recession purely with monetary policy and automatic stimulators. I frankly lean against that, but I understand that I’m in the minority on this one.

This recession is different though, as conventional monetary policy has maxed out: the fed funds rate is essentially zero. So we were left with fiscal policy and unconventional monetary policy. If multipliers are shockingly low and monetary policy is ineffective then we need a larger stimulus package, which sucks. Believe it or not, I’m not exactly enamored with $800 billion packages, never mind $2 trillion efforts. Looking forward, I’d like to increase the inflation rate, so as to enhance the capabilities of monetary policy during recession. It’s a matter of tradeoffs of course: I’m not advocating double digit inflation.

Some specific comments:
The implication in some of the papers was that Romer took an extremist model: this was not the case: her models were standard ones used in the forecasting industry. Taylor et al point out that a particular New Keynesian model has smaller multipliers but did not present any forecast comparison between the 2 types of model. So while it was an interesting paper on theory, the policy implications are nil.

I liked work by Ilzetzki, Mendozaand Vegh. It showed fiscal policy becoming less effective in the US over time, as its economy becomes more open. This is to be expected: expansionary monetary policy weakens the home currency, while fiscal policy strengthens it. Weaker currencies enhance exports and reduce imports. What was interesting were the numbers that the authors provided. Small open economies with flexible exchange rates appear to have multipliers under 0.5, so discretionary fiscal policy seems like a bad idea. Larger more closed economies with fixed exchange rates (eg China) have more scope for fiscal policy (and less for monetary).

I should like to see the model of Ilzetzki, Mendoza and Vegh compared with the models proffered by the 3 major macroeconomic forecasting firms, all of which show larger multipliers for the US, AFAIK. We need to compare the performance of these different simulations.

Romer and Romer’s paper didn’t really address liquidity trap situations. And Barro’s paper has some oddities that I can’t quite remember at present. In general though, I think there’s a good case to be made for the declining effectiveness of fiscal policy as a greater proportion of US economic activity is affected by world trade. Working out what the current multipliers are is an issue that deserves serious study and scrutiny, which of course we aren’t equipped to do in this forum.

For the sake of completeness, there’s a third aspect to economic recovery from financial crisis. Policy makers have to bite the bullet and get the banks to recognize their losses, declare bankruptcy if necessary, and start over. The process was slow during the S&L crisis, but interminable in the case of Japan: their system wasn’t equipped to handle that challenge. Then again, I understand that Japan had arguably superior policies than the US has had from 2007-2010, at least in terms of growth performance.

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I poked around the internet a little. In the US, there was indeed heightened unemployment among electrical engineers in 2009. Here’s one roundup: http://www.computerworld.com/s/article/9139095/Software_engineering_jobs_decline_slightly

But what I think is going on is that Canada’s NAIRU is apparently in the 7-8% range [1]: their current unemployment is 7.9%. So there isn’t anywhere near the same level of slack in the Canadian economy. Canada apparently doesn’t need a big stimulus package, probably because of their prudent regulation of banks in the 2000s. The US in contrast has a NAIRU of perhaps 5-6%, so the 9.6% rate today is rather elevated. So stimulus absorbs lots of unemployed resources in the US, but in Canada where there is less slack, a greater proportion results in re-allocations among the various economic sectors.
[1] Cite: Xia (2004) Estimating Canada’s NAIRU

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If you’re just looking at ‘electrical engineers’, you’re still not thinking granularly enough, and I think this is a real flaw among economists who don’t have a real grasp of the complexities of markets from real-world experience.

There are plenty of electrical engineers that don’t have jobs. But how about electrical engineers skilled in control systems and HMI design? There are lots of IT people out of work. But how about IT people who are capable of setting up load-balanced server farms? There are lots of programmers out of work - but how many programmers who are skilled in writing for Apple IOS with a track record of success?

In the real world, we hire people based on narrow specialty quite a bit. The aggregate unemployment number is meaningless. We have positions that have been open and unfilled for months, while people who would fit in the same employment category as far as the government and economists are concerned cannot find work. Our economy has become highly specialized.

Take the infrastructure projects that were supposed to be ‘shovel ready’. I’ve heard economists say that infrastructure projects are a good way to spend stimulus money because there is slack in in the construction industry and a glut of tradesmen. So let’s put them to work in other ‘infrastructure’. But in the real world, a road project doesn’t need carpenters - it needs people who can run paving machines. The skills needed in the early stages of building a bridge are totally unrelated to the skills required in later stages - or the skills required for building residential housing.

And you need lawyers. Let’s say there’s a glut of lawyers. But you don’t need divorce attorneys, tax lawyers, or public defenders. You need lawyers trained in environmental law, zoning regulations, and liability. You need contract lawyers. You need people who know how to make the wheels of government turn and get approvals. These lawyers may be in short supply even if there’s 20% unemployment in the law field in general.

That’s why I said earlier that the more the government tries to direct stimulus money to specific projects, the more crowding out there will be, regardless of the general level of employment, even within the broad job categories that fit the project.

For example, let’s say you decide to build a bridge. And let’s even stipulate that there are a lot of bridge workers unemployed. But who do you need in the early stages of bridge building? You need civil engineers who are skilled at planning large projects. These are high level people with great skill, and they’re probably near full employment. In engineering, it’ll be the junior engineers who can’t find work. But at the start of a project you need people who will be able to work with stakeholders, who can make proposals, wade the minefield of regulations, and do high-level architecture. Such people are almost always in short supply, and a new bridge project will likely have to poach such people from other projects.

So not only are they crowding out another job, but these people’s skills are often highly leveraged - poach a senior planning engineer from an ongoing project, and you can derail the whole thing and cost millions of dollars.

Or take that example in my own company - there may be high unemployment of technical salespeople, but when you’re trying to build electronic health records, the salespeople you need are people with both an engineering background and an understanding of the health care industry. Are those people unemployed? If not, and you get a government stimulus project that requires you to move into the health care vertical when your company’s experience is in automotive, suddenly you’ve got a lot of salespeople who are useless to you, and you have to hire the new salespeople away from other firms.

And what if you can’t find those people? Are you just going to turn away the government money? Probably not. You’ll try to build the project without having the requisite domain knowledge - and fail.

Maybe you could treat labor as an aggregate number in 1930, when building roads just meant giving a lot of strong people shovels and pickaxes. Today, I guarantee that no matter how high the unemployment rate is, any technical project will require employing people who are already committed to other projects.

As for creating jobs with infrastructure, the problem with that is that in the early stage of infrastructure projects there just isn’t that much employment required. For a long time the project will be in the hands of just a few people doing the design and legal work before the armies of workers can be brought in. And on many projects, even after ground is broken the early stages may be marked by just a few people doing things like seismic analysis, site prep, supply chain building, surveying, etc. And again, these are going to be high-level people who as a class are probably not highly unemployed.

In addition to labor, there’s the supply chain. Just because there is a lack of aggregate demand in the economy does not mean there’s a glut of all the things you need to build projects. For example, concrete is in short supply because of heavy use of concrete in China. So every new infrastructure project is going to be bidding against all existing projects for concrete. Certain types of heavy equipment like large cranes are always in short supply and sometimes have to be booked long in advance. And so it goes.

This is not to suggest that stimulus is always a bad idea. It does suggest that real-world multipliers are likely to be significantly lower than aggregate models would predict.

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Excellent post. As always Sam, you do a much better job than I at articulating why I do not advocate giving vast amounts of power, in the form of manipulating fiat money and or directing $100s of billions, to the government.

It’s not that in theory these things shouldn’t work. It’s that these systems are impossibly complex, need to be de-averaged (and then de-averaged again) and are filled with unpredictable and misunderstood 2nd and 3rd order effects and feedback loops.

I find rearward-looking econometric studies very interesting. But it does not mean that I as a citizen will advocate enormous reins of power to well-educated and well-intentioned technocrats. For some of the reasons you mention above.

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Can you guys use your economic understanding to recommend fruitful investment ideas?

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Work hard, live below your means, save and invest in a well-balanced portfolio.

Then enjoy being alive, and the gift of living in a free country.

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I was wondering if the in depth knowledge of macroeconomics could be translated into personal wealth.

As far as your suggestions, I have followed them, and have hit the 401K limit as a " highly compensated employee", so I need investment ideas.

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It’s fair to say that the Chicago people are generally in favour of deregulation and so on. They’re also the guys who came up with the efficient markets thing. And the point I’m making is that even after the market blew up they were still defending an idology which events had proven to be not exactly sound.

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Barro makes a great deal of the fact that private spending fell during World War II, rather than rising the way it should in a classical Keynesian (oxymoron?) story. What I and others immediately pointed out was that this tells us very little about what would happen under current conditions: during World War II there, um, was a war on: consumption goods were rationed, construction required special permits, and so on. The government was, in other words, deliberately suppressing private spending, through direct controls. So WWII is not a useful data point for determining what the multiplier is under other conditions.
Barro’s response to this, as far as I can tell, was … nothing. I don’t think he even acknowledged the nature of the complaint.

http://krugman.blogs.nytimes.com/2009/10/01/multiplying-multipliers/

Sam, in response to the financial crisis Ireland has done what you’d like to see happen in America. They’ve slashed government spending to the equivalent of America getting rid of its entire defence department. They’ve got the lowest corporation tax and lowest regulation of any country in Europe and have the most business-friendly policies towards foreign corporations. Yet things don’t seem to be improving over there, quite the reverse in fact. Why is that?

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Sorry, I missed this earlier.

Ireland’s problem was runaway government spending. Actually, until 2007 Ireland was doing just fine, with government spending rising pretty much in line with rising government revenue. Then the recession hit, and Ireland did what you think it should have done - in response to a floundering economy and decreasing government revenue, it ramped up government spending. This created a huge gap between revenues and spending, which put them in the fiscal situation they are in now.

In addition, Ireland is tied to the Euro, so it couldn’t devalue its currency or allow floating exchange rates to correct for imbalances between its policies and those of its neighbors. This is a flaw with the Euro Zone in general, and it’s manifesting itself in many countries right now.

And since you’ve cherry picked one thing - corporate tax rates - to blame everything on, I’d like to flip that around to you: Ireland’s government is huge. It consumes about 55% of GDP. If big government is so great, how come Ireland is failing? If deficit spending is required to recover from a recession, how come Ireland’s huge deficits and huge increases in government spending haven’t caused it to bounce back? Why has it become the basket case of Europe?

Let’s get back to those corporate taxes, since you seem to think that they are the problem.

Here’s the blog of an Irish economist, with a graph of spending vs revenue. You’ll notice a couple of things on that graph:

  1. When Ireland lowered corporate tax rates in the late 1990’s, overall government revenue actually started increasing faster, due to increased economic growth. The lower corporate tax rates were phased in between 1998 and 2003, and a reduction to 10% for manufacturers was added in 2003. The rate of revenue growth actually increased after this period.

  2. It’s clear from the graph where the problem lies - revenue collapsed due to the recession, but government did not respond by reducing expenditures. This caused the huge budget shortfall Ireland has today.

This Table shows Ireland’s corporate tax revenue from 1998, when the cuts started to be phased in, to 2001 when they had already been substantially lowered. During that period, Ireland’s corporate tax revenue increased from 2.1 billion dollars to 3.2 billion. Overall tax revenue increased from 16.1 billion to 22 billion. The other graph I linked to shows that annual revenue increased at a roughly equivalent rate right up to the recession.

It looks to me like lowering the corporate tax rate was a good thing for Ireland’s economy and government revenue, and the problem lies elsewhere.

The other Euro countries are fixated on Ireland’s corporate tax rate. Why? Not because those tax rates were the problem, but because other, higher-tax countries don’t like them. If makes the other countries less competitive, so they’re using the crisis as a hammer to force Ireland to raise taxes to the other country’s benefit.

By the way, Canada is also reducing its corporate tax rate to 12.5%, and it’s already much lower than the U.S. rate. And yet, we don’t seem to be in an economic crisis. Care to explain that?

Maybe a clue is in that rapidly growing government in Ireland - it’s grown from less than 40% of GDP to 55% of GDP in just four years! Canada, on the other hand, has reduced the size of its government from 53% of GDP to 35%, and we’re doing much better.

And Germany and the UK’s austerity programs don’t seem to be hurting them. The UK’s growth rate remains stable, and German business confidence is at a record high. In addition, consumers in Germany have reacted to the austerity measures by spending more money, because they are now more confident in the future finances of the country. Funny how that works, huh?

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I will note that we are in the midst of a hijack: Sam and I are discussing fiscal policy, while the OP addressed monetary concerns. That’s ok though: we are on page 2 after all.

What can I say, Sam? The aggregate data is consistent with your observed experience. Canada’s unemployment rate is at a level where the need for additional stimulus ranges from “Small” to “Unnecessary”.

Well… your story is a different than the usual description of “Crowding out” and my concern isn’t just terminological. Typically crowding out is mediated through the credit market and the central bank: it happens during times of economic expansion. Increasing government spending without offsetting tax cuts does increase aggregate demand – but since the government borrows in the credit market, it also tends to be offset by a decline in investment. Now the central bank can increase the amount of credit available – but when capacity limits are in place, they are reluctant to do so because of inflation fears. So there’s an offset.

You know all that of course – how does that story contrast with yours?

Nothing in that denies that an increase in government expenditures will add to demand. None of it asserts a decline in investment demand. Your remark is supply related – because the project draws off talent from other sectors, it becomes more expensive to produce such unfavored products. So a big conglomerate will expand its wind turbine production and delay introduction of its new electric generator. Of course part of the reason why they do that is that demand has collapsed among electricity producers (and I’ve noted that lame excuses aren’t exactly unusual within the business press ). But supply considerations plausibly play a role as well.

Here’s the punch line though: if it’s a supply effect and underlying demand for the abandoned product is constant then we should see higher prices as a result. (We might also see entry into the field by other firms). But again, the US has had continuous disinflation for the past year. Now it’s possible that in the absence of stimulus, inflation would have dropped faster – but that would have been a bad thing, right?

The existence of continuing disinflation implies that the effect you are alluding to is small. I prefer to discuss trends in trade dependence when discussing multipliers.

The hell? Look at the top graph in your link. Spending increased at the same rate as it always had – it was tax revenues that collapsed. The same pattern exists in the US by the way, provided you pool state, local and federal spending. Indeed, Rogoff and Reinhardt note that most financial crises lead to huge budget deficits, but that collapsing tax revenue explains about 2/3 of that IIRC.

In terms of politics, Ireland has been big on austerity – you can see it in that last blip downwards of government spending. It didn’t work: the economy contracted anyway: in fact they’ve performed worse than both Spain and Iceland, IIRC. Spain did better because they ignored calls for retrenchment. Iceland did better because they could devalue. (It seems we agree about the problem with the Euro by the way. As I see it, common currency areas require a robust federal structure and countercyclic transfers across borders: if you can’t manage that, then don’t merge currencies. Unfortunately, I understand from Barry Eichengreen that currency mergers are irreversible, absent unthinkable crisis. Which we might get anyway.)

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Isn’t that just one aspect of crowding out? Crowding out occurs whenever government action displaces private action instead of merely employing ‘idle’ assets. You can have crowding out in labor and materials and fixed assets just as much as you can have crowding out in the financial sector.

If there aren’t enough of a certain type of engineer to go around, then both projects cannot exist at the same point in time. If one was already being built, and the government attempts to build a second, then either the government project will be stalled for lack of available resources, or the private project will be displaced. Either way, there would be no increase in output.

I think this is an excellent point, and one that I hadn’t really considered. However… The effect would necessarily have to be small, wouldn’t it? We’re talking about a stimulus of roughly 1 trillion dollars. If crowding out causes (picking a number out of the air) a 20% decrease in the size of the multiplier, we might be talking about an effect of 200 billion dollars. If that in turn causes price inflation in the value of the assets crowded out of 10% per year, then that’s an inflationary effect of only about 20 billion - small enough to be hard to detect in aggregate inflation measures.

You’re right. My bad. When I wrote that, I was looking at a graph of spending as a percentage of GDP, which does show a huge ‘ramp up’. But as you say, that’s not because of additional program spending, but because GDP has gone down while spending remained constant.

Sure. However, Ireland’s government consumes a much larger share of the economy, so when GDP collapsed I imaging the gap between revenue and spending increased faster than in countries with smaller governments.

Well, it’s clear that austerity didn’t cause the downward trend - the sharp downturn in GDP began almost two years before Ireland started cutting spending. But the graph also shows that the downward decline in GDP did not get worse with spending cuts, in fact, the slope of the downwards curve flattens out just after the spending cuts. But I wouldn’t read too much into that. It could be just the natural business cycle asserting itself, or the result of something else. It’s also a little too soon to tell the full affect of the austerity plan - for good or bad.

I think the problems with the Euro will continue, and it will be phased out at some point in the future. I don’t think it can be done suddenly across the board. But it always seemed crazy to me to take numerous countries with different governmental structures and put them all on the same currency. I had thought we learned our lesson much earlier when we stopped pegging currencies and moved to floating exchange rates. I understand the problem Europe has with currency friction, and applaud the EU’s goal of a giant free trade zone, but the Euro was a mistake. They should have found a better way to deal with the problem.

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Sam - I’m imagining that conventional crowding out represents an offset to AD expansion, while your story operates through aggregate supply. So in this context increasing G shifts out aggregate demand by a large amount as it shifts back AS by a milder amount. Both cause higher prices, though the effects on output depend upon the relative magnitudes.

In the case of the US, total growth in federal, state and local expenditures were roughly constant during the period: the stimulus package was offset by state and local contraction. I would think that the AS effects would be proportionately larger in a country closer to full employment than one with some excess capacity – although your point that today’s labor is highly specialized relative to the past is noted. But specialization should be reflected somewhat in a higher NAIRU, which we have estimates for (5.5%US, 7-8% Canada).

The OP:

The Euro incidentally has actually weakened over the past few weeks, owing to problems in Ireland and Spain. So the effects of QE2 have been overwhelmed by events so far. Admittedly the dollar has declined against the Yen. Still, lowering 5 year rates by about 3/4 of a percent really isn’t that expansionary: opposition to this policy is IMO highly misguided and the case for expansionary policy is strong.

Cartridge must be defeated. We need more stimulus. To those who fear inflation, I say get back to me when US unemployment hits 7% (equivalent to a Canadian rate of ~9%).

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That’s a surprising reply about Irish government spending because what actually happened back in 2008 was that Ireland opted out of the eurowide stimulus programme and started to slash government spending. And from a low level too. It was collapsing tax revenues and the government bailing out the banking sector which caused the huge gap between revenues and spending. And the revenues/spending situation happened due to an unregulated financial sector and the Irish government’s business-friendly pro-growth policies. Here’s the rightwing nutjob think tank that you usually choose to rip off their stuff and plagiarise it here as your own ideas, the Heritage Foundation, praising Ireland for slashing gocernment spending and keeping it low:

The reductions in government were especially impressive. A Joint Economic Committee report explained: “This situation was reversed during the 1987-96 period. As a share of GDP, government expenditures declined from the 52.3 percent level of 1986 to 37.7 percent in 1996, a reduction of 14.6 percentage points.”[32] As Chart 2 illustrates, Ireland has been able to keep government from creeping back in the wrong direction.

And then Ireland had an economic meltdown. This was caused entirely by bad private sector lending/securities speculation by unregulated Irish banks and the government then having to bail out the catastrophic failure of the banking sector. Amazingly Ireland managed to blow its own economy up without having entities like Fannie O’Mae and Freddie O’Mac and politicians like Irish premier Jimmy O’Carter encouraging subprime lending 30 odd years ago to do it for them. I still can’t understand how a completely unregulated financial sector/low tax, low-government-spending business-friendly pro-growth economy could fail as disastrouslyl as Ireland has, perhaps you could explain it to us.

Anyway, the Irish economy started to melt down. And the Irish government responded to it by guaranteeing the solvency of their banks, causing the sovereign debt level to skyrocket. And they also started to slash spending :

Finance Minister Brian Lenihan started slashing spending in 2008, calming investor concern that Ireland would default on its debts amid the worst recession in the country’s history.
Now, Anglo Irish’s woes are casting doubt over the country’s creditworthiness and reignited calls to turn the nationalized lender over to creditors. The government seized control of Anglo Irish in January 2009, four months after guaranteeing deposits and most of the borrowing by Irish banks.

http://www.bloomberg.com/news/2010-09-01/irish-ask-how-much-is-too-much-as-anglo-irish-bank-rescue-trumps-austerity.html

Ireland won’t take part in EU stimulus plan

       Updated: Wednesday, 26 November 2008

The European Commission has proposed a €200 billion plan to revive EU economies, however it is thought that Ireland is unlikely to get involved.

September 25, 2008 - Ireland becomes first euro zone country to slide into recession in 2008 after its property bubble bursts.
September 30 - Ireland becomes one of the first countries to respond to the collapse of U.S. investment bank Lehman Brothers, approving a guarantee covering 400 billion euros ($532.2 billion) of liabilities at six Irish-owned banks. The package is later increased to 485 billion euros to cover foreign-owned banks with significant operations in Ireland.
December 21 - Ireland agrees to inject 5.5 billion euros ($7.7 billion) into its three main banks, taking Anglo Irish Bank under its control.
February 4, 2009 - Cowen says senior executives hired to work at banks receiving state funds should face at least a 25 percent cut in remuneration and their salaries should be capped.
March 30 - Standard and Poor’s downgrades Ireland’s credit rating from AAA to AA+ and says it could drop further, in a sign of no-confidence in Dublin’s efforts to get its public finances under control. Fitch strips Ireland of its AAA credit rating on April 8, reducing it to AA-plus.
April 8 - Lenihan outlines 10.6 billion euros in spending cuts for 2010-2011 and forecasts an additional 3.25 billion euros from taxation in that period in an emergency budget, the second in six months.
December 9 - Ireland’s 2010 budget delivers savings of more than 4 billion euros, slashing public pay and welfare to try to halt the soaring deficit.
http://www.reuters.com/article/idUKTRE6AO1KW20101125

As far as corporation tax goes, the fact that Irish revenues went up just shows that corporations operating in the EU free trade zone moved to Ireland to pay less tax. There’s no net benefit to the EU.

Canada is doing well due to the fact that its banking sector, unlike America’s, was heavily regulated and so it avoided the kind of crash America and Ireland have had.

And yet agsain you claim that improving conditions in the UK and Germany are due to them cutting government spending when it’s already been explained to you that this is not the case. Germany aren’t cutting spending till next year, the UK are starting cuts around now. German business confidence is strong because they’re seeing record demand from Asia for their exports and this might offset the decline from western markets. And Asian demand is booming due to the fantastic success of their governments’ fiscal stimulus programmes.

Germany launches second economic stimulus package; Spain joins Ireland and Greece on Standard & Poor’s credit watch list
By Finfacts Team
Jan 13, 2009 - 7:28:33 AM
Germany’s stimulus package was announced following high-level talks between the Social Democrats and Chancellor Angela Merkel’s Christian Democrats at the chancellery in Berlin. The two-year package will be worth €50 billion and is focused on investments in infrastructure projects and education.

Meanwhile, Germany has committed itself to deficit cutting, but it is not cutting now. Germany is one of the few euro zone countries to increase its budget deficit from 2009 to 2010. And planned 2011 cuts are quite small relative to those in countries pursuing crash austerity programmes, which are also suffering very weak recoveries (Greece has yet to get out of recession, and Spain may be heading back in).
http://www.economist.com/blogs/freeexchange/2010/08/german_recovery_3

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Ireland had a booming economy in the 2000’s, with skyrocketing revenue due to a large economic bubble. Ireland then simply grew the size of its government to eat up all the revenue. Then when the bubble collapsed and the revenue vanished, Ireland found itself with an unsustainable governmental structure.

Between 2000 and 2006 Ireland doubled the size of its expenditures. After their revenue began to collapse in 2007, Ireland continued to increase expenditures, adding almost as much again in two years as their entire expenditure level in 2000. It wasn’t until 2009 that Ireland began cutting spending, two years after revenue began to collapse. As of FY2010 they had only reduced spending back to roughly the 2007-2008 level, which is still more than double what they were spending in 2001.

If you look at the graph I linked, it shows that the rate of revenue loss actually slowed after Ireland cut spending. That may be just a correlation, but there’s nothing in the data that I can see which shows that cutting spending made the situation worse, and the cuts certainly didn’t cause the problem since they lagged the collapse in revenue by about 2 years.

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nm