Tuesday, May 10, 2011

A stimulus doesn't work

As regular readers will know, your humble Devil has not read any economics or philosophy books (if you exclude Ayn Rand); the philosophy that I expound has been gathered and moulded by events and the application of thought to the problems that I see. It is for this reason that I am, in fact, not nearly as dogmatic in person as you might expect.

Having said that, I have picked up enough to know something of these matters (mainly from bloggers, it must be said) and, as such, I can appreciate that both of Econstories.tv's Keynes vs. Hayek rap battle videos are great, laying out the foundations of their respective philosophies in an easy to understand and also, dare I say, rather funky way.

Whoever you think has won these little rap-spats—and yes, I think it is Hayek—there are three other points that are worth considering.

The first is that Keynes maintained that any level of general taxation above 25% GDP was unsustainable—our governments are now spending near double that.

The second is that Keynesian economics does require that governments save money during the good times so that the stimulus required in the bad times is sustainable—he did not advocate that governments borrow money like a family-less terminal cancer victim on his last blow-out.

The third is possibly the most important of all—what if the stimulus, of the sort advocated by Keynes, does not actually work?

Tim Worstall's article at the Adam Smith Institute seems to suggest that, for certain types of advanced and open economies, the net impact of the fiscal stimulus is not necessarily positive and may, in fact, be negative.
Rather a lot of macroeconomics is conducted with models. Given the complexities, this is inevitable, but it is necessary, at least occasionally, to look up and calibrate the model against reality. Which is just what this paper (via Scott Sumner) has just done. For those of a Keynesian persuasion, the results aren't pretty.

You see, the central conceit, that government borrowing to spend boosts the economy by more than the amount of the spending, the multiplier, just isn't true. Just isn't true for us here in the UK, that is. The fiscal multiplier just doesn't multiply.
... the impact of government fiscal stimulus depends on key country characteristics, including the level of development, the exchange rate regime, openness to trade, and public indebtedness.

Higher development (like us) makes for a higher multiplier. Openness to trade for a lower. These two might, in our circumstances, roughly balance each other out. However:
Indebtedness also matters: when the outstanding debt of the central government exceeds 60 percent of GDP, the fiscal multiplier is not statistically different from zero on impact and it is negative in the long run.

Hmm, so, UK debt is, end Jan this year, 57.6% of GDP. So, at current borrowing rates we've about 3 months before the effects of deficit spending turn negative. But that's not the end of it:
Exchange rate flexibility is critical: economies operating under predetermined exchange rate regimes have long-run multipliers greater than one in some specifications, while economies with flexible exchange rate regimes have multipliers that are essentially zero.

The pound is extremely flexible: so none of the fiscal stimulus we've already had has had any effect either.

If this paper is correct then that's it for Keynesianism in the UK, into the dustbin of history with it. For if the fiscal multiplier just don't multiply, there's no point to it all at all.

So, for economies like that of the UK, a fiscal stimulus is not only likely to do no good at all, it could be detrimental.

And that's apart from driving us further and further into debt.

So, that's why I am taking part in the Rally Against Debt next Saturday—I do hope that you'll join us...


Lord Blagger said...

Hmm, so, UK debt is, end Jan this year, 57.6% of GDP. So, at current borrowing rates we've about 3 months before the effects of deficit spending turn negative. But that's not the end of it:


Ignoring paying pensions, civil service, state and state second pensions. The really really big debts

Mr Ecks said...

Fantastic videos--esp the second one.

The message, true as it is(Hayek wins hands down),isn't as much fun as the medium tho'.
Mayhap the next video could show Keynes and Hayek rapping in a post-economic catastrophe wasteland. It could start with with the two of them meeting in a soup kitchen line and go from there.

Word Verification= WISEQU--I kid you not

CC Truckston said...

It boils down to this: For the profligate individual, spending more than one makes by borrowing against future income is a gamble that rarely pays off and often leads to financial ruin. For a government, spending more than tax revenue leads to inflation which taxes its citizens, the profligate and the responsible alike; and raising taxes to meet overspending leads to inflation which taxes its citizens, the profligate and the responsible alike. Spending what one doesn't have is wrong for government as well as individuals.

bewick said...

MMMM. Now I DID read economics for a short time but never trust economists (or statisticians, sociologists et al) as a result.

Nor do I trust the IPCC or Professor Jones of UAE. (professor? - charlatan more like)

I'm with the Devil - he reminds me of ME 30+ years ago. and I went to a Grammar School.
Would that I still had the fire. (maybe I still have but am too effing lazy these days)

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