The virtues and risks of fiscal packages

There are currently three schools of thought on how best to address the current global crisis.

One takes the view that it is all due to more expensive financing- not due to decreased demand. Peter Auer, Raphael Auer and Simon Wehrmuller want to rely exclusively on reducing the high cost of obtaining external funds, which accounts for most of the decline in employment in US industry since August 2007.

A second group, like Tyler Cowen and John Taylor, do see a strictly limited role for fiscal policy. For example, Taylor wants to respond with a Bush-like scenario, such as a permanent tax cut. It rejects the idea of an increased spending stimulus because expectations of the future that are now built into decision in virtually every market (the Ricardo effect).

Cowen believes that when monetary aggregates are falling, because of either a credit crunch or a liquidity trap, a fiscal boost can keep aggregate demand from deteriorating. Today, we are seeing a contraction in both credit and in the shadow-banking sector so we cannot expect the benefits of monetary expansion to kick in quickly even over six months.

Yet some fiscal packages are lousy. They tend to hinder the pace of adjustment and recovery e.g. cutting back on welfare, such as generous middle class welfare (much of which would be retained as savings) or of steps to strengthen unions and to keep real wages high (which could make it harder for the unemployed to get back to work).

They want to confine the fiscal package to reductions in taxes and investing in suitable infrastructure which are worthwhile on their own terms. Other than that, it is best to limit measures directed at the financial sector.

A third type of view one which is most widely held – comes from many people like Paul Krugman. He argues that, while freeing financial markets will certainly help, at this point we also need a big fiscal package. He points to the 1933 Keynesian Open Letter to Roosevelt, in which he advocates new infrastructure spending. While Keynes admits that in the USA it is more difficult to improvise the vast program of public works, the risk of less speed must be weighed against those of more haste. Krugman also advocates other spending and taxation measures and rejects Christina Romers (now tapped to run Obamas Council of Economic Advisers) against fiscal expansion: he quotes her as saying that the budget should be balanced over the medium term, but not each and every year and not in exceptional circumstances, including running budget deficits.

===

The Rudd Government has now embraced the argument that the Budget may soon turn into a deficit if the global financial crisis gets any worse. Mr. Rudd said that if Australian economic growth slows further— it would be responsible (if necessary) to use a temporary deficit to begin investing in our future infrastructure needs, including hospitals, schools, universities, TAFES, ports, roads, urban rail and high speed broadband.

Apart from introducing low-gestation infrastructure spending, Mr. Rudd also needs to announce a substantially higher level of Newstart Allowances. These benefits can be reduced later when the labour market has recovered.
===

7 thoughts on “The virtues and risks of fiscal packages

  1. May I please put forward a fourth school of thought which surely must have more advocates than just myself. Since the financial system is (by design) tied to the physical world of commodities, goods and services, and since we have seen substantial real-world changes in the past decade, a plausible explanation is that the financial system is being dragged along with no choice but to readjust.

    Changes in the physical world include: running out of oil, global warming, moving the primary manufacturing base into Asia, the USA losing the war in Iraq (to Iran, who didn’t even have to fight) and halfway losing in Afghanistan (to Iron Age tribesmen who have been doggedly surviving the onslaught of empires since Persia and Genghis Khan), the increasing prevalence (and profitability) of drug trade, the partial political and economic unification of the EU, reduced US dominance of technology, the rise of the Internet, and a steady movement away from a concept of personal liberty.

    Big changes in the world generally have winners and losers, the financial system can only go up and down so big change in the underlaying physical world tend to map onto instability in the financial markets, including bigger booms and deeper crashes. A fiscal package may be useful in all of this, but we are talking about riding a storm in a rowboat and arguing about whether it is better to row upstream or downstream.

  2. Some random thoughts on infrastructure spending, in between hospital visits.
    First up, surely spending on productive infrastructure is a plus all the time, not just when the economy is struggling?
    The hospitals of NSW are seriously run down but it is not all a matter of money because there have been major and expensive stuff-ups in the capital works program.
    Despite that the quality of care being delivered in both the public and private sector is beyond praise, at least what I have seen lately. There have been some issues but people are only human and the pressure on the personnel in the system is intense.
    Regarding the proposal to tie Federal finance to hospitals to reporting requirements regarding performance and quality, I really wonder if that is the way to go, given the amount of data that is collected already. Good data systems take years to design and implement. Surely professional people generally do the best they can, and I wonder about the benefit of having distant, desk-based administrators demanding more information.
    It is a worry that Kevin Rudd is alleged to have refused support for a major transport project in NSW on the ground that it did not run through any marginal electorates.
    It will be a disaster if the Rudd administration persists with the pork-barrelling modus operandi of the previous conservative social democrat administration.
    An independent study by a university-based engineer has revealed safety concerns about a significant proportion of the elderly wooden bridges in NSW. I wonder if that is on anyone’s list of possible projects.

  3. An independent study by a university-based engineer has revealed safety concerns about a significant proportion of the elderly wooden bridges in NSW. I wonder if that is on anyones list of possible projects.

    Dodgy roads only kill pot smokers, nothing for good upright folk to worry about.

  4. You raise a number of issues.

    Of course, spending on productive infrastructure is a “plus all the time” – but especially when the economy is struggling.

    There are many problems demanding much information – not just hospitals.

    I do not accept your allegation that Rudd has been refusing support for a mjaor project in NSW, on the ground that it did not run through any marginal electorates. This is nonsense. I would love to get the evidence for that, if it exists. It cuts right against all his principles.

    Repairing wooden bridges is a good one for the local councils.

    As Keynes put it to Roosevelt, you have the take some of the bad with the good.

  5. Given the importance of infrastrucure investment, how come an ALP administration arrived after a decade in opposition without a plan, ready to implement? Apart from nonsense like the school computer revolution.

    In the spirit of bipartisanship, how come the Howard administration ruled for a decade without developing a plan for infrastructure development, which they or some other incoming government could implement without further delay?

    Did the Opposition regularly put questions to the Howard government about infrastructure planning?

  6. a very easy answer.

    Howard’s time involved only increased economic growth where capacity constraints and infrastructure shortages were talked about for at least the last 4-5 years.

    To implement spending on infrastructure would mean cutting spending in other areas.
    Neither Howard not Rudd had the political courage to do that.

    In tough times where recessions appear spending on infrastructure does not mean cutting in other areas.

    Also spending on infrastructure takes time.

    I am afraid I didn’t hear our Enry when the Government spent money on the Alic Springs to Darwin rail link.

    Noe did I hear him when the Government wanted to spend $10b on the Murray-Darling without ANY economic input.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Notify me of followup comments via e-mail. You can also subscribe without commenting.