Some low hanging fruit for countercyclical investment: maybe next time . . .

Though our fiscal stimulus was exemplary (except by the standards of The Australian Newspaper which requires 20,000 investments to all go off without a hitch), there was one area where I argued at the time, that could have been improved. For reasons that are a tad mysterious but almost certainly related to market failure, the funding of small to medium sized enterprises and venture capital goes into hibernation during a downturn.

This doesn’t make any sense and the government should lean against this wind, putting more effort into such investment during downturns and recouping its equity or tax revenue with less assistance during the upswing.

I don’t know if the OECD suggests this somewhere in its report, but, though it finds it’s a major problem it doesn’t suggest any solutions in the press release to its new report which corroborates the phenomenon over the current downturn in a wide cross-section of countries.

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28 Responses to Some low hanging fruit for countercyclical investment: maybe next time . . .

  1. Paul Frijters says:

    yes, lending to small business is a big issue during recessions. Banks and other normal providers run for cover and the market for loans is flooded with bad prospects, quite apart from all the prospects becoming worse.
    I think the only way you can really do it is to have a national bank, or a quasi-national bank, regularly involved in lending to small businesses. There is then the expertise available to the government during a recession to expand lending to small businesses, though even then the lemons-problem of people with bad plans coming to ask for loans will be a real issue. You can imagine why this hasn’t happened yet.

    As to the stimulus in Australia, when were most of the 20,000 small projects (benefiting small businesses!) actually funded again and when was the height of the recession? If the stimulus came after the height of the recession then the question for the next recession is whether there is a quicker way to pump money through the system than that way. Organising 20,000 projects within a bureaucratic system simply can’t be done on time.

  2. derrida derider says:

    I don’t think you need to posit market failure to account for this, unless you define the whole “flight to safety” thing as a market failure. Depressed animal spirits means more risk aversion, and lending to small businesses is consistently riskier than lending to large ones because they go broke more often – that’s why they pay higher interest rates even in good times. Plus loans to very small businesses are often secured against the borrower’s house, and that collateral aint what it used to be in many places.

  3. Nicholas Gruen says:

    I agree with Paul’s point that to deliver more small business finance in downturns you may need a state run bank – which focused on small business lending. We stopped the CBA focusing on small business lending and then sold it off. But the particular context I was thinking of was more early stage venture capital, and there – responding to DD – I think there is market failure. One is investing for five and ten years out as a VC, or at least that’s what one would hope. So a ‘flight to safety’ doesn’t make much sense and the economic conditions of five or ten years time are not very correlated with the economic conditions today – moreover if one is engaged in a startup, its ultimate success doesn’t have much to do with economic conditions, but rather whether you could learn to make something that the market wants.

  4. Pedro says:

    One of the big problems in and after a recession is the uncertainty of valuations, something that is still a struggle despite us not having a recession! So, your new bank is going to have to have lower standards for lending.

    Though I suppose what you are really suggesting is a different path for fiscal stimulus and so maybe you don’t think it matters much if value is obtained.

    By the way, didn’t the goose just indirectly admit that at least some of his stimulus program led to higher rates? I know that sounds like a cheap RWDB gotcha, but surely we’re not dealing with a magic having-and-eating cake?

  5. Nicholas Gruen says:

    Pedro, your last point seems a bit confused. Pretty obviously if the stimulus led to greater activity it led to higher rates. (Hint: lower activity led to unusually low rates.)

    I really think as a sensible person you should forget the nonsense about the stimulus not working. Leave that to the ideologues. You can argue that it was badly implemented (which I don’t agree with but it’s a separate argument), but you can “follow the money” and see that (despite Malcolm Turnbull’s claims at the time) a large part of the cash splashes was spent and likewise see that the education and pink batts money increased economic activity.

    And yes, just to address the talking points, China and mining helped, but if you pay attention to when they helped they don’t account for our lack of a recession – they kicked in later. (Sigh)

  6. JB Cairns says:


    The one big thing about the credit crunch was about pricing risk.
    This is why there is such a discrepancy these days when the official cash rate is changed.

    The only way a stimulus can increase interest rates is by reducing the output gap very very quickly. It didn’t happen. Look at inflation!

    The only reason the RBA put up rates was they overestimated Mining boom 2 and under-estimated how contractionary fiscal policy is.

  7. JB Cairns says:

    But Nick China had an approved Stimulus but we had an unapproved one!

    Funny how they criticise Asutralia but seem mute when it comes to Canada or NZ who have inferior records but then some of these cranks approve of Estonia which had a depression!

    They are as bad as poor old Rafe

  8. Pedro says:

    That’s the problem with trying to make light, you end up sounding confused. I was merely saying it can’t be the case that interest rates have only just recently started being affected by the level of govt spending.
    Even an idealogue would have to agree that govt stimulus spending will show up in GDP and I doubt any have denied what is a necessary fact of the definition. The only complaints I’m aware of are along the lines that less money could have been spent for a satisfactory result or that fiscal stimulus was not needed at all because we did not get to the lower bound. These are claims about which reasonable people can disagree and, best of all, nobody can be proved wrong.
    Back to the Swan point, here is something PK said last October that would suggest Swan was correct the second time and which seems to support the claim that the govt went too hard and too long.
    “We have a model of the way the world works, and the world does indeed seem to work that way. And an implication of that model is that fiscal stimulus will work under conditions like those we face now. If interest rates had soared, if the rise in base money had led to rising GDP and/or soaring prices despite the zero lower bound, I would have sat down to reconsider what I thought I knew about macroeconomics. “

  9. Nicholas Gruen says:


    It’s obviously possible to misjudge things. The Government followed Treasury advice. What is it supposed to do? So if it was misjudged, then it was misjudged in the same way that we didn’t expect Sadam Hussein to invade Kuwait or the Berlin Wall to fall – or to be a little more relevant – it was misjudged in the same way as virtually every economic forecast is misjudged. You’re supposed to be there doing the best you can, not being clairvoyant.

    In fact I don’t see why the stimulus was overdone. The ideal result they were aiming at was not to maintain the level of activity as if there were no downturn, but to strongly moderate the cycle. So they were aiming for a small but significant rise in unemployment of a much smaller magnitude than turned out to be experienced in other countries like the US, Europe and New Zealand.

    That’s precisely what happened. There was no breakout of inflation and interest rates returned to fairly normal levels. As it’s cut yesterday showed, the RBA misjudged the strength of the economy for the last six months or more. That’s not necessarily a criticism of them – see para 1.

  10. JB Cairns says:


    if the stimulus was too hard and too long we would have very strong growth, increasing inflation and this rising interest rates.

    We have had growth below trend since March 2008, we have had inflation falling and a rising output gap.

    One might argue he has gone too hard on austerity but there is no evidence to suggest the stimulus was too hard and too long.

  11. Paul Frijters says:

    Have a look at the timing of the stimulus ( and the timing of the recession (

    The cash handout was clearly on-time, which was 13 billion. The rest was basically a continuous spending plan over the whole 2010-2012 period. Some projects are still running. It is Impossible to say if it worked because it was so smeared out. It would basically have to be compared with what else would likely have happened to the money. I can see the reasons for wanting to crow about it, but there is no real evidence.

  12. dave says:

    It’s hard to disagree with your general point – the stimulus neglected funding conditions for SMEs. The problem is, how can government target the problem?

    The “pink batts fiasco” was a massive stimulus to SMEs in the insulation sector (is that Manufacturing n.e.c?). But the choice to not require up-front payments as opposed to a rebate likely contributed to the examples the Australian jumped on. So maybe that’s a lesson learnt: direct (verb) incentives to areas of the economy we’d like to develop via tax rebates to consumers in industries where SMEs are dominant.

    But funding for venture capital firms is far more complicated. It involves government picking winners, which they do via the VC grants from Ausindustry anyway, albeit in small numbers.

    Surely the private sector is better placed to select potential winners. Maybe we could’ve spun it off as a program like Dragon’s Den, then have a Dragon’s Den Super Profit Tax (DDSPT)? At least the Australian would’ve been able to conjure up images of DDT and linked it with articles on climate warming/change.

    Re Paul’s point on a quasi-national bank, I don’t think it’s feasible and that’s a reflection on us as a community not whether it’s a good idea. Imagine the headlines: Govt bank wastes $xxx on whatever. So sadly it seems rebates are the least worse alternative because at least then the government of the day can hide behind the inscrutable numbers and say: “Well, Ms X chose Ms Y to do it, so it’s not our fault they didn’t audit them sufficiently.” Or is that too cynnical?

  13. Pedro says:

    NG, yes, agreed we shouldn’t expect anything but a reasonable shot at good judgement, I only make the point because others are un-humble about the level of their economic genius. I’m not sure that exemplary was the correct term and I think Paul’s assessment is pretty much mine.

    Homer, if the RBA is increasing rates to swish inflation then the govt is going to struggle to stoke demand for good or ill. The first easing was in Sept 2008 and the tightening cycle started in Oct 2009, at which point barely any of the construction spending had happened. Over the next year they tightened by 175 bp and in the last 18 months they’ve eased 100bp.

  14. Nicholas Gruen says:

    OK Paul, are you suggesting that there’s fairly complete substitutability between fiscal and monetary policy – in this kind of instance. Because presumably the spending pushed up demand – and given that it still coincided with higher than ‘natural’ unemployment presumably if it wasn’t there some other source of demand would have to be there?

    It seems to me to be a long bow that over the time after the crisis that demand could be kept up by lower interest rates.

  15. JB Cairns says:


    The point is they marginally tightened and we can now say they shouldn’t have.
    We also know fiscal policy is reasonably contractionary so without a lift expected from Mining the economy is not growing as it should.

    It is impossible to say the stimulus ( which was directed at preventing a recession and then ensuring a recovery) was too large and too long when GDP growth has not even got to trend since March 2008.

    Understand your subject

    This is not to say it was perfect it was not. however they were no infrastructure projects ready to go. This was a disgrace. The Pacific highway should have been ready to have dual carriageway from Melbourne to Brisbane but howard was asleep at the wheel. Same about port terminals.

    Thus Treasury had to come up with projects.

    some of the mad people at Catallaxy thinks Estonia is a country we should have copied.

    They had a depression following classical econmics Steve Kates style!

  16. nick,

    I am here merely querying the mantra that the stimulus was such a great success. In the usual logic of a Keynesian stimulus, you try to resuscitate the economy after it went down, i.e. you get money rolling and expectations up again by priming the pump.
    But the timing has to match up: the pump priming has to be round about the time of the growth dip, not years later. The recession dip was in late 2008, early 2009, which was also when the spending pulse via the one-off payout was. So that payout was well-timed. Yet, the 20,000 projects took a while to get underway and turned into a continuous spending plan through late 2009, the whole of 2010, 2011, up to the present day. It really should not be seen as a quick stimulus at all but much like any other form of government infrastructure spending. How can you say a plan has worked that it still underway and that in many ways is much like 10 other things you were doing at the same time? Its pure window-dressing to claim victory (or, for that matter, to claim its been a failure). Hence the brigade that claims to know it has ‘worked’ is doing so for political reasons, not economic ones.

  17. Nicholas Gruen says:

    I don’t follow what you’re saying Paul – can you address my question?

    The case for the 20,000 projects is that the GFC was going to impose a downturn on the Australian economy that would last for several years and that monetary policy was not up to the task of keeping growth strong enough. I’m happy if you want to argue otherwise – perhaps it was, but if you’re not arguing that, I’m not sure what you’re arguing.

  18. Paul Frijters says:


    What I am arguing is very simple: late 2008 there was a problem. The argument was made that ‘a stimulus plan’ would address it. That plan, with delays on its intended timetable, was implemented. I am saying that the claim that the plan really solved the original problem is spurious and that there is no real evidence for such a claim. The question you can ask next is whether something else (monetary policy) would have addressed the problem or if yet something else again would have addressed the problem. For me, that is a wide-ranging topic for a separate thread (or even a book!). My one-line answer to that at the moment would be that we should have pumped more money via the welfare system and not bother with the 20,000 projects, mainly because the welfare system is already in place to quickly get money out. Merely on the topic of how to do a stimulus I am thus saying that for future occasions we should find quicker ways to have a spending spree towards particular groups (SMEs in this case).

  19. Nicholas Gruen says:

    Thanks Paul, I think we agree. I think doling out cash is a good idea. I supported it – to Treasury’s consternation in the 1991 stimulus and (from memory) we ended up getting an extra family allowance payment into the othersise lily livered, ill-titled and ill planned ‘One Nation’ package.

    If you recall, in 2008 there was huge pushback against the ‘cash splashes’. How could fighting recessions be this frivolous. I always liked the idea of doling out money. Fast and has it’s own protections against inefficiency – people spend the money the way they want.

    In any event in punditland it became necessary to get the hard hats on. Everyone knows that a Fiscal Stimulus is a serious business calling for Bob the Builder much more than Therese the teacher (God forbid that we be saved by Sally the spender!). So given that that was what we were going with, what we got seemed well judged to me. And there was a backlog of physical investment that our schools could do with. It would also be good to try to plan for more countercylical light infrastructure spending – ‘shovel ready projects’ and all that, though that may be a bit of a pipe dream.

    As for monetary policy, until that book gets written can we both agree that it might have taken more than monetary policy even a year or so out from the GFC? (Not that we really need to worry too much about it if we both agree that if things are not going well you can shovel out more money at short notice.)

  20. JB Cairns says:

    Nicholas shame on you.

    Two authors showed the one nation package only affected the economy AFTER the recovery had started. Given that cash rates could fall from their 18% highs and Banks had no funding problems there was no need for any fiscal stimulus.

    ( Those two authors were named Glen Stevens and somebody called David Gruen!)

    in 2008 Banks had very large funding problems ( they couldn’t get any money overseas even with a government guarantee ) so monetary policy was severely impaired. Look at the credit figures! They were lending to one part of a sector as well. why?

    Net Exports were only positive not because exports rose dramatically Icelandic style but because imports fell off a cliff. No Stimulus there.

    Paul has a major problem on his hands.

  21. Pedro says:

    Surely you need to address the policy goals. In the early stage the goal is to limit the damage by engineering a softer landing or a higher (employment) bottom, which a cash splash may help.

    Once that is done the policy goal is to feed growth or the resumption of growth. If you are claiming a multiplier from govt spending on projects then you have to accept that monetary tightening will work in the other direction. Here’s Krugman
    “Via Brad DeLong, there’s a paper by David Romer (pdf) summarizing recent research on fiscal policy, inspired by the crisis and aftermath. And his conclusion is not at all what you hear on the talk shows; it is that there is now overwhelming evidence that fiscal policy does in fact work when it’s not offset by monetary policy.”

    And of course he wasn’t always so sanguine about spending
    “Fiscal expansion is certainly an alternative way of pumping demand into the economy. And given Japan’s grievous plight, coupled with the real uncertainty about what will work, I would advocate fiscal expansion as well as a commitment to inflation.

    But I have doubts about fiscal policy’s effectiveness on its own, for three reasons.

    First, if Japanese consumers really do exhibit something like Ricardian equivalence, there will be no multiplier effects from government spending. (My previous note actually misstates the implication of the model that’s one of the marks of a good model – it is sometimes smarter than you are). The true implication there is that current consumption is completely unresponsive to current government spending (it’s tied down by the Euler condition, if you really want to know), so that public works projects will increase spending by exactly the amount the government spends – no more.

    Which brings us to the second point: Japan’s long-term financial position is a bit worrisome, so keeping the economy afloat with year after year of massive deficits is a problem. And absent powerful multiplier effects, it will take massive deficits to keep the economy from slipping ever deeper into recession, unless a one-time fiscal push has a long-term effect.

    Although discussion of the long-term implications of fiscal stimulus is rare, most people probably have in mind some idea about pump-priming. (Actually, very few people either in the United States or in Japan have any idea what that means. Jump-start is probably a more useful metaphor). The idea is that once the economy is moving again, confidence will return and spending will no longer need to be supported. Now this might be true, but there is not much evidence for it; it is at least possible that Japan has a structural negative real interest rate that will last for a number of years. That means that the economy must either receive continuing massive fiscal stimulus, or have sustained inflation. “

  22. JB Cairns says:

    On Japan, Adam Posen with some-one else I cannot remember looked at Japan and found no evidence for ricardian equivalence.

    He also found fiscal policy works. The economy expanded when there was fiscal stimulus and contracted when fiscal policy did also.

    Also Richard Koo has shown quite conclusively that the large deficits in the 90s and after came from ill advised premature austerity measures but don’t tell Steve Kates!

  23. Nicholas Gruen says:


    I wouldn’t advance what I regard as the plain commonsense I’m dispensing on the Australian situation (with negligible debt and a very different expected economic future) as the recipe for Japan. It seems pretty obvious to me that Japan is different. Personally if I were the government I’d print money rather than borrow it, but what would I know?

    The Australian situation is (mercifully) much simpler and more benign.

    (On the other hand people taking Ricardian equivalence seriously – even the redoubtable Brad – need a cup of tea and a good lie down. Go ask your average Japanese person how much the government owes – even roughly. When you find out they don’t know, remind me again how Ricardian equivalence is supposed to work?)

  24. Paul Frijters says:


    just as it is foolish to say the stimulus worked, so too is it foolish to say conclusively that the need for a stimulus was completely gone after early 2009. Dont forget the double dip in the housing prices with the associated drops in consumer spending. Who is to say if the stimulus meant for early 2009 didn’t in fact prevent a recession in 2010? Good luck trying to find evidence either way by staring at quarterly GDP.
    What should sober people up in this debate is the realisation that in the scheme of things, the stimulus was small-fry compared to other events in the same period. The big one was the capitulation to mining interests (Gillard’s original sin) of which the accumulated effect completely dwarfs any stimulus or monetary policy. Simply in a different league in terms of accumulated lost tax revenue (as I have argued before, probably way above 10 billion a year. the main reason for austerity now is disappointing tax revenues from the mining sector. Some people are only now waking up to how huge the original sin really was). To argue on the effects of the stimulus is missing the real fiscal elephant in the room.

  25. Pedro says:

    Homer, good to know that is all clear then.

    Everyone else, I’m not sure the quotes above are making extreme claims about ricardian equivalence, though I think it a bit like the EMH. Obviously it can’t be exactly true, but equally you can’t argue with the idea that the level of AD created by any particular spending measure could be off-set to some degree by a general apprehension of future increased taxes and that the greater the level of deficit spending going on, the more that will happen.
    And yes NG, thank god we’re not them and things are simple here.

  26. JB Cairns says:


    you are contradicting yourself in the first part of your comment but since that is my view anyway it doesn’t bother me.

    As for the second part of your comment I am uncertain as to your point.


    you just have to examine the evidence.

  27. emess says:


    “… It would also be good to try to plan for more countercylical light infrastructure spending – ‘shovel ready projects’ and all that, though that may be a bit of a pipe dream….”

    If you are saying that politicians could not be bothered doing it, I would tend to agree. If you mean it would be difficult to do, I would respectfully disagree.

    Most projects these days are actually done quite inefficiently for political reasons. If you have a major project, it is generally the case that the quicker you can get it up and running, the quicker the revenue and other benefits start to flow, and the lower are the ongoing and establishment costs. However, from a political point of view it is much better to have many projects going at once in as many electorates as possible, rather than a smaller number of projects with optimal resources being used to ensure quick project completion.

    The classic examples of slowness would have been the original Pacific Highway and national rail system upgrading projects. Painfully painfully slow and inefficient. However, the Treasurer (of whatever ilk) could, year after year, crow about spending on these issues and claim credit for progress.

    Which brings me to your point. Given that these types of schemes generally exist and have been deemed worthy of funding (whether on a strict economic basis, or some notion of ‘nation building’ or just a desire to stop killing people on the Pacific Highway), then accelerating them is a relatively simple exercise in project management 101. All that is required, is that for such projects, enough pre-design and approval has been done. None of this is wasted if the project has been deemed worthy of proceeding, and in the case where the project is accelerated, as I have explained above, it will mostly improve the overall economics of the project. The reasons why these projects take time to get shovel ready at the moment is that the design and approval process does not cover the whole scheme in most cases, it merely chugs along a year in advance so that approvals and design are done just ahead of the work. It is relatively cheap to have an extra year or two of design and approval in the back pocket so that if an economic downturn happens, the work can be immediately and efficiently accelerated. From a project management pov doing this would be a doddle.

  28. Pedro says:

    I know it’s an old thread now, but here is an explanation of how the monetary policy of the US is impacting on the value of stimulus measures, which is exactly the point I was making about the exemplary stimulus here. Given the latest cash-splash, its worth a read.

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