Arnold Kling  

Talking Points on Stimulus

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For Seattle public radio, 10:20 AM Pacific Time today. I will add a link to a recording, probably within the next 24 hours. My main theme is that we should have a small, temporary stimulus, not a permanent shift of power and wealth toward Washington.

[UPDATE: Here is the show. My segment starts about minute 15. I like the fact that the host lets me talk, even when I stammer, without interrupting. At one point, I am called on but someone else answers. No big deal. As far as the stimulus was concerned, there was no one to argue with--the other two panelists did not want a big spending stimulus, either.]

1. The economy is in recession, and it would be nice to be able to do something about it. Increasing the government deficit now does long-term damage, but if it helps in the short run we are willing to live with that trade-off.

2. We will never know how much the stimulus helped. We cannot run a controlled experiment where we set up two economies with identical conditions and try different policies. Macroeconomics is not that scientific. Since we cannot even know after the fact, predicting before the fact is highly uncertain.

3. Potential benefit of the stimulus: short-term endure less painful recession in terms of unemployment. Potential costs of the stimulus: incur deficit that has to be paid back; threaten creditworthiness of U.S. Treasury; difficult "exit strategy" if economy becomes dependent on government sector; misallocation of resources because it is hard for so few to spend so much in a way that is wise

4. The larger the stimulus, the greater the risk that costs will exceed benefits.

5. The more the stimulus is focused on spending, the greater the risk that costs will exceed benefits.

6. Profits are in more dire straits than wages.

National Income Accounts2007 Q32007 Q42008 Q12008 Q22008 Q3
Wages and Salaries6,377.76,465.56,518.06,531.36,570.1
Corporate Profits1,668.31,611.11,593.51,533.31,514.8

Source: Commerce Department

The upshot is that from the third quarter of 2007 to the third quarter of 2008, wages and salaries increased 3 percent, while corporate profits fell 9 percent. Next month, when we get data for the fourth quarter, we are likely to see wages and salaries looking about flat for the year, with a decline in profits of 20 percent or more.

7. Profits are especially important now, because with the stress in the financial sector it is difficult to raise money. Businesses need profits to fund operations and to stimulate investment and hiring.

8. Business tax cuts can stimulate profits and hiring. One particularly intriguing proposal is to cut the employer contribution to payroll taxes. This would reduce the cost of labor and encourage companies to hire more workers.

9. In contrast, consumer tax cuts are likely to be saved, not spent. Not that saving is a bad thing, but we need to get investment going. Government spending increases will appear in 2010 and later, when we need stimulus as soon as possible.

10. The stimulus proposals are likely to produce a major, permanent redistribution of spending and power away from the private sector and toward government. If we are going to shrink the private sector and expand the public sector, we ought to have an explicit debate about that rather than sneak it in under the guise of "fiscal stimulus."


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COMMENTS (14 to date)
Sempronia writes:

A quick question, from an economics student.

I would have thought that consumers choosing to save their tax-cut windfalls would place that money with banks and credit unions --and thereby make that money available via loans to business. Is the credit market really so tight, or the tendency to stockpile reserves so high, that this money wouldn't make it to businesses?

winterspeak writes:

Arnold:

You say: "incur deficit that has to be paid back; threaten creditworthiness of U.S. Treasury".

Given that the US Fed can print money -- and I'm sure you don't deny that point -- why does paying back the deficit matter at all? The US Fed is good for the dollars.

Also, given that the Treasury can print money, why is its creditworthiness an issue at all?

Arnold Kling writes:

@sempronia,
if the government borrows to give consumers money, then the government absorbs savings; if the problem is to get more savings into the system, the solution is for government to run a surplus. The Keynesian presumption that we're working with here (not necessarily correctly) is that the problem is not to get more savings into the system. Instead, the problem is to get more spending into the system.

@winterspeak,
printing money in huge amounts is a form of default. Borrowers get paid back in cheaper dollars. Not that you didn't know that.

If as a borrower I think that the Treasury is going to go on a printing binge, I don't lend (except perhaps through inflation-indexed bonds.) But I think investors who fear a printing binge will turn to gold more than to TIPS.

hutch writes:

just thinking out loud, but what is the propensity of corporations saving tax cuts for a rainy day as well? the people who are consumers cutting back consumption/would save a temporary tax cut are also the same people who are making business investment decisions.

if businesses expect profits over the short term to fall, would there be pressure not to invest due to liquidity concerns? extra cash on hand would help cushion against debt covenants or help with interest payments, maybe. i guess i'm a little skeptical it will necessarily be turned around into investment or hiring. but that's just a gut thought with nothing to back it up empirically.

mk writes:

I second Sempronia's question.

Does anyone have an estimate of where 100$ of saved money would go?

For example: "50$ would sit in a bank's reserves to help them deleverage, 25$ would get lent to a company, 25$ would get lent to governments."


Even if 100% of the money sits in banks while they deleverage, doesn't that savings help them deleverage, and thus bring us closer to a functional banking system? Is that a viable strategy to recapitalize the banks? It has the "advantage" that all the money shelled out belongs to people, not banks.

mk writes:

Sorry, I missed the response to Sempronia.

Is it the case that "borrowing money to give it to people so they can deposit it into savings accounts" doesn't get us any closer to a deleveraged banking system?

Or is it mistaken to take the summation of "government money borrowed" and compare it to the summation of "consumer money deposited into savings accounts", because the banks that lent out the government money are not the same as the banks receiving deposits from consumers?

MattYoung writes:

Arnold, if it is not too late, please mention that here in Fresno CA, the stimulus money will be better spent.

First, our priorities for stimulus money:

1) Give back Obama his Blackberry
2) Automate residential delivery
3) Automate long haul delivery

4) Send the remaining 699.8 billion to the Fresno City College for further studies.

winterspeak writes:

Arnold:

You said "printing money in huge amounts is a form of default. Borrowers get paid back in cheaper dollars. Not that you didn't know that."

I did *not know* that printing money in huge amounts is a form of default.

I thought default is failure to make payment as agreed.

I am not aware of any contracts predicated on zero inflation. I also believe that most every currency has inflation most years, and yet they are not in default.

I also don't believe that any ratings agency has every classified inflation as a default, nor do I believe a single credit default swap has ever been written that had any inclusion of inflation in it, nor do I know of any other default provision to include such a clause.

But I may be wrong -- can you please point me to any contract that has a default provision that includes a zero inflation clause.

The Treasury does not need you, or anyone else, to lend if its about to go on a printing binge. It just changes numbers in its spreadsheets. A currency issuer does not need "financing" the way you or I do.

liberty writes:

"@sempronia,
if the government borrows to give consumers money, then the government absorbs savings; if the problem is to get more savings into the system, the solution is for government to run a surplus. The Keynesian presumption that we're working with here (not necessarily correctly) is that the problem is not to get more savings into the system. Instead, the problem is to get more spending into the system."

I appreciate your answer to this question, however isn't it true that government tends to borrow at least partly from overseas, and that it may thereby not affect domestic investment to the full extent that investment would increase by the spending and savings resulting from the tax cut?

Furthermore, since it also has to borrow when the tax cut is on employer-payroll, would not the same problem occur?

In other words, if the idea is that we are going into deficit for this stimulus, and that we want to produce investment via this deficit-induced-stimulus, then I do not see how tax cuts to consumers, saved or spent, are not as good as tax cuts to employers.

Either way I think the stimulus comes from (a) transferring from the future to the present via any overseas borrowing that doesn't crowd out domestic investment and (b) the efficiency improvement via transferring from state to private spending.

-- and I don't see why you are making Keynesian presumptions.

winterspeak writes:

LIBERTY: The Government does not borrow to give consumers money. It does not have to, as it can create money at will. (The Federal Government can create as many dollars as it wants, all by itself)

The Government does not absorb savings either. Savings just sit in a savings account, and don't do anything there. Banks do not lend out savings, banks make loans and then borrow what they need from the Fed to make their reserve requirements.

The Government does absorb taxes though. Government creates money through spending, and un-creates money through taxes.

The Government does not borrow overseas, the Government has no need to borrow as it can print its own money. Yes, the Treasury issues IOUs (bonds, t-bills etc.) but it can print as many notes as it wants to fulfill those IOUs, so it isn't really borrowing the way you or I have to. Lately, foreigners have been very willing to exchange real stuff for bits of US paper. That may not last.

The Government must run a deficit so the private sector can net save. This is weird, but true. The way to increase that deficit in the most efficient way (easy to turn on, easy to turn off, fast, and least distortive long term) is for the Treasury to pick up the tab for payroll tax until CPI begins to tick up.

Running a deficit does not transfer anything from the future to the present. Running a deficit just creates the money the private sector needs. How that deficit is created (tax cuts, spending, etc.) has huge implications for future growth though.

Lord writes:

Profits is the wrong focus. In a declining economy profits are destined to be down as lower sales mean lower profits. Even higher profits will not lead to investment if the market is already oversaturated. The focus should be increasing the capacity and number of customers. That is what will increase profits.

Isaac K. writes:

Sorry to pull a juvie econ move, but don't economic profits naturally trend towards zero in a competitive environment?

Dr. Kling, you're positing that banks whould be allowed to fail, yet conniving the best use of bolstering corporate profits - that's contradictory.
Yes, let banks fail, let ineffecient competitors drop out of the market - out of ALL markets.

The only reason why corporate profits are so important is corporate investors - the ones who lay claim to that profit.
Essentially, the stock market simultaneously increases competition for investors money by increasing the "demand" for profits.
By decreasing the cost of labor, you only help those corporations that are already in danger of failing - zombie companies who aren't truly competitive or robust enough to survive.
Those corporations who DON'T need the stimulus but will receive higher profits due to payroll tax cuts will only serve to concentrate the investment market and artificially inflate their values - bouying them when the market already is sending the message that they should quit.

Fight the zombie invasion -
No zombie banks
No zombie corporations

Ralph Musgrave writes:

Much the smartest points above are those by Winterspeak. I assume this is the “Winterspeak” of http://www.winterspeak.com/. I recommend the latter site to anyone. Intriguingly Winterspeak is coy about his/her identity: I’m as interested to know this identity as I was in the case of “deep throat” in the Watergate episode.

Anyway, my comments on the above are thus. In answer to Sempronia, (are tax-cuts deposited in a bank reflationary or “stimulatory”?), it strikes me this depends on whether these cuts are financed with printed or borrowed money (a point on which Arnold is vague). If its printed money, this will obviously encourage the bank to lend thus the effect will be reflationary. If it’s borrowed money (i.e. if we are talking Keynes) then the picture is more obscure. It is not obvious to many of us why having government borrow and spend should stimulate economies because borrowing is deflationary (in the “reducing demand” sense of the word), while the spending is reflationary (i.e. boosts demand). Perhaps “borrow and spend” gets the money supply churning a bit, so there is slight reflationary effect. But I would guess, to answer the original question, that in view of this muted effect, the latter might be wiped out if tax-cuts are banked.

Re Arnold’s claim that printing money causes inflation, we need to distinguish between normal levels of inflation, 1-5% say, and hyperinflation. Assuming the former, then as Winterspeak points out, there is no problem. In contrast, hyperinflation is a BIG problem and can lead to economic and civil breakdown (it helped usher in the Nazis).

Thus the crucial question is, does money printing cause inflation? The answer is (barring completely lunatic money printing exercises, like Mugabwe’s) there is little relationship between the money supply and inflation. For example the UK’s money supply expanded by a factor of 2.6 in REAL TERMS between 1982 and 1998 and this was way beyond the expansion of the economy in real terms. Yet inflation was subdued during the 1990s and up to the present day. And for another example, the US monetary base was FOUR TIMES LARGER relative to GNP in the early 1950s than in the 1980s, yet inflation was far worse during the latter period than the former! How’s that for “counter-intuitive”?

In short, there are numerous factors influencing inflation apart from the size of the money supply, ergo money printing does not necessarily cause inflation during a recession. The big problem may come during the upturn: will economists and politicians have the skill and will to claw back the extra money if it looks like being inflationary? My fear is that they are so incompetent that they may not.

AmandaWCU3592 writes:

With this particular article in mind, I absolutely agree that the spending that is involved in the proposed stimulus is going to outweigh the benefits. The national debt is already at an unreal level and I am afraid that the stimulus plan is going to just increase that national debt. Yes, it may help in the short term with our economy, but what about in the long run when my generation has to start dealing with the problems that come from the giant deficit in the United States? We cannot just keep on passing the debt to the next generation and say “Oh well, they can deal with that.”
Also, everyone is yelling about tax cuts to go along with the stimulus plan. They think if there are tax cuts enacted, people will have more money in their pocket and therefore be willing to spend a little bit more. This is true, there will be more money in the pockets of Americans, but only some Americans. The poorer people in our country still receive no help from tax cuts. If people don’t earn enough money, they don’t even have to pay taxes, so they won’t receive benefits from the tax cuts. Also, this article points out that if people did have more money to spend, chances are they are going to save it instead of spend it so they can have the money when they REALLY need it. Saving is great, but our economy needs stimulating and the only way that can happen is with spending.
The first point that is made about trading a healthier economy for dealing with the national debt later is the part that really scares me. They are proposing this huge stimulus plan with all this money going toward great programs, but where are we going to get all that money? My guess is tax payers and other countries. So we are going to just keep piling up this national debt while trying to help the economy. There has to be a better way. I don’t want my generation to have to deal with a humungous deficit just to help the economy go well for a few years.

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