Keynesians Have All The Bases Covered
The Irish Economy‘s Alan Matthews has posted a piece which questions the effectiveness of the fiscal stimulus packages of various EU countries. Unsurprisingly, there is no discussion as to whether or not fiscal stimuli are the appropriate policy response to a recession. It is merely assumed. The post focusses on the size of the stimulus packages.
the IMF warned that “Monetary and fiscal policies need to become even more supportive of aggregate demand and sustain this stance over the foreseeable future, while developing strategies to ensure long-term fiscal sustainability.”…
On their estimates, the fiscal stimulus breaks down as follows: for the US €199.6 billion or 1.8% of US GDP; for the EU, €112.5 billion or 0.9% of GDP, and for China €233.1 billion or 7.1% of GDP….
But the question is, is this a sufficient contribution from the EU on the fiscal side to support aggregate demand in the coming year?
Now Alan Matthews is a smart guy and he teaches a mean stats class at Trinity College, but it seems that he has misidentified the root cause of economic downturns. Recessions do not stem from a sudden collapse in aggeregate demand. This is but a consequence of the credit induced boom. A lack of real savings is revealed, consumers begin to cut down on spending and begin saving. Bad investments are liquidated. Any government intervention preventing these adjustments is bound to prolong a recession.
In fact, Murray Rothbard lists six things a government can do to turn a short sharp recession into a decade of misery. Here is number 5:
Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by “food stamp plans” and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed. Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.
Or to put this in layman’s terms: if Crusoe’s house burns down (the island equivalent of a sub-prime mortgage crisis), he should start cutting back his berry consumption and carefully repairing his home. Matthews thinks this is the cause of Crusoe’s woes and would urge Crusoe to consume more berries and his previously accumulated capital.
What perplexes me further is that while most of us identify credit expansion as a contribuing factor to our woes, Matthews (and the IMF) claim that fiscal and monetary policy should “become even more supportive of aggregate demand”.
So how can credit expansion and “aggressive” monetary policy be both a cause and solution to the crisis? This is surely nonsense.
But the final thing I want to emphasise is that Matthews wants to have his cake and eat it too. Matthews can claim that Keynesian style fiscal stimulus “works”, however he is already preparing an escape hatch in case it fails. An excellent way for someone to not have to reconsider his faith if I do say so myself.
Post-script: If anyone knows of any pro-Austrian school economists at Trinity (or other colleges) please drop us a line!