Monday, February 14, 2011

Stimulus Around the World

Interesting new working paper out from the NBER today, on Net Fiscal Stimulus During the Great Recession. It purports to compare the level of fiscal stimulus across 28 rich and developing countries, with results that are decidely gratifying for a Keynesian.

Purports, I say, because unfortunately their chosen measure of fiscal stance makes it hard to know how seriously to take their results. They look only at final expenditures by government, ignoring both transfers and taxes. While there are certainly contexts in which this is the right approach -- where the alternative would be double-counting with private expenditures -- it's not at all clear that it's right for the questions they are trying to answer. From the stimulus side, in theory one would expect the demand effect of final government purchases to be qualitatively greater than the effect of transfers or tax cuts only if the recipients of the latter don't face credit constraints, so that temporary changes operate only through wealth effects. And while I do think that the importance of credit constraints in the Great Recession may be overstated for businesses, they're clearly very important for households, especially the ones most likely to receive transfers like UI. On the debt burden side, obviously deficits add the same whatever their source. On the other hand, it may well be that changes in final expenditure by government is a good proxy for the fiscal stance in general, and perhaps a better one for discretionary stimulus spending. It would be nice to see the paper redone with other measures of stimulus, but let's tentatively accept their findings. What do they show?

First, as Krugman says, if stimulus didn't work in the US, it's because it wasn't tried. The US ranks 9th from the bottom of the 28 countries in the growth of government spending, and even that is only thanks to spending in 2007-08; taking all levels of government together public consumption and investment didn't rise at all in 2009. Of course we knew that already (And we also knew, as Aizenman and Pasricha seem not to, that the earlier increase was almost all military spending.) But it's useful to see it in comparative perspective.

Second, the most interesting finding, that countries with the biggest increases in public spending did not see any larger increase in real interest rates on public debt, either contemporaneously or in the following year, but they did see faster growth. This means the real debt burden - measured as (r - g) * d, where r is the real interest rate on public debt, g is the real GDP growth rate, and d is the debt-to-GDP ratio - fell in those countries where public spending rose the most. If it holds up, this is obviously a very interesting result.

Finally, there's a point they don't make. They observe, correctly, that the US is far from any objective financial constraint on public spending. And they observe; also correctly, that the most aggressively countercyclical fiscal policy is found in middle-income countries like Korea, in sharp contrast to previous downturns, especially the late 90s. But they don't offer any explanation for this change except a vague suggestion that countries chastened by the Asian crisis got their fiscal houses in order, leaving them plenty of space for stimulus. But that's obviously not right. As they themselves note, there's no correlation between the public debt burden prior to the crisis and the trajectory of government spending over the past few years. As I've pointed out before, what's different in countries like Korea in the period before this crisis compared with the Asian Crisis isn't the fiscal balance, but the external balance. They were running external deficits then, external surpluses this time. That's what created the extra space for stimulus. (Same thing in Europe: public-sector surpluses in Spain and Ireland didn't matter because the countries had big current account deficits. It was the corresponding private liabilities thy ended up on public balance sheets in the crisis and created the pressure for spending reductions.) Which brings me to the punchline: If the US had had a smaller trade deficit with,say, Korea in the past few years, that would have had a negligible direct effect on US demand and there's no reason to believe that it would have created space for more expansionary fiscal policy, since we're using nowhere near the space we have. But it very well might have forced Korea to adopt a more contractionary policy, just as other not-exorbitantly-privileged countries without external surpluses have had to. In that sense, though they certainly don't draw this conclusion, I think this paper supports the view that global imbalances have moderated rather than exacerbated the crisis.

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