Robert Murphy Takes Issue with my Reading of Empirical Data on the US Stimulus

For the interested reader, you can find his posts here:

“Just the Facts, Ma’am: “Testing” Keynesian Theory,” 29 April, 2013.

“Believing Is Seeing, Part II,” 29 April.

The unrealistic assumption that he appears to be making in his criticisms of me is this: that real output and private investment must have started expanding immediately after the stimulus began.

But it is obvious that government spending takes time to induce changes in private investment.

Why should there be an immediate and instant movement? I know of no Keynesian economist who has ever thought that there should be instant effects on private investment from stimulus.

With reference to the graph of US private-sector investment Murphy posts, I do not find it surprising that private investment continued to contract in 2008 and early in 2009. The shocks to business confidence were very severe indeed in 2008: probably worse than in any other recession after 1945.

But private sector investment did turn around in mid-2009: after 6 months or so of stimulus spending, which stabilised demand for products. There is a clear trend of rising private sector investment with rising government spending for years after mid-2009.

If private sector investment had continued to contract for years after the stimulus, then Murphy would have empirical evidence to support his anti-Keynesian, Austrian case. But that is not what the data show.

This Takes the Cake...

I asked Robert P. Murphy these three simple questions in a previous post:

(1) Do you dispute that Sweden implemented a stimulus, with expansionary fiscal policy in 2009 and 2010?

(2) Do you dispute that the Swedish recession ended about the middle of 2009 after this stimulus was implemented, and real output growth resumed? If “yes,” then what in your view caused the end of the recession and real output growth that Sweden has had subsequently? Magic?

(3) Do you dispute that the Swedish recovery led to rising tax revenues? That the budget deficit fell?

His response is here, and demonstrates the intellectual bankrupcy of his position:

“LK, do you really not see the problem in your argument? You might be right, but I could use your same approach to “demonstrate” that the Obama stimulus package caused the US economy to suddenly become much worse than people thought (a la Romer unemployment forecasts).

Look, do you dispute that there was a thunder storm in Sweden in 2008 and also in 2009? Do you dispute that there was an ensuing recovery? Surely you can’t deny, then, that the thunderstorms caused the recovery. Only someone versed in magic would deny this obvious causality.

The reason you think your argument is better than mine, is that you believe on antecedent grounds that stimulus spending causes economies to recover. Yet that is precisely what we are debating. If someone genuinely believed that thunderstorms caused economic growth (maybe by breaking windows?) then he’d find my own argument compelling.”
http://consultingbyrpm.com/blog/2012/05/lord-keynes-beautifully-illustrates-why-we-get-nowhere-in-the-stimulus-debate.html#comment-38326

I see that Murphy:

(1) refuses to answer the questions. This is very telling.

(2) Murphy asserts that the relationship of cause and effect running from fiscal expansion to real output growth is in doubt, yet refuses to explain how Sweden had real output growth after its stimulus.

(3) Murphy resorts to a absurd example. No one has ever argued that thunderstorms cause economic recovery. But the empirical evidence that expansionary fiscal policy, whether through tax cuts and/or increases in government spending, causes rises in private investment and consumption is overwhelming.

For example, if the government held its level of current spending stable, and implemented a large tax cut (making up for the shortfall by borrowing), would Murphy deny that this would stimulate the private sector?

(4) In fact, the very logic of the Austrian business cycle theory requires that monetary expansion (and presumably when accompanied by fiscal stimulus) causes booms that drive demand for capital goods over and above the scarce resources available for this investment. Murphy has now taken a position that destroys even the logic of his own Austrian business cycle theory, for, if both monetary and fiscal stimulus do not cause increases in private sector investment and consumption, how could an Austrian business cycle even occur?

Not even Hayek was so stupid as to deny that higher government expenditure can increase employment:

“… a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. .... I no longer think ... [sc. deflation] is a politically possible method and we shall have to find other means to restore the flexibility of the wage structure than the present method of raising all wages except those which must fall relatively to all others. Nor did I ever doubt that in most situations employment could be temporarily increased by increasing money expenditure. There was one classical occasion when I even admitted that this might be politically necessary, whatever the long run economic harm it did.” (Hayek 1978: 210–211).

(5) Finally, if we turn to a recent example, Steve Keen provides a careful sectoral breakdown of Australian national accounts showing exactly how Australia’s economic growth after 2008 was the result of the federal government stimulus:

Steve Keen, “Giving the Bird to the Stimulus?,” DebtWatch, August 18th, 2010.

BIBLIOGRAPHY
Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.

Robert P. Murphy Gets it Wrong on Stimulus in Sweden and the US

Robert P. Murphy has a post here criticising a comment of mine on fiscal policy in Sweden (as compared with the US):

Robert P. Murphy, “Lord Keynes Beautifully Illustrates Why We Get Nowhere in the Stimulus Debate,” Free Advice, 21 May.

Unfortunately, his response is flawed:

(1) the links I cited were to demonstrate that Sweden implemented a stimulus from 2008, not what Murphy says.

The first remarks of Murphy’s post are therefore of no value: it is only Murphy’s erroneous assumption that is at fault here. Murphy assumed, falsely, that my links were meant to prove this idea: “that Sweden is running a budget surplus now is a demonstration that their stimulus worked.” In fact, they were there to prove my assertion that Sweden “passed a large stimulus package in 2008, which continued in 2009 and 2010.” Does Murphy deny this?

Nor did I deny that “the US under any plausible metric ran a bigger Keynesian stimulus than Sweden” – of course it did. That is not the point.

The inference that Sweden’s stimulus worked is my inference, easily confirmed by the fact that

(i) the Swedish stimulus has resulted in real output growth in 2009, 2010, and most of 2011 (which, of course, the links confirm; see here as well) and
(ii) rising tax revenues.

Does Murphy deny either of these two facts?

(2) The whole assumption underlying Murphy’s comparison of the size of the stimulus in Sweden and the US is flawed for the following simple reason: what kind of naive or ignorant person believes that the global recession of 2008-2009 was exactly of the same scale, depth and magnitude in all nations?

What kind of naive person believes that the financial crisis and resulting debt deflationary effects were exactly the same in all countries? Or that the asset bubbles and private debt levels (and resulting private sector deleveraging effects and knock-on effects on the real economy) were all the same?

This is a nonsensical assumption: different countries had different economic conditions, and different crises; consequently, there is no reason why different levels of stimulus will have worked in some nations and not in others. Or why a stimulus of a certain level in Sweden was appropriate there, but not in America. Or why America’s stimulus, even though it was larger than Sweden’s, had different effects too (e.g., not as great an affect on employment).

America had a financial crisis and credit contraction of much greater severity than Sweden. America’s housing bubble and private debt levels are much higher than Sweden’s.

(3) Murphy shows himself incompetent in even understanding basic elements of Keynesian economics. He asserts:

“First let’s consider the deficit as a % of GDP, which is how Keynesians typically evaluate stimulus in the 1930s.”

Um, no, they don’t, Murphy – at least not serious Keynesian economists. How Keynesians “evaluate stimulus in the 1930s” will be find in E. Cary Brown, 1956. “Fiscal Policy in the ’Thirties: A Reappraisal” (American Economic Review 46.5: 857–879): it does not evaluate stimulus in terms of some crude citation of deficits. There is a reason why. It is not the size of a budget deficit per se that will show you if a budget is expansionary or contractionary in terms of fiscal effects. It is perfectly possible to have a budget deficit and have contractionary fiscal policy (as in Ireland and Greece today).

In order to stimulate an economy back to its growth path and potential GDP, one has to do the following:

(i) calculate potential GDP and estimate how severely GDP is likely to collapse by,
(ii) estimate the Keynesian multiplier and
(iii) then design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier.

A great deal of any budget deficit during a recession is merely the result of maintaining spending because of tax revenue collapse.

In both theory and practice, you could have a budget deficit, yet impart zero stimulus to an economy. You can even contract an economy and run a deficit. It beggars belief that a person like Murphy, who sets himself up as some great critic of Keynesianism, appears ignorant of this.

One will need to look at the overall expansionary effect of a budget in terms of its addition to aggregate demand, the most important part of which is how high increases in discretionary spending were.

Sweden and the US both had different recessions. The US had a severe financial crisis. Sweden had no serious financial crisis (see under the heading “Do we have a financial crisis in Sweden?”). America had a huge housing bubble; in Sweden there has been a much smaller real estate bubble and it has not yet burst. Develeraging and debt deflationary effects in America and Sweden have been different. The state of the private sector in both countries is different.

Comparing the size of budget deficits in Sweden and the US does not even show us comparable data for the size of the stimulus in each nation. As a matter of fact, the US stimulus was about 2% of GDP in both 2009 and in 2010. Sweden was much smaller: additional fiscal spending was about 0.38% of GDP (David Saha and Jakob von Weizsäcker, “Estimating the size of the European stimulus packages for 2009,” 20th, February 2009, p. 17).

But then Sweden’s financial sector was not crippled, nor was its private sector in such a bad state as America’s in 2008, 2009 and 2010. It is not surprising that a differently-sized stimulus to that in America worked well in Sweden’s case.

(4) Murphy then cites the overall size of government spending in the economies of Sweden and US, and comes to conclusions so bizarre it so difficult to take him seriously. Here are his data:

Swedish Gov’t Spending as % of GDP
2007: 51.0%
2008: 51.7%
2009: 55.2%
2010: 53.0%

US Federal Gov’t Spending as % of GDP
2007: 19.7%
2008: 20.8%
2009: 25.2%
2010: 24.1%

The fact that Sweden has government spending of over 50% means that its economy was already cushioned from private sector shocks and falls in real output in the 2000s long before the great recession, and certainly to a far greater extent than an economy where it is on the order of 20-25% (like the US).

Sweden’s recovery is thus partly a function of the high degree of government spending (G) in its GDP already in 2008 when its recession struck.

Nor is the particular degree to which government spending rose in each country relevant here: for the US and Sweden experienced different types of recession and thus the degree of stimulus necessary was different in each case (horses for courses, so to speak).

(5) And what is this?:

“Since Sweden handled the crisis much better than the US did, I would say the case of Sweden is prima facie evidence for the Austrian / austerian camp. As always in these matters, these particular data don’t prove anything; maybe there are confounding factors.”

What!? A nation that got out of recession after implementing a stimulus, and where government spending was 51.7% of its GDP in 2008, which then increased to 55.2% in 2009, is “prima facie evidence for the Austrian ... camp.”

Then the whole thing collapses with the words “these particular data don’t prove anything.” What? So what was the point of citing them?

Finally, some questions for Murphy:

(1) Do you dispute that Sweden implemented a stimulus, with expansionary fiscal policy in 2009 and 2010?

(2) Do you dispute that the Swedish recession ended about the middle of 2009 after this stimulus was implemented, and real output growth resumed? If “yes,” then what in your view caused the end of the recession and real output growth that Sweden has had subsequently? Magic?

(3) Do you dispute that the Swedish recovery led to rising tax revenues? That the budget deficit fell?

BIBLIOGRAPHY

Cary Brown, E. 1956. “Fiscal Policy in the 'Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

Gerald O’Driscoll on Stimulus

A short interview here with Gerald P. O’Driscoll, the co-author with Mario J. Rizzo of The Economics of Time and Ignorance (2nd edn; Routledge, Oxford, UK., 1996), one of the more interesting books on Austrian economics (for a critique of it from the Post Keynesian perspective, see Davidson 1989 and 1993).



I take issue with O’Driscoll’s analysis, as follows:

(1) O’Driscoll states that “all efforts to stimulate the economy with monetary and/or fiscal policy have failed.” What does he think happened in 2009 when the US rapidly emerged from one of the most severe recession in decades with fiscal stimulus? One can see here how the GDP contraction was reversed by Q3 2009:

http://www.tradingeconomics.com/united-states/gdp-growth

What is the Austrian explanation of this?

Of course, there certainly has been a failure of fiscal policy: it has not been large enough. Current fiscal policy, while insufficient to stimulate the economy back to full employment, is nevertheless keeping the economy on life support, and preventing a severe debt deflationary recession/depression.

(2) It is true that quantitative easing has failed to significantly stimulate aggregate demand. However, that is what any good Keynesian would tell you anyway: monetary policy is a feeble tool for aggregate demand expansion, especially when you are mired in a diseased economy with excessive private debt, barely staving off outright debt deflationary collapse. We currently in a “lost decade,” much like Japan in the 1990s. Japan also gives us a stark lesson in what not to do: in 1996–1997, the Japanese Prime Minister Ryutaro Hashimoto turned to contractionary fiscal policy and austerity, including personal income and national sales tax increases. This plunged Japan back into recession and the lost decade persisted until the early 2000s. That is what the advocates of fiscal austerity would inflict on America and Europe.

(3) O’Driscoll appears to subscribe to the nonsense idea of “crowding out” in current circumstances. This is similar to the absurd New Classical idea of Ricardian equivalence, which I have debunked here.

BIBLIOGRAPHY

Davidson, P. 1989. “The Economics of Ignorance or Ignorance of Economics?,” Critical Review 3.3/4: 467–487.

Davidson, P. 1993. “Austrians and Post Keynesians on Economic Reality: Rejoinder to Critics,” Critical Review 7.2/3: 423–444.

O’Driscoll, G. P. and M. J. Rizzo, 1996 [1985]. The Economics of Time and Ignorance (2nd edn), Routledge, Oxford, UK.

William L. Anderson Flunks Keynesian Economics 101

William L. Anderson runs a site dedicated to criticising Paul Krugman, called Krugman-in-Wonderland, one of the various Austrian blogs I read. His latest post is here:

William L. Anderson, “Is it Austerity, or Reality?,” May 23, 2011.

Anderson pretty much demonstrates to us all how little he understands about Keynesian economics. He asserts that

“Keynesians really believe that spending money is what creates wealth, and that governments can create wealth out of thin air simply by cranking up the spending.”

It’s no wonder Austrian economics will never be taken seriously by voters or governments.

Money is (1) means of payment, (2) unit of account, (3) medium of exchange and (4) store of value, and, when it is spent by (1) government in a Keynesian stimulus or (2) by private businesses or individuals, this spending creates the demand that causes the private sector to create wealth (i.e., commodities we consume), either by increasing production through using unutilized capacity or by new capital goods investment. When government employs people directly, these workers will still buy whatever commodities they desire to satisfy their wants, and, if they don’t want commodity a, b, or c, the producers of those commodities will go bankrupt. Malinvestments will clear even in a Keynesian system.

Just as in private transactions, money is a means by which these things are facilitated. Keynesian stimulus is about getting the private sector to create wealth by increasing capacity utilization and using idle resources (including labour), just as private investment, bank credit, and payment of wages to workers by a business can create the private spending that does the same thing.

Post Keynesians are also well aware that the capital stock is heterogeneous and not perfectly malleable. In fact, the Post Keynesians had a massive debate with the neoclassicals in the 1950s and 1960s called the Cambridge capital controversy, and were arguing precisely that capital goods are not homogenous. They won that debate, but the neoclassicals typically acted like nothing had happened.

William L. Anderson (in his comments section) in response to my earlier comment asks:

“By the way, why didn’t this [sc. Keynesian stimulus] work in Argentina or Zimbabwe?”

I am not quite sure what period he is talking about in Argentina, but, as for Zimbabwe, that was hit by massive output contraction after 2000, because of Mugabe’s disastrous land reforms (and natural disasters contracted output too), and, if Anderson knew anything about Keynesian economics, he would know in those circumstances, a demand contraction, not some huge, ridiculously large stimulus, is necessary, as is carefully explained by Bill Mitchell to the unenlightened:

“Zimbabwe for Hyperventilators 101,” Billyblog, July 29th, 2009.

You don’t stimulate an economy when its capacity to produce output has been severely diminished or damaged, or external supply shocks mean you cannot obtain the necessary factor inputs for production. Nor do you stimulate a booming economy. That is a basic Keynesian policy.

Anderson’s rather feeble question demonstrates that in fact he has no proper understanding of Keynesian economics. No big surprises there: it’s a common failing of Austrian ideologues, and Robert P. Murphy is in the same boat too.

Germany: The Success of Global Keynesianism and State Intervention

The recent strong economic growth in Germany provides yet more proof of the success of global Keynesian economics, as well as certain other state interventions that distort the free market.

In the second quarter of 2010, German GDP growth was 2.2%, and it appears that this exceptionally good growth came mainly from a surge in exports, helped to some degree by the weaker Euro.

But this immediately raises the question: where were Germany's largest export markets accounting for this growth? Although the US and Europe remain Germany’s largest export markets, the real driver of this surge in growth was mainly from China, and to a much lesser extent India, Brazil and Russia (see “German exports jump on Chinese demand,” Financial Times, July 8 2010 and Vanessa Fuhrmans, “China Cultivates Taste for German Cars,” August 19, 2010).

China, India, Brazil and Russia have all implemented Keynesian fiscal stimulus programs, so the demand for German exports in these countries is itself the result of Keynesian economics. The sheer scale of China’s fiscal stimulus is well known: the Chinese budget deficit is projected to be about $154.4 billion in 2010 or about 2.8% of China’s GDP (see “China forecasts $154.4 billion deficit,” 5 March, 2010), and it was China that was the main cause of the strong growth in German exports.

Although demand from the US and the rest of Europe was apparently not strong, even here the American and other EU stimulus packages will have propped up Germany’s export markets, and prevented a much larger fall in Germany’s export revenue.

Is it really remotely credible that if the US, EU, China, India and Brazil had implemented savage austerity that Germany could have achieved such impressive export growth? Not in the least. The idea is nonsensical. It is obvious that the recent record growth in Germany must be explained to a significant extent by Chinese Keynesian stimulus.

Chinese Keynesianism is the factor ignored by the Swedish blogger Stefan Karlsson, who notes (no doubt correctly too) that German government purchases rose only by 0.5% in Q2 2010 (as compared with 6.6% between Q1 2008 and Q1 2010) showing, he thinks, a negative correlation between German government purchasing and GDP growth (see Stefan Karlsson, “Nice Try,” August 28, 2010).

My response is: “Pull the other one, Stefan.” It is rather obvious that, since it was mainly exports driving the rise in German GDP growth in Q2 2010, you should be looking at the purchases of German goods by China that were either directly or indirectly the result of China’s large Keynesian stimulus, as well as (to a lesser extent) the other emerging economies like India, Brazil and Russia, which all had Keynesian stimulus packages as well. (As an aside, it can be noted that Australia also benefited from China's Keynesianism, and, along with its own stimulus package, actually escaped having a recession.)

Various conservatives are attributing the strong German growth in 2010 to German fiscal conservatism, but this idea is so obviously wrong it is laughable.

For an excellent account of the nonsense being spread by conservatives, see “Conservative Media attribute German economic growth to spending cuts that have not yet begun,” Media Matters, September 10, 2010.

Let’s review the facts. First, the German response to the global downturn of 2008–2009. In late 2008, the German government implemented an emergency bailout package of €480 billion for German banks. In November 2008, the government then approved a stimulus package of €23 billion ($29 billion). On 27 January 2009, the German cabinet approved a €50 billion (£46.7 billion) stimulus package over two years (at 1.6% of gross domestic product).

Germany had two stimulus packages that pumped about €80 billion ($104 billion dollars) into the economy. At about 1.6% of GDP, the German stimulus was larger than the G-20 average, and, along with Germany’s automatic stabilizers, government spending to stabilise the economy was 3.2% of GDP (see Marc Champion, “Germany says its spending package is already big enough,” March 12, 2009).

As you can see in this link, the German stimulus took effect by mid-2009 when Germany got out of recession:

http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=DEM

Thus recent commentators who are pointing to the strong growth figures for summer 2010 ignore the fact that the German recession actually ended a year ago. The recovery in 2009 was clearly caused by government stimulus (i.e., good old-fashioned Keynesianism). Even in 2010 the German economy is still feeling the effects of the stimulus, and austerity measures will not begin until next year. Merkel’s recent €80 billion austerity programme is spread over 4 years and will commence slowly in 2011 (see Quentin Peel, “Hefty stimuli dent Germany’s ‘Swabian’ habit,” June 21 2010).

Furthermore, one important part of Germany’s state intervention to stabilise the economy was the “Kurzarbeit” (“short work”) program. This was a program of government subsidies to German industries to keep people employed by working shorter hours. The measure has significantly supported aggregate demand, which in turn prevented a large fall in consumption and production. The measure also stopped unemployment from rising significantly. You could not have a more obvious instance of state intervention and distortion of the free market than this program, but it was clearly highly successful.

Moreover, the German government moved quickly to protect its manufacturing sector and other industries from the effects of the financial crisis by setting up a “German Economic Fund” (first with €100 billion and then €115 billion) through the state-owned development bank KfW. This allowed the government to lend money directly to German companies unable to borrow from private markets. As of July 2010, some €13 billion had been borrowed by German companies. This is an obvious example of emergency industrial policy – and a sensible one as well. Britain and the US should have copied the Germans and protected their industries by adopting similar measures.

But there is growing evidence that the recent record growth might be the highpoint for the German recovery. Like Japan, Germany is an export-led growth economy. With the abandonment of Keynesianism and the turn to austerity measures increasing worldwide, it is likely that Germany’s exports will fall, which will cause growth to slow.

For the various aspects of Germany’s stimulus, there is a good account in Der Spiegel (see “A Keynesian Success Story: Germany's New Economic Miracle,” Spiegel Online, 19 July 2010).

To attribute German recovery to austerity is, quite frankly, a sign of ignorance, idiocy, or outright dishonesty. Whether the various conservatives peddling this nonsense are idiots, ignoramuses, or just plain liars is a question I’ll leave for readers to decide.