Stimulus or Austerity: Can Either Succeed?

by John Brian Shannon

In the age-old debate between stimulus and austerity, many commentators fail to realize both schools of thought could be correct — and in fact, both are.

For one, look at the uncountable billions of stimulus added to the American economy during President Reagan‘s two terms. Unprecedented billions were directed towards defense, R&D, infrastructure — and even to Chrysler — although, strictly speaking, those were loan guarantees.

Do loan guarantees count as stimulus? Almost. And those guarantees tied up billions of U.S. Government dollars until they were no longer required — and served to establish and add gravitas to a new momentum in the U.S. economy. Courtesy of President Reagan’s leadership, I hasten to add.

When we look at historic stimulus, it works. When the stimulus is added at the first sign of recession it is most effective. Once all those factories are shuttered, trying to add stimulus to improve the economy is an uphill battle, every day.

The Marshall Plan to rebuild Europe at the end of WWII is a classic stimulus success story. Anyone who visited 1945 Europe and then visited again in 1960 can attest to that! About $40 billion dollars were used to stimulate the European economy — a lot of money in those days, even by United States’ standards.

Think of stimulus spending as emergency funding to keep the economy functioning. It really only works when applied immediately and at the first sign of recession.

For two, austerity does work. Although, it must be said, removing obscene debt and irresponsible deficits from a large economy constitute a major structural change. It is no band-aid solution — although as I said above, band-aids do work.

Austerity fixes the underlying structural problem — while stimulus fixes the symptoms, if you will.

There is no doubt about the Baltic austerity success story and there are others. You need only look as far as Canada in the 1990’s. Canada’s credit rating was on the rocks, the economy was in the tank and economic vital signs were heading in the wrong direction.

Prime Minister Jean Chretien and his astute Finance Minister Paul Martin, decided to adopt aggressive Canadian-style austerity and it worked (short-term pain for long-term gain) better than anyone had imagined. It just took some political leadership, unusually good communications with voters and some serious brainstorming.

A final word on economist’s everywhere. European economists work for Europe’s well-being, Chinese economists work for China, er, directly! While American economists work to arrange things to America’s advantage — you can’t begrudge any side for ‘playing for the home team’.

If the New York Times, Nobel Prize winning economist Professor Paul Krugman believes that it is in America’s best interests to float the economy with stimulus money, then he is right. Of course while agreeing with him, I always point out that stimulus is a merely a temporary fix and that additional deficit-financing (and accumulated debt) should be ‘pared down’ during the boom times.

Just as John Maynard Keynes suggested.

When this is not done, decade after decade, or should I say, recession after recession, it adds to the unbalanced economy and the entire economic structure is thereby weakened.

For now, stimulus — although it is almost too late for band-aids. Then, during the next boom, adroit movement towards zero-deficit financing — then, once that is achieved, regular scheduled debt paydowns after that.

Stimulus will stop the worst of the present economic malaise from taking an even higher toll — and later, austerity will begin to improve the entire structure of the U.S. economy.

John Brian Shannon

Why Are We In Debt? – MY COMMENT

by John Brian Shannon

As far as economist’s go, you can’t have enough respect for Professor Paul Krugman. Passionate about his calling, vociferous in his critique of failed fiscal or monetary policy and as fine a gentleman as you could ever hope to meet.

He is so compelling and believes in his mission so deeply that even his fiercest economic critics find themselves nodding in agreement with him – before they snap out of it and return to the party line they were following prior to the beginning of the good Professor’s speech.

He is arguably the leading economist on the planet – and I doubt he would have a problem with me putting his life’s work into those terms as he himself realizes that he is in some pretty fine company.

So why would I, wearing my junior economist hat, ever disagree with him on any matter of economics? Just who do I think I am?

Well, I have found a clearer version of my usual answer and it was the kind Doctor of Economics himself, who provided it to me in one of his recent articles.

To read his article, please visit: The New York Review of Books

How to End This Depression
by: Paul Krugman
http://www.nybooks.com/articles/archives/2012/may/24/how-end-depression/

In case you just got back from Mars, Krugman is famously anti-austerity, regularly informs us of the ills of the American economy and posits remedies for present fiscal and monetary maladies. I should say right now that he is most often right. Depending which year it is, that is usually 364 out of, oh well, 365 days of the year. Just saying.

So, three paragraphs into his fine article, we read this:
“But don’t we have to worry about long-run budget deficits? Keynes wrote that “the boom, not the slump, is the time for austerity.” Now, as I argue in my forthcoming book*—and show later in the data discussed in this article—is the time for the government to spend more until the private sector is ready to carry the economy forward again. At that point, the US would be in a far better position to deal with deficits, entitlements, and the costs of financing them.”

Imagine me nodding my head in full agreement with Professor Paul Krugman! Me – a fervent austerity-booster! Imagine that. Didn’t I tell you that was going to happen? Yes I did.

He does have that effect on economist’s all over the world – including those who disagree with his views on the austerity question.

I too, am a Keynesian and I agree profoundly with those words spoken by John Maynard Keynes so long ago and I’ll prove it now.

Ricardian Equivalence aside, lagging economies do need stimulus! The time for the government to begin spending money to boost the economy is in the first few seconds after an official recession has been called by the market. That’s three consecutive quarters of zero growth or decline, or a mixture of both, followed by an official announcement in order to qualify for recession status.

Irregular government stimulus has been happening since before the stock market crash of 1929 when government intervention began in earnest the American marketplace as a force against market turmoil.

Let me say it as plainly as I can, John Maynard Keynes and Paul Krugman are absolutely right, stimulus has been proven to work, it begins to work immediately and it does fulfill the desired effect. It works every time.

The fact that Ricardian Equivalence kicks in part way through the process to begin the incremental process of diminishing the government stimulus – doesn’t change a thing. The stimulus does exactly what it is supposed to do and the fact that consumers later adjust their savings and spending, resulting in a flat net gain to the economy a decade or two later matters little – because all of that takes place on a completely different schedule compared to the instant economic gratification stimulus spending plan.

To put it plainly, the full effects of Ricardian Equivalence take 10-20 years – and if the stimulus hasn’t recovered the economy before Ricardian Equivalence kicks in, you have way bigger problems than three quarters of net loss in the market!

Spending our way out of recession by virtue of taxpayer-supported government stimulus is the equivalent of knowing well-in-advance the exact future day that your house will burn down — and going to the bank as soon as you find this out, in order to borrow sufficient funds to buy the property next door and build your new house identical to the old house — and having it completed and ready to move into, just hours before your old house burns down.

You are no further ahead in absolute terms – but you have an exact duplicate house and property and the exact same mortgage and you don’t have to sleep in a hotel for six months waiting for your new house to be built. Saving you significant misery – which is the whole point of government stimulus, saving millions of citizens from significant misery in the 0 – 10 year time-frame.

This is the secret of government stimulus spending. The government can spend as much stimulus money as it wants. If government stimulus is large and the spending commences soon after the announcement of recession, the economy begins improving almost immediately.

If it spends the stimulus money too slowly, over a ten year period for example, the effect is greatly minimized and could end up a complete failure in every sense. The law of diminishing returns is what happens when government begins a large slow-motion spending program designed to stimulate the economy.

But when it begins immediately and is targeted to produce the best results, it is the exact medicine a country needs – even if, sometime past the ten-year mark, the national economy is no further ahead in absolute terms on account of that stimulus.

Why is stimulus important? Because it immediately and dramatically begins to lower the misery felt by millions of citizens who suddenly become unemployed during recessions. In fact, government stimulus spending creates jobs and can prevent further job cuts as the market sees the strength of the economy and the level of government commitment to the economy. Many a recession has turned out to be a paper recession because a government took early action, spent much – and pushed the evil day farther down the road.

We’re here at the evil day. And if not now, certainly by the next recession – which used to be farther down the road, but is now close to where we live these days.

Keynes wrote that “the boom, not the slump, is the time for austerity.”  – That is very true.

As Professor Krugman wrote in his article which I quoted above:

“Now, as I argue in my forthcoming book… is the time for the government to spend more until the private sector is ready to carry the economy forward again. At that point, the US would be in a far better position to deal with deficits, entitlements, and the costs of financing them.”

Which decade after decade, continues to not happen. Many multi-billions have been spent on government stimulus but none, not one, of those borrowed multi-billions have ever been paid back. Deficit after deficit has accumulated since before there were rocks, and now the debt is piled so high we might not have the chops with our lenders to borrow stimulus multi-billions so that we may assist those who are in unemployment misery – or worse.

The simple fact is, governments can borrow as much as they like and not pay it back – ever! And they have. But eventually, a day will arrive when nobody will lend us more money. Whether this is the case now, or whether it waits till the next recession, we are at or near the end of this particular paradigm of borrow, stimulate and not pay it back during the boom times.

We can’t blame the economist’s – their job is to help the economy progress, to create wealth, to lure capital, to innovate new ways of using money for the good of the nation – and so much more. But economist’s do not have secret powers to force governments to “pay off deficits and pay down debt when times are good” as John Maynard Keynes many times suggested.

We can’t blame the Russian’s anymore – this wasn’t their fault.

We can’t blame our politician’s – because any politician who brings up the topic for even a nanosecond – simply does not get elected!

We want our nice life now, we want our tax breaks now, we want our government spending programs now, we want our toys now, and we don’t want to hear about paying for them.

Why are we in debt? Because that’s what we have asked for every year since before there were rocks.

If we want to continue as a solvent and sovereign nation, we need to authorize a President and a Congress (at the same time!) to print enough money to cover next year’s deficit, effectively clearing our current account to zero. We need to pass legislation that will eventually outlaw deficit spending – except during times of national emergency. We need to pass laws that will force the government to pay down the accumulated government debt by 2% per year until it reaches a sustainable level, say debt-to-GDP ratio of 50%, or less. And we need to start living within our means as a civilization.

Other nations cannot be expected to take the lead on this and until the U.S. begins to do so, western countries will remain uncomfortably near the end of this present paradigm, living uncomfortably close to economic disintegration.

An economic netherworld beckons.

Follow John Brian Shannon on Twitter: https://twitter.com/@JBSCanada

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Related articles

Greek and French Voters Overturn Austerity

By John Brian Shannon

Greek and French voters have overturned austerity in Europe, but voters have really overturned a change to sustainable economic policies.

The structural changes there have caused some level of financial problems for individuals and families.

But the alternative was to let the outrageous, drunken-sailor spending continue until there was nothing left of the economies in question. Eventually that would have caused a real pan-European depression  – instead of five years of austerity in only those countries foolish enough to have overspent themselves for decades.

It is the obscene deficits which have run year after year (and have piled up into unaffordable debt) that are responsible for the lowered credit ratings in those countries and the poor economic performances found only in those particular European countries, it must be said. I note that the rest of Europe is doing quite well – even accounting for the combined drag and multi-billion euro bailouts of Greece, Portugal and Spain.

Blaming austerity, is like blaming the doctor who is now fixing your broken arm for the original accident — as you drunkenly stumbled out of the casino! The Greek economy was a basket-case long before austerity ever arrived and it will be a basket-case now that austerity is leaving Greece.

Greek and French citizens have voted for the former glory days of unrestrained spending with lots of toys and goodies from their governments – and to hell with paying for it!

“Let the EU bail us out forever, for tonight, we drink like drunken sailors!” And, if you think that isn’t being hollered at full volume at many thousands of cantina’s and spilling out on to the streets of Greece tonight, you’ve never been there!

Follow John Brian Shannon on Twitter: https://twitter.com/@JBSCanada

The Economist Asks: Does Britain need a fiscal boost? — MY COMMENT

Just as a matter of principle, the UK should not be running deficits. It is  unconscionable for any 1st world nation, especially one with so many gifts, to NOT spend within it’s means.

Running deficits year in and year out, is the kind of undisciplined behavior we expect from the most primitive undeveloped economies, not the UK, for goodness sakes!

Legislation should be passed in the UK (and independently in all other 1st world nations) banning deficit spending by the federal government except during wartime, or other significant emergencies.

Whether it is affordable or not, is irrelevant as it is simply morally wrong to mismanage, when sound management would suffice.

Mismanage how?

Every pound that is borrowed when in deficit, and then later tacked onto the federal debt of a nation, takes food out of the mouths of the citizens – as each individual pound borrowed carries with it a borrowing cost (compound interest) which, any banker can tell you will end up costing you very many pounds in compound interest.

Which would be almost fine, I suppose, if that interest was staying in the country. But it’s not.

International lenders carry shiploads of money out of the UK and other Western economies every single year in the form of interest paid on government deficits and accumulated deficits (debt) from years and decades gone by.

It is a travesty and it’s immoral to give away the wealth of a nation in slow motion. That money is gone forever.

For now, to solve the immediate problem, the UK as it is sovereign in it’s own currency, should print more than enough money to pay the deficit — PLUS 20% — and that 20% could be used as a stimulus fund on “shovel ready” infrastructure money in the highest unemployment regions of the country.

Instantly, that money would begin working to return the economy to a better place and through taxation (employed people spend more and pay more income-tax) lift the government’s revenues.

Not only would the government save the cost of the compound interest for this year’s deficit, they would receive much of it back through various taxation, further removing stress from the government’s accounts. Let alone continuing to pay interest on it for a decade or two, before finally getting this year’s deficit paid off.

And while they are at it, they should invoke a slight devaluation of the pound, to enhance exports, to further stimulate the economy, adding jobs in the process, which means adding more taxpayers to the government revenue stream.

To read the original article and to vote in the poll, visit:

http://www.economist.com/economist-asks/does-britain-need-fiscal-boost

Follow John Brian Shannon on Twitter: https://twitter.com/@JBSCanada

Nobody Understands Debt by Paul Krugman | MY COMMENT

Nobody Understands Debt  NYT
by Paul Krugman Jan 1, 2012

MY COMMENT — What is wrong with historically low interest rates in America? If not for those low rates, twice (or, even ten) times as many American homeowners might have lost their homes due to higher payments caused by — yes, higher interest rates!

Is that any way to stimulate the economy?

Paul’s second point, — “Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing.”

Take a good look around, citizens are already impoverished on account of huge government deficits and government debt. It’s called compound interest that the government pays to foreign lenders to finance American government overspending and it goes on decade after decade.

It is money that could have been spent in America for the benefit of U.S. citizens — but instead was spent to pay astronomical interest payments to Japan, Europe, Canada and recently, China.

You err in failing to account for the difference between the situation that exists now — and the situation which would exist if there were no government debt/deficit at all.

IF all the money that has been thrown away as interest payments on federal government deficit and debt financing — had been spent wisely — just imagine all the job-creating national infrastructure projects that could be continuously running in America. We’re talking mega-billions of dollars here. You know how compound interest works.

In practice, it goes like this; supposing we are talking about the paltry sum of 100 Billion dollars:

Which is a better use of 100 Billion dollars from America’s point of view?

A) Pay it to a foreign lender to cover compound interest payments.

B) Use it to build a job-providing infrastructure project.

Results:

A) that money, once gone, will not produce anything of value for American’s.

B) that money will be paid as professional services, to engineers, draft-person’s, architects, lawyers and others — and paid to companies who hire thousands of construction labourer’s — WILL spur the economy on the macro scale and American households.  Also, a good portion of it will return to the government in the form of taxes and income-tax.

From such spending, the government could reasonably expect to recover 50% of that 100 Billion dollars in taxes, income-tax and other fees and services paid to the government by engineering and construction companies within five years!

Possibly to spend again on even more infrastructure programs — starting that process anew!

In your scenario, ever-increasing taxes to pay an ever-larger deficit/debt load eventually leads to low citizen-satisfaction levels. Don’t believe that? Wait till the income-tax rate hits 70% — there will be a revolt, or outright revolution.

Western governments have proven to be among the worst historically, to curb excessive spending. Which means eventually taxes rise to meet lender demands for payment.

We will see much higher income-tax levels in North America, just to cover existing interest payments on government debt. Of that, there is no doubt. Let’s try to keep it under 70% by not adding to the problem daily.

Finally, only an economist like yourself would have a large enough calculator to calculate the following. How many American dollars have been paid out of the country to finance government debt and to finance government deficits, since the U.S.A. began deficit financing?

Of course, that is only half the equation. The other half is this; If no deficits had been run, how much national infrastructure or education spending would that very large amount have bought?

http://brillig.com/debt_clock

For just one example of how it’s done, Saudi Arabia has paid down it’s government debt which sat at 102% of GDP 20 years ago — to 6.3% of GDP for 2011. All while maintaining balanced growth.

http://arabnews.com/economy/article554645.ece
http://arabnews.com/economy/article554176.ece

It can be done. If the Saudi’s can do it – so can America! It’s called leadership. If anyone suggests otherwise, be advised I’m not listening — because I don’t want to ‘catch’ whatever you have.