High fiscal multipliers undermine austerity (spending cuts) programmes

[ShcShc11 0]

http://blogs.ft.com/gavyndavies/2012/10/21/high-fiscal-multipliers-undermine-austerity-programmes/#axzz29xQFTZDU

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If the multiplier is 0.5, then an initial public expenditure reduction of 1 per cent of GDP reduces real output by 0.5 per cent. Using normal rules of thumb, this drop in output would in turn reduce taxation or increase public transfers by about 0.2 per cent of GDP, leaving the budget deficit improving by 0.8 per cent of GDP. This ratio of budget improvement to reduced growth might be just about acceptable to democratic governments.

If, however, the multiplier is 1.7, then the same initial public spending cut of 1 per cent of GDP would reduce real output by 1.7 per cent. The second round effects of this reduction in output would reduce tax or raise transfers by 0.68 per cent. The net overall improvement in the budget deficit would therefore be only 0.32 per cent. The economy would be in recession, and the budget deficit would hardly improve at all. Even if this were acceptable to governments, it would not be acceptable for very long to their electorates.

This pessimistic arithmetic is not that far away from describing what has actually happened in some countries, like the UK, in the past two years. Furthermore, if we take this arithmetic as a given, there is more bad news to come. The major four advanced economies are now all planning to tighten fiscal policy in the years ahead by an average of 1 per cent of GDP per annum.

I believe the article is important in order to understand why countries such as U.K, Germany and even Greece have such a hard time "balancing their budget". Its not because they are socialist countries, but because they are cutting spending when they are nowhere near full employment %.

What is happening with the U.K NOW should serve as a real warning sign to the U.S.

Neither Romney or Obama can/should "balance the budget" for at least another 3 years because of this multiplier problem.

Its also why a country's debt shouldn't be compared to a household debt ("credit card" debt argument). Trying to cut debt in a country simultaneously cuts income for a country while it does no such thing for personal debt.



(note that Gavyn Davies is right-leaning economist)


Hope this helps clarify why the economy is sluggish.
Cheers! Shc

[StreetScooby 5]

Maybe you could help some of us here by explaining the multiplier. Why is a government spent dollar more potent than a private dollar? Is that a reasonable way to phrase the question?

We are all engines of karma

[SkydiveJonathan 0]

The government spends money and the economy grows. The government cuts back spending and the economy shrinks. The multiplier is the amount the economy responds to government spending.

[lawrocket 3]

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The government spends money and the economy grows.

but the government spent more in 2008 than it did in 2007. There wasn't a year under Bush when the government spent less than it did the year before. So explain how the economy tanked even though the government had never spent so much before.

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The government cuts back spending and the economy shrinks

Like after WWII? yeah - the US economy was devastated, wasn't it?

Evidence is much stronger than rhetoric.

My wife is hotter than your wife.

[SkydiveJonathan 0]

The economy tanked because there was too much private debt.

[lawrocket 3]

Oh! So government spending does not grow the economy. There are other factors.

Gotcha.

My wife is hotter than your wife.

[SkydiveJonathan 0]

The sun rises. The sun sets.

[champu 1]

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Maybe you could help some of us here by explaining the multiplier. Why is a government spent dollar more potent than a private dollar? Is that a reasonable way to phrase the question?

A government spent dollar is not inherently more or less potent than a private dollar, and not all government spent dollars are equally potent in stimulating the economy. (A trivial example would be foreign aid money paid to another government is unlikely to have the same effect on our country's economy as a social security payment to a retired person living in the US.)

The reason this "multiplier" idea comes up when it comes to government spending is that if the economy is stimulated in a particular way by government spending and the tax structure is set up to tax that sort of economic activity, then cutting spending or raising spending won't affect the deficit 1:1. That's the big take-away.

More private money spent within the country is even better for the deficit because then you get the added revenue without the direct outlay, but the government doesn't have direct control over that. The government can [try to] influence private spending if they so choose, but that generally translates back to the government spending money.

I didn't read the full article in the OP because I'm not going to register to do so, but this "multiplier" concept is probably best kept as a qualitative exercise. Anyone who claims, "You can't cut spending now! I've calculated 'the multiplier' and it is currently 3.14159265! That would be foolish!" is full of crap.

[StreetScooby 5]

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...is full of crap.

That's my take on the multiplier, also.

But, ShcShc11 is an accomplished economist, and he's also very good at explaining his thoughts. I'm looking forward to any reply he chooses to make. I'm certain to learn something, and I love it when that happens.

We are all engines of karma

[kallend 2,027]

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The government spends money and the economy grows.

but the government spent more in 2008 than it did in 2007. There wasn't a year under Bush when the government spent less than it did the year before. So explain how the economy tanked even though the government had never spent so much before.

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The government cuts back spending and the economy shrinks

Like after WWII? yeah - the US economy was devastated, wasn't it?

Evidence is much stronger than rhetoric.

Did anyone claim that there was ONLY one input to the system?

...

The only sure way to survive a canopy collision is not to have one.

[lawrocket 3]

Yes. The initial statement was "the government spends money and the economy grows."

I got the admission from him that there was more than one input.

My wife is hotter than your wife.

[headoverheels 333]

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Yes. The initial statement was "the government spends money and the economy grows."

I got the admission from him that there was more than one input.

The government spent a lot on the GI Bill post WWII, which helped build a middle class, my Dad included.

[SkydiveJonathan 0]

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Yes. The initial statement was "the government spends money and the economy grows."

I got the admission from him that there was more than one input.

And I explained how the sun works - just for you.

[ShcShc11 0]

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Maybe you could help some of us here by explaining the multiplier. Why is a government spent dollar more potent than a private dollar? Is that a reasonable way to phrase the question?

The answer is: It isin't.
A private dollar is preferable and "more potent" than a government dollar spent.

However, this is only true IF the private sectors are spending this dollar...and its only true IF the private sector is functioning correctly.

In the circumstances we are currently, the private sector has a lot of money, but they are hoarding/stashing their cash (often in super-safe U.S bonds that gives them negative return).

http://www.bloomberg.com/quote/USGG10YR:IND (I've shown this chart before)

So, in the end, we have to ask ourselves how do we make the private sector spend??
This is where politics converge:
The right-wings say: "Obama is undermining confidence" and "cut taxes"

This is fantasy that keeps repeating itself. The U.K experiment with Cameron clearly shows that confidence has nothing to do with the politician, but on the demand forecast. (I can show the charts again if you want on business confidence).


Cutting tax helps, but is inefficient because you are giving a cash-rich company more cash. And this cash ends up in U.S bonds (which the Gov is doing nothing with it).

Cash flow ends up either under the company's bed or under the Gov's bed doing nothing to the economy. Point is, cash becomes clogged doing nothing.

By far, the #1 reason why companies are hoarding the money is because they have no reason to spend it. Their current capacity is under-used and there is zero reason to invest in new machinery, new employees, etc...

This is what they mean by "uncertainty"- not uncertainty of gov reg, but uncertainty due to volatile demand forecasts.

Uncertainty from Gov Reg. affects a minority of businesses (5%) such as Coal and Oil. Volatile demand forecasts affects 100% of businesses.

Why are demand forecasts volatile?
http://creditwritedowns.wpengine.netdna-cdn.com/wp-content/uploads/2011/08/US-Private-Debt.png
Because people are busy paying off their debt hangover (private debt exploded after the Financial Crisis of 2008...but that's another topic). Ordinary U.S citizens can't spend if they have urgent debt to pay off.


So it isin't so much that Gov $ is better than Private $. Its just private $ is doing nothing at the moment and going nowhere (usually something that is fixed by lowering interest rates, but interest rates is at 0 right now).

If you cut gov spending, private companies simply have even less reasons to spend.


Another solution would be high inflation, but this is politically highly unpopular. High inflation erodes private debt, forces people to spend (by eroding their savings account) and private $$ goes back into real investments (e.g: machinery, employees, etc...).


The current European saga really shows all this in details, but people keep having this misconception that they are in trouble because they are "socialists" .


Anyway, my 2 cents.

Cheers! Shc




EDIT:
If anyone wants to learn more about the U.K, this interesting article came out today
http://www.voxeu.org/article/fact-checking-financial-recessions-us-uk-update

[StreetScooby 5]

As always, good stuff. Thank you.

Are you saying the Keynesian multiplier is only applicable when the velocity of private money is low?

We are all engines of karma

[kallend 2,027]

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The current European saga really shows all this in details, but people keep having this misconception that they are in trouble because they are "socialists" .


Anyway, my 2 cents.

Cheers! Shc




EDIT:
If anyone wants to learn more about the U.K, this interesting article came out today
http://www.voxeu.org/article/fact-checking-financial-recessions-us-uk-update

Absolutely true. If anyone wants to see how the Romney/Ryan plan would work in practice, just take a look at Europe and see what the same policies have done over there.

...

The only sure way to survive a canopy collision is not to have one.

[SkydiveJonathan 0]

Data from the European Central Bank show that the tentative rebound in the money supply over the summer may have stalled again in September.

The broad M3 gauge -- watched by experts as an early warning signal for the economy a year or so ahead -- shrank by €30bn and is now down by €143bn since April. This is highly unusual.

The narrow M1 gauge watched for signals of activity six months head has held up better but also contracted in September, falling by €16bn.

"The message is clear," said Lars Christensen from Danske Bank. "The ECB needs to stop obsessing about fiscal issues and do real quantitative easing (QE) if it wants to stop the eurozone going the way of Japan."

Loans to firms and households fell 1.3pc as banks continue to shrink their balance sheet to meet tougher rules. Private bank lending has been falling almost continuously since April.

The ECB’s €1 trillion lending blitz to banks last Winter helped shore up Spain, Italy, and other sovereign states but has not filtered through into private lending as originally hoped.