Don’t miss Tyler Cowen’s excellent post on the size versus the length of fiscal stimulus. Key passages:
For all the talk of a “large stimulus,” you don’t hear much about a “longer stimulus.”… Ideally a stimulus employs some
idle labor, stops it from depreciating, and tides those workers over
until they can look for other jobs in fundamentally better economic conditions… If conditions are not improving
soon, the ability of the stimulus to “buy time” for those workers isn’t
worth much. The workers get laid off from the government projects and
their reemployment prospects are no better than to begin with. We end
up having spent a lot of money to postpone our adjustment problems,
rather than achieving takeoff…In those cases a well-designed stimulus program should not be so
“timely.” For a given presented expected value sum spent on stimulus,
it is better to spread it out across the years. It is better to help a
smaller set of workers for five years (or however many years it takes
for most of the deleveraging to end), after which they are reemployable
, than to temporarily boost a larger number of workers for two years,
and then leave them back in the dust…Oddly, there is not much discussion about the length of fiscal stimulus. But there should be.
Even in a dinosaur Keynesian framework, Tyler’s dead-on. There’s a multiplier, but the entire effect of stimulus on demand – direct plus indirect – vanishes as soon as the stimulus runs out.
Question: Is this size versus length distinction relevant for monetary policy, too? The answer initially appears to be yes. After all, interest rates only stay low for as long as the Fed keeps pumping money into the system. You can either pump in lots of money quickly, or a smaller amount for gradually. The former reduces interest rates a lot for a little while; the latter reduces interest rates a little for a long while.
However, this interest rate channel for monetary policy is only one among many. The most fundamental monetary transmission mechanism: When people (including banks) have more base money than they want, they spend it. And since everyone can’t reduce his cash holdings simultaneously, nominal income has to rise until people are willing to hold all the cash that exists.
Intuitively, the equilibrium effect of a one-shot helicopter drop that doubles the money supply is to permanently double nominal income. If this leads to a stealthy, stable reduction in real wages, then output and employment go up permanently, too. Otherwise the price level doubles. Either way, there’s no reason for nominal income to recede as time goes on.
In short, if you think that boosting nominal income is the cure for recession, here’s yet another reason to prefer monetary to fiscal stimulus. One burst of expansionary monetary policy increases nominal income forever. One burst of expansionary fiscal policy increases nominal income for as long as the extra spending continues. At best.
READER COMMENTS
Foxy
Aug 30 2011 at 1:50am
This is just the type of thinking that has gotten America into the state it is now in.
There is not way to grow infinately. We live in a closed system a planet with finite resources and an ever increasing population straining the environment and infrastructure to the point of catastrophic failure.
As the system has been implemented decades ago for a much smaller population with no thought of the numbers that would need to be supported because of political preasure to save money and only spend what is needed now with a total disregard for the futrue consequences we are now going to have to pay dearly for that narrow minded ignorant and spineless decision making.
The result is aninevitable total collaps of all systems where the sustainable level has been exceeded. In this case all systems will inevitably fail and billions of people will die as a result. It is inevitable and unstoppable because of human nature and design.
Arthur_500
Aug 31 2011 at 4:59pm
Without a doubt if we pump money into the economy in a substaintial amount for a long enough period of time the economy will start to hum. But what happens when it stops?
The idea is foolishness. Keynes promoted stimulus but acknowledged that the debt had to be paid down when the good times rolled.
When have we reached the good times?
If the basis of the conomy is government stimulus then once the candy is gone the party is over.
I suggest that some stimulus may have a positive effect but the circumstances must exist for a healthy economy to begin with.
Today we have lost wealth (housing), we are unsure of the future (government regulations), we are paying down debt (and still may be underwater), and we are afraid of the future pain (many jobs will never return). Gee why are people not optomistic?
Eventually, people need to eat and we will persevere. People will gamble on their ideas and the economy will generate jobs where there were none before. Until people are desparate enough or willing to gamble none of these changes will take place regardless of what artificial stimulus takes place.
Rob
Sep 20 2011 at 8:14pm
I’m not sure I get why as stated the benefits of fiscal policy “vanish as soon as the stimulus runs out”.
If the government funds a program aimed at increasing AD (for example investing in infrastructure projects) by borrowing money that would otherwise remain in people’s cash balances then even after the projects have finished isn’t the additional money spent still circulating and contributing to increasing AD indefinitely (or until the government runs a surplus and pays back the loan)
Is there any mechanism I am missing that would cause the spending on fiscally-funded projects to return to cash balances after the actual project spending runs out in a way that would not happen with monetary measures ?
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