Tuesday, February 10, 2009

Journalism and Economics

My students complain I'm a harsh marker. So just for a change I thought I'd mark a journalist writing on economics. For some reason I came across this article at the Kansas City Star and found an interesting piece on the current economic stimulus package.

These are a few criticisms of the article:
"First, a stimulus, even if it works, assumes the underlying economy is healthy and just needs a “jump start.” "
No, the whole point of a fiscal stimulus is to provide an injection into the economy when it is well below full capacity. If the underlying economy was healthy there would be no need for fiscal stimulus. Keynesian fiscal policy was developed in response to the great depression. When output falls significantly below full capacity leading to a fall in private sector spending, the government needs to intervene to move the economy out of recession. Fiscal policy can be used to fine tune the economy, but it is difficult to get it right. However, when you are facing the most serious recession since the 1930s, it is clear the economy is in trouble.
"Second, ANY deficit-financed, i.e. inflation-financed, government package cannot be a stimulus. There is no wealth created when money is simply printed."

It is a myth that government deficits always cause inflation. (Japan's national debt of 190% only caused deflation)

Governments borrow to offset the rise in private sector saving that tends to occur in recession. If a deficit is financed by borrowing from the private sector it doesn't cause inflation. One problem the US faces is that the recession is so severe it is causing deflationary pressure. Deflation would exacerbate and lengthen any downturn.

Now, currently, the US Federal reserve is undertaking quantitative easing to try and offset the risk of deflation. This is not without risk of inflation. But, when the velocity of circulation is falling, as at present, increasing the money supply doesn't necessarily cause inflation. (money supply and inflation)

The aim of Keynesian fiscal policy is not to print money (though increasing money supply may be necessary if there is deflation), The aim is to get unemployed resources back into activity. Rather than allowing people and resources to remain unemployed the government actively employs them and this creates a multiplier effect to boost economic growth.
"Let’s throw out his “tired KEYNESIAN policies of the past” and get back to the traditional economics that turned America into a major world power by the early 1900’s."
It was this traditional economics that created the 1920s asset /credit bubble and consequent Wall Street Crash. It was also traditional economics which advised Hoover (and McDonald in the UK) to increase tax and cut spending in 1930-31 at the height of the Great Depression. This ideological insistence that the market would get us out of the recession which caused a steep decline in output, and unemployment to reach 25%.

For all the faults of the government response, thankfully, we are not repeating the mistakes of the great depression where we allowed banks to fail and tried to balance the governments budget which made the initial fall in demand much worse.

There are legitimate questions about the economic stimulus package?
  • How much can the government borrow without causing credit markets to be alarmed at the scale of government borrowing
  • Is the Stimulus package enough? given the marked decline in output and consumer spending even the large stimulus may be insufficient.
  • - What is best form for economic stimulus. Some studies suggest tax cuts are most effective. Some suggest government spending on public works scheme are best. But, can we find reasonable projects to spend money on.
But, the criticism in this article are weak.

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