Tuesday, September 14, 2010

Cost of Stimulus

Mr Blanchard, chief economist of the IMF, recently said authorities should not rule out another fiscal boost, despite debt worries. "If fiscal stimulus helps avoid structural unemployment, it may actually pay for itself," he said.(Telegraph article)

How Can Fiscal Stimulus Pay for Itself?

If fiscal stimulus increases growth, then:
  • Higher growth rates lead to higher tax revenues - higher income tax, corporation tax and higher VAT receipts.
  • Lower unemployment leads to lower spending on JSA and related means tested benefits
Critics argue, that fiscal stimulus tends to just cause higher borrowing and 'crowding out'. Crowding out through higher interest rates and reduced private sector saving. But, as I mentioned here, interest rates haven't risen as many feared.

One concern I have is that the UK, Europe and US will avoid a technical second recession, but, that growth will be very sluggish leaving significant amounts of spare capacity and rising unemployment.

We need growth of well above the long run trend rate of 2.5% to reduce the spare capacity and make a dint in unemployment.

Recent growth forecasts by the EU have been upgraded UK growth from 1.2% to 1.7%. But, that low growth still leaves high unemployment and spare capacity. Yet, we here much of spending cuts and talk of raising interest rates.

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