Kerry Stirton, a New York-based investment manager formerly of Goldman Sachs, is a long-time student of macroeconomic trends and financial public policy. Each week he will examine a facet of the current economic situation, reviewing the best thinking on the topic, filtered by his own. Today, he begins by reviewing the matter of stimulus, central to the debate in Washington and Ottawa.
Milton Friedman would not approve.
The U.S. free-markets economist and Nobel recipient once famously said: "If you put the federal government in charge of the Sahara Desert, in five years there'd be a shortage of sand."
But he's no longer around to condemn the current enthusiasm for government stimulus, which suddenly enjoys a remarkably broad consensus. The current basic approach in Washington and in New York proceeds this way: "What's Plan A? Answer: Massive fiscal stimulus. What if it doesn't work; what's Plan B? Answer: More massive stimulus."
The questions that economists and politicians are really grappling with right now are occurring at a different level of emphasis:
How much stimulus is enough?
How much of a multiplier on spending can we expect?
Are direct spending programs more or less effective than tax cuts?
At precisely what should the direct spending be targeted?
When will we see the benefits?
This is where the differences start to emerge, in both economic theory and in political practice.
The Democrats - with Barack Obama and the director of the National Economic Council, Lawrence Summers, in the lead - tend to favour large-scale direct spending programs on projects they conceive as multiplier-rich public goods: hospital and school infrastructure, clean energy technology, highway and transmission line construction. These are areas where they think the private sector would not be stepping up, especially in this under-capacity economy.
The main arguments are that direct spending can target long-term, strategically beneficial priorities, yet get three to four million people back to work quickly, according to the president-elect. The programs cannot be hijacked into savings accounts or stuck under mattresses as tax credits can be. Invoked as supportive authority for this approach are John Maynard Keynes and the reinvestment programs of the Thirties and the period around the Second World War spawned by Keynes's thinking. That said, the proposed program is a real political compromise that throws together a large tax cut of about $300-billion with nearly $500-billion in direct spending.
Republican economists tend to agree that a sizable stimulus is needed, but prefer monetary tools and tax cuts. They think direct spending is misdirected and slow. They see such spending as inevitably wasteful because it comes in a pressured and artificial manner, and is not allocated by pricing mechanisms in the market; with lower multiplier effects than tax cuts. They prefer tax cuts, because in theory they could start going to work as soon as they are passed into law, as people should know they have more take-home income.
But regardless of left-right balance, most economists will acknowledge that even if a spending program's multiplier effects are reasonably positive, the effect unavoidably lags. Promises of millions of created jobs in the very short term are probably not well grounded. As Anthony Karydakis, former chief U.S. economist for JP Morgan Asset Management, now teaching at Columbia University, states:
"The potential of such a package to turn the economy around in any meaningful way in 2009 is actually quite limited. In fact, it is nearly impossible to alter the trajectory of economic activity over the next two to three quarters, fiscal stimulus or not. ... Over that time frame, the economy will simply do what it is already on track to do, which is essentially to experience additional contraction."
