Finking about stimulus

The position of Fraser Nelson and Guido Fawkes on deficits should hearten the left. Tax cuts are stimulative but spending rises even more so.

Keen blog readers will have been following the fascinating debate over deficit-findanced tax cuts between Danny Finkelstein on the one hand, and Fraser Nelson and Guido Fawkes on the other. The left should be heartened by the latter’s position.

Yesterday, Finkelstein, the fiscal hawk, wrote: “If the Tories were now to cut taxes immediately upon on entering office, what would happen? It would, erm, destabilise the economy, wouldn’t it.” Guido responded:

“bond traders understand that a growing economy supports their coupon payments, whereas a flat or contracting economy is a greater sovereign credit risk. A growing economy can afford to finance a budget deficit if necessary. An over-taxed, low to no growth economy can’t. High taxes, and Britain is a high tax economy after 13 years of Gordon, destabilise the foundations of a strong economy, driving enterprise into the ground or overseas.  Guido remembers when this was ideologically core to Conservative thinking, it was when they won elections…

Today, the Fink replies:

“He is forced into that position by his view, cogently and frequently advanced, that tax cuts should always be proposed since they force the state to cut spending.”

But that’s not quite right. Guido does want tax cuts to be offset by spending reductions but, recognising that spending cuts are politically tricky, believes “in the realm of lesser evils” that deficit-financed tax cuts are stimulative. And he’s right – but spending rises are even better.

During the stimulus debate in the US, much was made of Congressional testimony by Mark Zandi, the Chief Economist of Moody’s Economy.com, an independent provider of economic analysis. In this updated report assessing ‘The Impact of the Recovery Act on Economic Growth‘, Zandi outlines the “bang for the buck” from different aspects of the US fiscal stimulus. While some tax cuts delivered increases in GDP beyond the amount pumped back into the economy, it shows that spending increases were the most efficient form of deficit spending.

The key to recovery is growth. Some tax cuts – like the Government’s VAT cuts or Obama’s tax rebates – can play a stimulative role. But as this independent study shows, government spending is the most efficient way to address the low aggregate demand that typifies the current recession.

33 Responses to “Finking about stimulus”

  1. He's Spartacus

    Which would be fine and dandy if Labour had any intention of cutting spending.

  2. Anthony Painter

    RT @leftfootfwd: Why @GuidoFawkes is right about the stimulative effect of deficit-financed tax cuts //bit.ly/bTSe1u

  3. Jessica Asato

    RT @leftfootfwd: Why @GuidoFawkes is right about the stimulative effect of deficit-financed tax cuts //bit.ly/bTSe1u

  4. David Coats

    Well said Will. This is exactly right. The problem with the Tories is that they have forgotten all about Keynes. Without growth everything else is wishful thinking…and Finkelstein style fiscal sadism is certain to push us into a double dip recession. We need robust arguments on the left to get the market fundamentalists back in their box and keep them there. Most importantly, the political task is to get the Tories reading the General Theory again. If Macmillan found the arguments compelling then today’s Tories should too. That they don’t tells you something about their preparedness for the tough choices (and fine judgments) demanded in government. Deficit reduction does have to happen at some point, but start too soon and disaster will follow.

  5. dave jones

    Double dip recession is an absolute certainty – the only issue is whether the election comes before the second dip, then it will be Cameron’s fault!

  6. Giles

    I was actually a pretty big fan of the VAT cut as it was hard to save, like an income tax rebate might be. I’m glad that Guido thinks the income tax ideas of the liberal democrats would be stimulative. I am slightly surprised he thinks stimulation is what we need, when he is already worried about inflation. If people think inflation is about to happen, then they must think demand is bumping up against supply.

    but perhaps the view is: you increase the supply potential of the economy by lifting these tax levels. but then you would also increase rates if you allowed your deficit to bloom , wouldn’t you?

    On the nelson-fink debate, I suspect nelson is wrong, because fink is a seriously brainy guy. And has probably read the history; if you read N Lawson’s closely detailed account of 1979-89, you find that Mrs T was frequently very cautious, backed down a lot in the beginning, held back for silly political reasons from rational reforms. Nelson has a cartoonist idea of Mrs T. Read the history, I say.

    I would not personally call for spending rises right now. I would rather deploy QE money in the real economy, ease some financing strains that are holding back some investments. We have a 13% deficit, and control over our own currency. One is a weakness, the other a strength….

  7. Psi

    Will –
    no you are wrong, your economic understanding is stuck somewhere in the 1960s. To suggest that ALL spending increases are more economically effective than ALL tax cuts would have shown you to be ignorant 40 years ago but to do so now is inexcusable.

    The report to which you refer is one about an American plan which spent money on particular projects and cut taxes in particular ways. Any spending project or tax cut will have a different multiplier effect.

    For example it would be possible to spend a great deal of money laying tarmac over the entirety of Ross and Sutherland but the multiplier would be considerably less than 1 (probably very close to zero).

    Where as if you were to spend that putting a heated extra runway at Gatwick (leaving aside environmental issues for the moment) with a high speed rail link from several London locations (Canary Wharf, London Bridge and Victoria for example) the multiplier would be higher.

    If you were to spend the money improving literacy and skills in areas where those are particularly poor the multiplier would be higher still.

    As to tax rises, again not all will have the same effect the effect of raising the tax free threshold would have a much larger multiplier (more stimulating) effect than the same amount of money spent on reducing the top rate.

    @ David Coats
    Do you understand Keynes? He advocated running up a deficit during falls in aggregate demand but then when growth returns you have to run large surpluses.

    If you do understand this basis concept I assume you were equally critical of Gordon Brown for running deficits (or, very rarely, small surpluses) when he was chancellor and the economy was growing? He clearly should have been running huge surpluses given the level of deficits runs now.

    Additionally Economic understanding as moved on considerably since the time of MacMillan, for example the huge QE process (based upon understandings derived from Friedman’s work). There would have been very little monetary stimulus if we did as you suggest and stop economics somewhere in the 1950s.

    The Tory economic position may be laughable, but they seem to stack up quite well against the sort of criticism they receive from places like this. Perhaps intelligent comment is not what this blog exists for (feels rather like a site intended to preach nostalgia to the converted) then perhaps you should dump any pretence of being “evidence based.”

  8. Mark

    I’m not sure about Will Straw and Guido Fawkes discussing economics, it seems a bit like two Premiership footballers discussing Stoicism!

    Anyway, for what it’s worth, you can’t view the spending in isolation. The money has to come from somewhere and the funding issue is critical for the UK.

    As we see today the government is borrowing record amounts. As a result of today’s shocking borrowing news the spread on British debt is at the same level as Portugal, not a flattering comparison, we are supposed to be a G7 member, not an agrarian peripheral member of the Europe. Unlike the US, Britain does not have a reserve currency and its economy is far more dependent on one sector, finance to drive output.

    Besides, analysis of the US economy does not always match the UK. But let’s assume it does, for the sake of argument. If so, then why is the government cutting back in the areas where spending at the margin delivers the biggest “bang for buck”? The FT’s Martin Wolf puts it better than me “the parts of public spending that sustain the long term health of the economy should not be sacrificed. Yet that’s exactly what the government is doing: net investment is being slashed from 3.5% of GDP in 2009/10 to 1.3% in 2013/14.” As usual, Gordon Brown is getting it all wrong.

  9. Ellie Gellard

    another good'un frm @leftfootfwd .Some tax cuts can stimulate economic growth,but Govt spending does it better. //tinyurl.com/yhfoy83

  10. Thomas Byrne

    I actually agree with this piece, in that Guidos position is idiotic. (Re: Tax cuts funded by borrowing, but obviously not Left Foot Forwards conclusions.

  11. Will Straw

    Thanks for the comments. It’s a fascinating debate. A few replies:

    David – Completely agree.

    Giles – whether we need more spending rises right now is a different debate. I was just outlining that those who support deficit-financed tax cuts must not rule out deficit-financed spending increases.

    Psi – You mischaracterise my argument. I didn’t claim that ALL spending rises would be more stimulative than tax rises. The chart I reproduced clearly shows that there are different multipliers. And you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect. The point is that there would be better ways to spend that money just as there are better ways to spend money than tax cuts. The central point of my argument was that if you conceded that deficit-financed tax cuts can help the recovery, you have to also accept that well targeted spending rises do the same.

    Mark – I agree that the US numbers will, at the margin, be different but a similar exercise in the UK would yield similar results and show that both well targeted spending and tax cuts are stimulative – an argument that the right are keen to ignore. As to mine and Guido’s economic knowledge, he was a successful trader for a number of years so I do happen to respect his take on these matters. For my sins I covered economics in both my undergrad and graduate degrees before working on economic policy at the Treasury. So perhaps Guido and I are a bit Cantona and Mourinho discussing stoicism.

  12. Mark

    Will, sorry if that was personal but this is not yet the economists forum of the FT. Although a successful stint as a trader does not guarantee economic wisdom, although perhaps “Guido” had some clever insights, who knows.

    Like I say, we can’t look at the UK’s spending in isolation, you must consider the funding question. The markets are keen to pick a new whipping boy, for appearances sake at least the UK needs to avoid giving speculators ammunition for an attack. This would be ruinous, we can’t discount the event.

    So like I say above, there’s nothing wrong with targeted spending but the government is doing the opposite of what is necessary for long term growth. Spending on the NHS and other areas is “ring fenced” but net investment gets slashed, the reverse of the argument above. Now we get into another political debate but if there’s no economic growth in the future, we can’t fund the NHS as well. Spending should go to where it delivers the greatest gains at the margin but the government is doing to reverse. Indeed it looks like spending is being directed towards where it delivers marginal electoral gains, these are short term and cynical.

  13. lee james brown

    @leftfootfwd shows that best way to stimulate economy is by gov spending. //tinyurl.com/yhfoy83 Treasury figures show the same.

  14. Bearded Socialist

    we’re not highly taxed, compared to other countries. Compared to somewhere where no one pays tax, only then are we highly taxed

  15. David

    “…you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect.”

    Ah, the broken window fallacy rears its head again…

  16. David

    …or is that ‘The Public Works Fallacy’?

    Either way, the author actually believes that employing people to do something useless is a way of boosting prosperity. It would be funny, but unfortunately it is a view shared by people with influence. Very worrying.

  17. Josh

    One of the biggest myths perpetuated in modern times is that deficit spending helps a depressed economy, and that reducing a deficit in the middle of a recession/depression is suicidal. The deficit during the final year of Herbert Hoover’s presidency was 4.5%. So much for being a contractionist. The deficit averaged 5.1% during the first 3 years of New Deal. Are you really suggesting that a difference of 0.6%, or 60 basis points, means the difference between depression and recovery? If so, why did America did tip back into depression after WW2, when a deficit of 21.5% was turned into a surplus of 1.9%, a swing of 2,320 basis points!!! If 60 basis points means the difference between depression and recovery, surely 2,320 basis points would do even more damage. But it didn’t. The post war recession lasted 8 months with an unemployment rate of 3.9%, compared to over a decade of depression with an unemployment rate that never fell below 14% despite massive fiscal stimulus.

    Robert Barro has produced some research that suggests the multiplier for non-defence outlays is zero. Christina Romer suggests it could be 1.9. Don’t trust the perceived wisdom of economists. They are mostly useless, relying on sophisticated models that attempt to replicate human behaviour, relying on crackpot theories like the Efficient Markets Theory or Rational Expectations. The Keynesians, Monetarists, Marxists and New Classicals were moronic with a few exceptions. The Austrian School however called it right from the beginnning. The only solution is Austrian, as President Warren Harding proved when he cut spending by 33% and cut taxes at all levels during the 1920 depression, which lasted only one year despite no monetary or fiscal stimulus*

    *If you argue that spending has a larger multiplier than tax reductions, then bigger spending increases than tax reductions would imply a negative multiplier, implicitly suggesting no fiscal stimulus.

  18. Harry Harrison

    @ Beardyweirdy
    Measured on an internationally comparable basis, the UK has the highest tax burden of the G7. Higher even than France, which is quite something when you compare their public services to ours.

  19. Major Plonquer

    You clowns are still at it. Forget that it was the Left’s over-egging of the State that got us into this mess in teh first place. Forget that the UK can’t afford all your stupid non-jobs. Your arguement is all about how to make the pain SEEM less. Forget it.

    Personally I don’t give a damn. I’ve abandoned the UK with my family, my business, my jobs and my wealth creation and moved to a country where they recognise and reward capitalist endeavour. China.

    What amuses me is that you lot seem to think that Chinese peasants will continue working hard creating foreign trade surplusses just so they can continue to underwrite your bloated government spending. Take a look at the headlines in this morning’s China Daily: China’s holdings of US Treasury debt slashed.

    If the people here won’t underwrite the USA why do you continue to believe they’ll underwrite the UK’s debt? In a year or two the UK won’t have the luxury of defeicit spending. You’ll have to live within your means and I don’t think Keynes is going to rise from the dead to save you.

  20. Marcus Aurelius

    And Will if we really have “low aggregate demand” why the jump in inflation. We have too much demand and too little production.
    If you create millions of highly paid non jobs in equality commissars, five a day coordinators all you do is drive up house prices (they all want to live near the only good school) and drive down the currency (they buy BBMW’s and Panasonic flat TVs.

    Record rise in inflation follows record increase in money supply, who would have thought it?

  21. Psi

    Will –

    Two quick issues:

    Firstly “You mischaracterise my argument. I didn’t claim that ALL spending rises would be more stimulative than tax rises.”

    I my have mischaracterised what you meant but not what you said. Your statement was infact:

    “But as this independent study shows, government spending is the most efficient way to address the low aggregate demand”

    I simply added one word all which highlighted how in your argument you were over simplifying the issue. I’m willing to accept you meant that you believe that generally government spending is more effective than tax cuts but perhaps you should be more open to the idea that the situation is more complicated than churning out statements that read like they have come from the Labour party of 1982. If your statements can be parodied be someone adding the word all in them once you argument needs refining.

    Secondly in the spirit of accepting what you say may not actually be what you meant perhaps you would reconsider your answer:

    “you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect.”

    I did deliberately start with an example that even an A level student would easily see was ridiculous. Particularly the phrase “substantial” too me that would tend to imply a multiplier greater than 2. As anything with a multiplier less than unitary should be considered terrible.

  22. Michael Burke

    Will, an interesting piece.

    You are right, goverment spending is more useful than tax cuts in promoting growth. And we don’t need to rely solely on the US example to prove it. The Treasury here has also demonstrated it. The Treasury Public Model 2002 shows that, in the first year, the ‘bang for buck’ from a tax cut is 0.3, compared to 1.1 for an increase in government spending. Better, both types of stimulus rise over time so that in year 3 the return is 0.9 for tax cuts and 1.4 for increased spending.

    //socialisteconomicbulletin.blogspot.com/2010/01/investment-not-cuts-by-michael-burke.html

    Of course, the Treasury estimates, like Moody’s are just long-run averages, and in current conditions the multipliers are certain be higher.

  23. Dave B

    The NY Times had an interesting article on this:

    “…Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. In an October study, they looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. They identified 91 episodes since 1970 in which policy moved to stimulate the economy. They then compared the policy interventions that succeeded — that is, those that were actually followed by robust growth — with those that failed.

    The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending.”

    //www.nytimes.com/2009/12/13/business/economy/13view.html

  24. Ewan Watt

    Do people on the left still claim that the New Deal saved the American economy? I had no idea.

    But Will, would you not also say it depends on the value of stimulus you inject into the economy? For example, surely using a surplus – as Keynes advocated – would be a much more robust response to a downturn than financing spending through, well, printing money?

    That’s my problem when some folks – I’m not necessarily referring to you in particular – claim that a fiscal stimulus is the answer to all our problems. Furthermore it could even be argued that the UK never had a fiscal stimulus because around 99% of the newly printed money was used to finance existing public spending. On the other hand the Germans actually had reserves – rather than a printing press – to stimulate growth. Funny that, because I’m sure the Germans are aware of what happens when you print money.

    Personally I’d prefer the FN/Guido route, but like the United States, can we honestly claim that we’re stimulating the economy whilst destroying our own currency and frightening the hell out of bond traders? I’m also glad to see that some folks – incidentally, often on the right – have a better understanding of Keynes than the Left does. Keynes actually liked surpluses and noted that deficits were only necessary during a downturn. Can we really say that Labour are following Keynes here? One part of Keynes they may well be familiar with is causing inflation that cuts the deficis and attempts to fool the working man into believing that because he’s still in work he’s doing just fine. But as we’ve seen with Jimmy Carter, inflation also pushed the poor into a higher tax bracket – fiscal profligacy has its consequences and they usually hurt the most vulnerable, folks I would have hoped Labour would seek to protect.

    Finally, rather than a fiscal stimulus what I’d prefer to see is a real, concerted attempt to sort our banks out. Given the non-existent interest rates it’s near enough impossible for some banks not to be making a profit right now, mainly because they’re failing to pass on these cuts to the taxpayer – that was what exacerbated the Great Depression, not a lack of stimulus. In fact, most banks are actually hiking their interest rates to consumers. Will, I know you’ve often highlighted that when cutting rates fail the only recourse is to enact a fiscal stimulus, right? But what happens when consumers and the population at large fail to get these cuts passed on?

    Unfortunately it will be the bond market – rather than politicians – who decide when spending cuts have to start. That’s unless you’re advocating more QE?

  25. Ewan Watt

    “…you’re wrong about your example too: Who would doing the tarmacing and where would the tar come from? The money going to those workers and companies would trickle back into the economy so you would get a substantial mutliplier effect.”

    Are we working on the basis that the road needs to be tarmacked or what? Or are we advocating digging a hole and refilling it for the sake of it?

  26. Psi

    Ewan –

    If you read my example, (deliberatly ludicrus, to make it east to understand) I was suggesting tarmacking a distant area of Scotland (not even roads) where there would be no demand for the increase in tarmacked area and destroying the tourism industry. Will, apparently, thinks it will have a “substantial” multiplier effect, but I hope he has mis-stated his view on this. We’ll find out when he replies.

  27. Ewan Watt

    Psi – sorry mate, I wasn’t deliberately mocking your example – I was just looking for folks to try and defend how this often cited “stimulus” programme would actually aid the economy. Y’know, public works etc… We could also have referred to the broken window or throwing gold down a mine shaft, filling it up with concrete and giving unemployed folks pick axes…

    I see plenty of this stuff in the US – the “stimulus” has been used to maintain airports or stations that nobody uses this anymore. How is that productive? And I would imagine that most of these studies that advocate a stimulus are based on the presumption that every dollar – or pound – is targeted. But when you spend almost $1tr, that’s just impossible.

  28. marcus Aurelius

    How’s that “No more boom and bust” thing workin’ out for ya?

  29. Will Straw

    I’m glad this has provoked such a good debate. And apologies for taking a while to come back. Some thoughts:

    Mark – I didn’t take it personally at all but thanks for saying so – just a bit of light ribbing. Of course, you’re right, it would be disastrous if the bond markets stopped funding the deficit but we’re not there yet and the judgment of the 67 economists is that cutting in 2010-11 raises that risk.

    David, Psi, Ewan – I’m not suggesting that the best policy would be to tarmac rural Scotland or to fill in holes for that matter, of course not. But there would be a multiplier higher than zero (and probably close to 1 given the raw materials and labour costs). Reading your earlier comment, I think we atually agree on different policies having different multipliers (the reason I reproduced that table). My contention was that, on average, well targeted spending projects will have higher multipliers than tax cuts. As Giles points out, this is particularly true when the savings rate is rising.

    Josh – You’re priceless. To paraphrase: you can’t trust any economists apart from the ones I agree with”

    Marcus – Giles Wilkes is good on why there is still a deflationary risk. See here: //freethinkingeconomist.com/2010/02/16/ive-been-waiting-for-this-inflation/

    Ewan – Agree with you on the banks but we can walk and chew gum, no?

  30. Marcus Aurelius

    I wouldn’t pay that much attention to state employed economists. Remember the 1981 budget, which turned conventional wisdom on its head by raising taxes sharply despite the fact that the economy was in a deep recession?
    Many in the Treasury objected, as did 364 British economists who signed a celebrated letter predicting that the budget would condemn the economy to a prolonged depression.

    The 364 economists were discredited when the budget led the way to the long economic upturn of the 1980s. Professor Sir Alan Walters’s critics had missed the reason to raise taxes – to allow interest rates to be cut sharply. Interest rates are a key driver of UK economic performance because of the huge amount of debt – including mortgage borrowings for houses – dependent on short-term interest rates.

  31. Ewan Watt

    “David, Psi, Ewan – I’m not suggesting that the best policy would be to tarmac rural Scotland or to fill in holes for that matter, of course not. But there would be a multiplier higher than zero (and probably close to 1 given the raw materials and labour costs). Reading your earlier comment, I think we atually agree on different policies having different multipliers (the reason I reproduced that table). My contention was that, on average, well targeted spending projects will have higher multipliers than tax cuts. As Giles points out, this is particularly true when the savings rate is rising.”

    Will, thanks for replying.

    But what if the money being used is freshly printed by the central bank? That’s where my real concern comes in. If we’re printing money to finance this stimulus, surely this has a negative effect on the multiplier? This is why I’m surprised why people on the left aren’t more fiscal ‘c’onservative. Sure, if you must, spend money – but spend it using real funds.

    I also struggle to see how building a road that nobody’s going to use is a net benefit to the economy.

    Finally, on inflation – would you not agree that given the fall of the pound (in large due to monetising debt, the perilous state of our economy and our deficit as a whole) it is highly unlikely we’re going to be facing inflation in the short term? Look at our trade imbalance.

    Thanks again for your response – always good to know that people actually take the time to read these emails.

  32. Ed Balls Take Note, Obama’s Keynesian Stimulus Has Failed - Guy Fawkes' blog

    […] growth. Will Straw argued, citing research by a “progressive” American economist that spending increases were the most efficient form of deficit spending. The theory can now be tested against the […]

  33. Nick

    Keynes is economic voodoo on a par with homeopathy for the current mess.

    The mess is too much borrowing and spending.

    The cure isn’t more of the same.

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