Friday, June 24, 2011

When has stimulus ever been politically feasible?

Brad DeLong says that he and everyone he knows were taken aback by our government's inability to prevent the financial crisis from turning into a protracted recession:
In order to have successfully predicted that we would be where we are now, you would have to have predicted a large number of things:
  1. That a global savings glut and a period of low interest rates would produce a housing boom.
  2. That the housing boom would turn into a housing bubble.
  3. That the housing bubble would lead to a collapse of mortgage underwriting standards.
  4. That risk management practices on Wall Street would have been nonexistent.
  5. That the Federal Reserve would not be able to construct its usual firewall between finance and the real economy.
  6. That the Federal Reserve would not feel itself empowered to take the emergency steps to stabilize demand needed during and in the immediate aftermath of the financial crisis.
  7. That the incoming Obama administration would come out of the gate with too small an economic recovery package.
  8. That politics would prevent the Obama administration from being able to take a second bite at the apple.
  9. That the Obama administration would then give up on pushing the envelope of its powers to try to generate a strong recovery.
  10. That the intellectual victory of Keynesian approaches on the level of reality--forecasting and accounting for the course of the Little Depression--would be accompanied by a non-intellectual defeat of Keynesian approaches on the level of politics.
Get all of those 10 right, and you are a wizard.

But I know of nobody who did.

The smart people I know--there imagination failed after number five or so.
Numbers 5-10 on this list deal with the inability of the American government to enact effective countercyclical policy. I have to say that I am not surprised by this at all...and I think that even without the benefit of hindsight, I would not have been surprised (and indeed, I always believed that the government's response would be inadequate). Why? Because we've never really implemented effective countercyclical policy in the past!

First, take the Fed's ability to construct its "usual firewall" between finance and the real economy. What usual firewall? Can you name a systemic financial crisis in our history that was not followed by a protracted economic slump? I am not sure I can. (Caveat: this does not establish that financial crises cause recessions, though I happen to believe that they do.) I suppose the Panic of 1907, but there was no Fed then. Maybe the LTCM collapse?

Now take the Fed's inability/refusal to stabilize nominal GDP growth after the crisis. At the zero lower bound, Fed action pretty much means QE. And when have we (or any country) ever implemented large-scale QE in the absence of out-and-out deflation? I can't think of any example.

Finally, let's consider the political feasibility of stimulus. Has the United States ever purposefully enacted a large countercyclical fiscal stimulus in the past? There's the New Deal, but as DeLong himself has mentioned, it was actually pretty small beer. Clinton's 1993 stimulus bill died a quiet death by filibuster. In fact, the only real example of fiscal stimulus that I can think of was Reagan's military buildup...but that was hardly sold as a stimulus.

So history would seem to indicate that the U.S. government is not very good at protecting the economy from financial crises or implementing countercyclical policy in really deep or prolonged slumps. I suspect, therefore, that Brad's belief in the government's abilities was really more hope than fear, and his reaction to our failure was more disgust than surprise. In other words, he was an optimist regarding the U.S. political economy. Sad to say, that is something I have never been.

Update: Mark Thoma points out that automatic stabilizers are generally politically feasible. That is certainly true.


  1. "the housing bubble would lead to a collapse of mortgage underwriting standards"

    Shouldn't we also worry that DeLong gets his arrow of causality so wrong?

    So, yeah, Michael Kalecki and all that, and, I'll raise you Simon Johnson, on the politics.

    But, what about the first 5? what about the economics?

    "savings glut"?

    "usual firewall between finance and the real economy"?

    When the topic is economics, and the thesis is whocoodenode, . . . ?

    Why can't we have a better corps of economists?

  2. Matt T9:05 AM

    It's mind-blowing that all the stimulus efforts over the past few years can be characterized as "inadequate." Exactly *how much* stimulus would be "adequate"? Borrowing and spending 20% of GDP? 50%? What happens when this massive dose of helicopter money runs out, and all we're left with are the consequences? I suppose they'll scream for yet more stimulus...

    The fact is that "the intellectual victory of Keynesian approaches on the level of reality" was nothing of the sort. Keynesian approaches got us into this mess (see #1; *why* were interest rates held too low? Well, there was a recession, and then the government started stimulating...) and the basic Keynesian viewpoint of economics as a demand-driven math equation is entirely bunk. The utter failure of Keynesian approaches to achieve anything at all over the past three years, or indeed over the past twenty-plus years in Japan, ought to speak for itself.

  3. Check out the Naken Capitalism post which includes the research piece Cracking the Credit Market Code.

    This entire disaster came directly from an unregulated shadow banking system comprised primarily of hedge funds. They used mortgage backed derivatives to create huge leverage risks, under the cover of a trio of corrupt rating agencies, the total sum of which is yet to be accurately figured. This Ponzi scheme needed systemic fraud to even happen.

    Noah, stop defending these creeps. Many of them knew exactly what they were doing.

    And then they extorted the public, in your face extortion, in order to survive.

  4. "Borrowing and spending 20% of GDP? 50%?"

    Um, Matt? The spending portion of the Obama stimulus was about 60%, out of about $800B in overall stimulus, which means that spending was about 4% of GDP. Doubling that, as suggested by critics at the time, wouldn't even get you into double-digit percentage of GDP, much less to 20%.

  5. "The utter failure of Keynesian approaches [...] in Japan, ought to speak for itself."

    Actually, what Japan neatly demonstrates is that if you don't commit much, you don't get much; and when you do, you get results.

  6. Delong's 5, 6 and 7 are all of a piece, not independent events. $1T or more of stimulus was a non-starter because of solid GOP resistance and fairly firm Blue Dog resistance; it would never have passed. Once you pass a very-likely-to-be-inadequate stimulus, you can't then go out and further damage what little confidence you've inspired (and stimulus you've created) by saying "it's not enough". However, since it's not enough, in the next election, voters will "throw out the bums" who didn't deliver jobs, and that will swing Congress rightward just by unseating incumbents - in this case, the very Democrats who make *any* stimulus possible in the first place. That makes any future stimulus far less likely; but again, the administration can't afford to further damage what little confidence there is by saying, "there wasn't enough stimulus." And so it goes.

  7. This is why automatic stabilizers matter so much. I don't think discretionary fiscal policy was ever a practical possibility in democratic societies. Automatic mechanisms are far better (for example, why can't the tax code automatically shift payroll taxes between the traditional income tax and a consumption tax, based on GDP and the current account balance?).

    It's telling, I think, that the only successful discretionary fiscal policy was Reagan's fiscal expansion, where the need to anchor inflation expectations forced the administration to lie about what they were doing (which many people believe to this day).