Tuesday, 23 March 2010

IMF et al on Fiscal Stimulus

Michael Burke: Philip Lane has posted a link to a very useful IMF working paper here. The paper draws on a wide variety of leading macroeconomic models (IMF, EU, Fed, Bank of Canada, etc.) to examine the effectiveness of fiscal stimulus.

Some interesting features of the paper’s conclusion: “There are four broad conclusions flowing from our analysis.

First, there is no such thing as a simple fiscal multiplier. The response of the economy to temporary discretionary fiscal stimulus depends on a number of factors, including most importantly the type of fiscal instrument used and the extent of monetary accommodation of the higher inflation generated by the stimulus.

Second, temporary expansionary fiscal actions can be highly effective, particularly when the fiscal instrument is spending or well-targeted transfers, and when in addition monetary policy is accommodative.

Third, permanent stimulus, that is a permanent increase in deficits, is much more problematic than temporary stimulus. It leads to a long-run contraction in output, but in addition the perception that deficits will become permanent also substantially reduces short-run fiscal multipliers.

Fourth, the G20 stimulus should have significant effects on global GDP in 2009 and 2010.”

So, it seems that the rest of the world has good reason to believe in the ‘tooth-fairy’ of fiscal stimulus. No such naïveté to be found in the ranks of Irish policymaking, unfortunately.

In discriminating as to types of stimulus, the verdict is also rather clear,

“A number of results are consistent across all models.

First, the multipliers from government investment and consumption expenditures, which are roughly similar in size, are clearly larger than the multipliers from transfers, labor income taxes, consumption taxes and corporate taxes.

Second, multipliers are small for general transfers, labor income taxes and corporate taxes, and somewhat larger (but still small relative to government expenditures) for consumption

Third, only targeted transfers come close to having multipliers similar to those of government expenditures……[Yet....]
…it is of interest to note that in none of the regions [of the world adopting fiscal stimulus] do increases in government consumption play a predominant role.”

Figs. 22 and 31 show the very large multiplier effects of government investment and (slightly lower) effects of targeted transfers to the low paid in the US economy and Figs. 64 and 73 show the same for the EU.

There is one unproven assertion in the article on government finances, evident in the phrase above ”a permanent stimulus, that is a permanent increase in deficits.” If, as the models consistently find, the effects on GDP of government consumption and investment have multipliers that stretch to 2 over more than one year when interest rates are low (and have a cumulative five-year impact of more than 5), then the effects on government tax revenues would exceed the initial outlay by some considerable degree; ie investment and government consumption can lower the deficit, not create a permanently higher one. There is too the unacknowledged benefit to government finances from a growth-related decrease in welfare spending.

The alternative approach, based on ‘Expansionary Fiscal Contraction’, is dismissed in the IMF WP. An examination of how the EFC experiment has failed Ireland can be found on this blog.

The main argument against Ireland adopting a fiscal stimulus is openness (The debt and deficit arguments do not hold since Ireland’s debt level is below that of the peer group studied and the deficit matched by some). Yet the openness argument is tested (Fig.88) and found to have no appreciable impact on the effectiveness of fiscal stimulus - perhaps, unstated by the authors, because the propensity to import is offset by both a greater propensity to export and the greater efficiency that openness brings.

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