Effects of Fiscal Stimulus in Structural Models

If I read the whole lot canihazdockratz?

http://www.irisheconomy.ie/index.php/2010/03/22/effects-of-fiscal-stimulus-in-structural-models/

I got past the first page. They seem to ignore the effect of low interest rates and credit bubble.

Somehow, I do not need to strain to read the rest!!!!!! I predict a good career for the 7 or so authors in banks around the world …..

@John McHale,

“We should be pushing for a less crude fiscal adjustment policy.”

Couldn’t agree more, but what chance that the MoF, his special advisers and the few policy-influencing senior DoF officials will pay any attention?

In the equation that links the NAMA discount on bank loans to be transferred, the value of existing shareholding in the banks, the likely haircut for non-senior bondholders, the amount that can be extracted from the NPRF for bank recap and the maximum EBR in the context of the fiscal stabilisation programme agreed with the European Commission targeted public capital expenditure is the residual variable that will be sliced and diced to ensure the other variables have politically and legally acceptable values. In other words, ensure the political survival of the Government and avoid legal challenges from parties whose investments may be revalued downwards.

All the rest is arm-waving about “innovation ecosystems” (and the scattering of small, but photo-shoot friendly, amounts of money) to distract attention from the fact that the rest of the real economy will be burdened with the requirement to adapt to generate a solution to the equation that will be politically sustainable in the short-term (max. 2 years).

It would take a lot of effort to generate the counterfactual, but it is very likley that the Celtic Tiger was beginning to run out of puff in the early years of the century. The property bubble concealed this and it’s difficult to assess whether or not a more rational reallocation of the resources swallowed in the bubble would have sustained the previous high level of economic performance.

However, a sensible reallocation might have sustained a lower, but sustainable, long term trend growth. But we didn’t do it when we had the resources and the external environment was benign; it’s so much more difficult now with constrained resources and a grim external picture – and the world has moved on in way that has eroded the competitive and strategic advantages that the Tiger enjoyed in the late ’90s.

There is no way out while this Government remains in office – and even then it will be a tough, long haul.

@Paul Hunt
Excellent post. But then I would say that! (seeing as I agree with what you are saying!).

Steady on folks. None of the seven models analysed here fits a small, indebted Eurozone member facing a credit supply curve (of unknown location) that slopes sharply upwards, and is subject to meteorite shocks. Add small multipliers and a dash of risk aversion and it is not hard to get nervous about fiscal stimulus.

In the Irish case, what evidence is available that current and planned public investment levels are too low on conventional cost/benefit grounds? Value-for-money, project-by-project, anyone?

@Colm and Edgar,

In the face of your well-based cautionary advice I know I run the risk of being accused of advocating throwing money at “famine follies”, but I don’t see this as a choice between some (or a lot of) physical capital investment or very little. Yes, the current recession/depression? has redefined the nature and extent of the infrastructure deficit – and it may be difficult to define the precise nature of the infrastructure required to sustain future growth, but the deficit still exists. Furthermore, there is a requirement for investment in human capital and (I know, horrible word) “interconnectivity”. This last involves a rapid expansion of broadband and the associated hardware and software to support economic activity and access to public services – which would have a major impact on the efficiency of public service provision.

A coniderable amount of state equity is buried in financially inefficient state and semi-state agencies that could be released to leverage the financing of investment without impacting on the current requirement for fiscal consolidation. But the vested interests obstructing this are powerful.

Although I remain unpersuaded by a number of aspects, FG’s NEWERA proposals present some options for consideration – and this has just been underpinned by their “New Politics” proposals:
http://www.finegael.org/upload/NewPolitics.pdf

which contain interesting proposals on the design and implementation of fiscal and budgetary policy.

Interestingly, Lane-Benetrix has found similar results for fiscal multipliers in Ireland as that presented in the IMF paper whih suggests that the contraints of a small open economy may be over stated. This is reinforced by reference to the CSO Input-Output tables which indicate that, excluding the multi-national dominated sectors, leakage is proportionately smaller than gross totals.

Edgar, it may be a mistake to think that what is happening is a ‘consolidation of public finances’. Rather, as the article on Progressive Economy (which Michael Burke linked to above) points out, what is happening is that current fiscal contraction, particularly spending cuts, is merely embedding the deficit into the economic base which will result in lower output in the future. Current spending cuts, especially, will have little impact on the deficit burden but will be economically damaging. This may help explain the EU Commission’s and the IMF’s warnings that Government growth projections are too optimistic which will mean that the current strategy will fail, once again, to meet its fiscal targets.

Investment, on the other hand, has the potential to embed growth in the economy, while providing an identifiable return in the form of increased productivity and Exchequer returns. Clearly this was the continual message of previous ESRI evaluations of NDP and EU-financed programmes – and these were conducted during times of relatively high growth. That we have severe infrastructural deficits is contantly highlighted by the National Competitivness Council, referencing their own research and that of other bodies. In short, we have considerable needs – what better time to start work than when there is considerable slack.

It would be helpful to confront the key, and contestable, assertions in the debate – that cuts equal savings, and that investment is a cost – in a pragmatic manner.

Michael, many models grind out fiscal multipliers without specifying a short-run government budget constraint of the type now faced by debt issuers in the Euro periphery. There is assumed to be an elastic supply of external credit at prevailing rates. Build in an upward sloping curve and its easy to wipe out the multipliers: indeed, negative multipliers are entirely possible.

Paul, the task is to achieve the best outcome for employment that is now feasible, given all the damage that has been done. If I thought that a fiscal relaxation, or an investment splurge, would achieve that, I would be in favour. There is no point lamenting if the best that can be done does not look attractive.

@Colm McCarthy

“In the Irish case, what evidence is available that current and planned public investment levels are too low on conventional cost/benefit grounds? Value-for-money, project-by-project, anyone?”

The National Pension Reserve Fund.

“.. the best that can be done ….”

Give us a break! As noted earlier – It appears that Schrodinger’s cat is simultaneoulsy both still alive and still dead within The Minister’s unopeable NAMA Box_bank, for which The Minister has the only availabe unusable key, a key which changes its shape each time he observes it. Surely The Breakthrough Cute-Heuristic Equation in Quantum Finance of the Century deserves to be honoured? Where is the ‘conventional economics’ in all of this ……….?

@Colm,

Apologies for appearing to be annoyingly tenacious, but I think it is only in the context of an upwardly sloping supply curve for external credit – and the risk that this curve may shift upwards and outwards very rapidly – and of the use of public capital expenditure as the sole fiscal instrument that the current policy could be considered optimal.

I know I’m straying beyond the focus on a fiscal stimulus that kicked off this thread, but I don’t think it makes sense to say “well that won’t work here, so we’ll have to stop considering any other options”. Apart from its fiscal stance, I would be surprised if you didn’t find many other government policies/proposed policies that impact/would impact on economic activity less than optimal. (You were particularly, and justifiably, scathing about the report of the Innovation Taskforce.)

My modest proposal involves restructuring state and semi-state agencies, releasing the buried and inefficiently-used state equity and facilitating investment in the efficient provision of infrastructure services. This is the very least the state should do to encourage the “animal spirits” on which private sector economic activity relies.

My only lament ia abour a lack of gumption among those who wield power – and among those who might be able to influence them to act in the public interest.

@Paul Hunt
“facilitating investment in the efficient provision of infrastructure services. ”
Actually, what we want is inefficient provision… rather than machine digging, we want the equivalent cost to be spent on chaps digging holes and filling them in. We don’t make machines, we do make people. Machine HP agreements don’t spend in Ireland, hole-diggers do.

Of course, this would have to be for the same price as a machine would do it, which would require current hold digging prices to be reduced, but is it feasible?

Colm,
I don’t think you place enough emphasis on the mix of the fiscal adjustment. I certainly share your concern about the fragility of credit supply and see your argument about playing it safe. But what is most important for perceived solvency is that government demonstrates its capability to bring the deficit onto a sustainable path. This is why I don’t think there was any choice but to severely and permanently contract current spending and ultimately to broaden the tax base. I think creditors look differently on temporary capital spending—although clearly it must be well allocated so that it improves longer-term supply potential.

Edgar,
I know we have been around this a few times, but I am still unsure about your view on how positive investment multipliers (given a large output gap) affect cost-benefit calculations. (The DOF puts this gap at over 7 percent.) We usually assume a zero multiplier for an economy at potential. Increased investment then involves a reallocation of resources. An investment multiplier of just 0.5—which does not seem wild given the available evidence—would mean that we are getting the investment at “half price.” I think even Colm might find that worth a look. I don’t pretend any detailed knowledge of individual projects, but I do believe in doing things that need to be done when they are cheap. I would have no objection to taking a small amount of time to evaluate the capital programme given changed circumstances. This doesn’t appear to be what the government is doing, with plans to cut a further billion in 2011. This all makes sense if the multiplier is truly negative given the induced credit price effect that Colm mentions. But that strikes me as an extreme assumption given the available evidence.

http://www.scribd.com/doc/28795508/Dylan-Grice-Selling-the-Yellow-Stuff

There is a rather frightening chart within. Thankfully, it is only a remedy/prediction.
Warning, do not read unless you have eaten. He is an analyst type, what does he know?

The Aussie$ is still going up against the Euro. Some folks think that we are a commodity currency. They are correct. The gyrations of the $ are amazing. Compared to the rest of the world Australia looks good. But very rough times are ahead and the youngest generation know very little about it, yet.

@paul quigley,

Many thanks for your comments on my effusions. I agree with your take on the Eircom debacle, but, for me, this a classic case study on “how not to do it”. Many privatised utility businesses in Britain have had their balance sheets hollowed out in a similar manner by the private equity ghouls. The penny is beginning to drop not only in Britain, but throughout the EU and in the US as well – and, in particular, in the energy sector – as the infrastructure deficit mounts up and the requirement to modernise infrastructure service provision – the sinews of the economy – becomes pressing.

Ireland is not immune from these pressures, but the economics of “Doing Nothing” seems to have taken hold. The best, or worst, examples (according to taste) are the ESB and BGE – the wealthiest and most financially inefficient semi-states. Yet there seems to be no interest in tackling this financial inefficiency which costs consumers dearly. The Energy Policy Centre of the ESRI, by virtue of its commercial sponsorship, is, I believe, constrained from tackling this issue. The principal sources of demand for consulting services are the Department, the CER, the ESB and BGE. I work in energy consulting. By virtue of the stance I have taken on this issue I don’t have a snowball’s chance in hell of getting work in this area in Ireland, so I can understand why others remain silent.

For me, this is just another example of why Ireland is struggling through another, largely self-imposed, financial and economic crisis. It may seem small beer compared to the liability the Government’s approach to bank resolution will impose on current and future citizens, but the costs are real and significant and are a symptom of a much deeper malaise.

With a binding budget constraint (and the Greek case shows that it is binding) increasing public investment implies reducing current expenditure e.g. wages and/or social welfare.

For the short-run the question then is, which has the higher short-run multiplier, current or capital spending? I only know of one paper that has looked at this and the results were mixed – for some countries (Canada, Netherlands and Germany) a shift from current to capital expenditure was positive while for others (France, Britain and Japan) the impact is negative.

The long-run returns on infrastructure are positive and reasonably large so there is a strong rationale for investing (we had an estimate of 14% in the Mid-Term Evaluation). However, this is irrelevant if we can’t find the money for investment.

If the budget constraint means that we have to curtail investment using public funds, and if there are large returns to such investment then we should look at alternative ways of getting the investment in place, and that means looking at private sector sources. Of course there is no free lunch here and this is not going to happen overnight.

@ paul hunt

The insiders are not ‘doing nothing’. They are busy avoiding and misrepresenting the core issues rasied by civic spirited economists like your good self. You will find it interesting to observe, and perhaps document, the variety of interesting methods used.

Nothing is more difficult than facing down monopolies and vested interests, and nothing is more necessary. The challenge is one of economic and personal survival while the necessary changes evolve. Your view is manifestly souind, so don’t stop sawing.

Edgar – your reference to the return on infrastructural investment is helpful. There is a strong argument that such investment – combining demand and supply-side impacts – would create such a boost that, rather than being a charge on the Exchequer, it could work in both the short and long-run to create additional tax revenue, reduce unemployment costs and permanently increase GDP. In this instance, the issue of credit constraint becomes less of an obstacle as it may actually work to relieve those constraints. This is all the more the case when we consider that:

(a) Ireland has a relatively low gross debt level within the Eurozone. In addition to that, we are maintaining an average Exchequer cash balance of approximately €20 billion (or 12 percent of GDP). This suggests some fiscal space.

(b) The ability to mobilise investment resources through a restructured public enterprise system (as per Fine Gael’s NewERA policy which builds upon ICTU’s original proposals) that could engage in both enterprise expansion and start-ups. That this could leverage private investment would be additionally beneficial.

It would appear that a fruitful course, therefore, would be to at least explore alternative investment strategies as a means towards boosting output and repairing public finances. Especially since there is evidence that the Government’s current strategy of fiscal contraction is not working effectively as per the article on Progressive Economy.

@ Edgar

Of course current expenditure matters. My point is with regard to the budget constraint. It is endogenous, and can move outward if government spends money on productive investment.

@All

Good Stuff!

The Bank of Greece has recently reported that the measures to date have already had the effect of depressing taxation revenues and that, as a result…..further contractionary measures will be necessary. Like their counterparts in Ireland there is a failure to grasp the effect of their own actions on depressing activity and the taxation dervived from it. In the European phrase they are sawing off the branch they are sitting on.

I’ve just been running through the 2010 British Budget. Stimulus is over. Strange thing is previous measure were modestly stimulative (VAT, tax holidays, brought forward capex, etc)- and worked. The borrowing requirement fell by £11bn vs forecast, mainly on higher tax receipts. Lower interest costs accounted for £1.5bn of the £11bn, while stimulus was in place. Seems to have had the effect of ‘reassuring financial markets’. Alas, no more. They can now look forward to the familiar prospect of falling tax receipts, based on lower investment (and its multiplers) no improvement in the deficit, perhaps renwed deterioration, and higher gilt yields.

As an aside, I thought John Bradley & Karl Whelan’s demolition of EFC as long ago as 1997 was fairly conclusive. Maybe someone needs to drive a stake through its heart on a crossroads at midnight. Whatever the the theory, Ireland is currently experiencing a severe CFC of the traditional type.

Edgar

Since there is a positive fiscal return from government investment, it is a fiscal imperative to increase investment, along with the infrastructural imperative. The current constraint on borrowing relates to lack of return; lengthening dole queues and zombie banks. Productive investment, with a positive return shifts the curve outward, to use Rory’s phrase.

Edgar – yes, our debt has been going in the wrong direction. The question is – how can we bring it under control. If the Government’s current delationary strategies are not only ineffective in the face of rising debt but actually contributing to it, then doing more of the same won’t alter that dismal equation (in this regard, readers might be interested in an analysis of what we might expet if the IMF’s, rather than the Government’s, growth projections prevail: lower output, even higher debt – http://www.progressive-economy.ie/2010/03/day-after-imfs-tomorrow.html )

Therefore, juxtaposing current spending cuts and increased investment may be missing the point as there is little return from spending cuts – in terms of providing extra resources for investment. Indeed, cutting public spending may well limit resources for investment as the fiscal situation continues to slide. That is why a better course is to move away from absolutes, especially those absolutes that are untested or unverified.

As to privatisation and PPPs – I certainly wouldn’t want to give that impression. However, I would gladly be willing to engage in a constructive discussion over how they might or might not advance economic growth.

We need to get real on a number of fronts here.

First, Michael Taft – from the left/progressive camp – may say he “would gladly be willing to engage in a constructive discussion over how they [privatisation and PPPs] might or might not advance economic growth”, but you can bet your bottom dollar that he and his comrades (and the union that employs him) would fight them tooth and nail – particularly for the ESB which is a prime candidate for major financial restructuring. Even if the Government were minded – which it isn’t – to tackle the current scandalous arrangments, it doesn’t have the bottle to engage in battle on this front – and the unions know this.

Secondly, (and moving beyond debate about the stringency of the current fiscal constraint) in addition to investment in human capital, perhaps the most important thing government – any government – can do to boost economic activity and future economic performance is to facilitate the provision of efficient infrastructure and utility services. People with the necessary drive and capability will be able to establish and develop businesses only when this vitally necessary platform exists. Any idea that those safely ensconced in the wider public sector – and by definition fundamentally risk averse – can identify and direct the establishment of new businesses is for the birds.

Thirdly, an opportunity to effect the necessary restructuring of the state and semi-state infrastructure service providers arose at the end of the ’90s and in the early 2000s when regulatory arrangements were introduced. It wasn’t seized and the property bubble route was chosen. When that imploded there was another opportunity. Again it was ignored. It will certainly not be tackled during the lifetime of the current Government. Even if it were to be tackled by a new government it is unlikely its political complexion would allow implementation of the reforms required – and, even if they were implemented, it would take a number of years to bear fruit. And the productive capability of the economy will slump even further.

Fourthly, economists will have to accept – yes, I know it will be hard – that retail competition, in the absence of the profound technology changes seen in IT and communications, in most infrastructure sectors has failed to deliver improvements in economic efficiency. Short-term auctions, day-ahead and real-time markets and suppliers with no assurance of retaining a share of the customer base are not able to provide the assurance of the recovery of investment in specific, long-lived assets. The investment that is forthcoming willingly is dwarfed by the demand for investment. In the face of this, retail competition in gas and electricity in the US – in so far as it took any hold – is being rolled back. The EU, for the first time, has been forced to provide grant-aid to gas and electricity projects (rather than to studies) – to the tune of €4 billion. Brtitain is contemplating a government backed, electricity central buyer. And, of course, Ireland embraced this retail competition lunacy enthusiastically and has gone so far down the road that it will proved extremely difficult to unwind.

And while economists have been cheering on this lunacy that has imposed significant additional costs on consumers with minimal improvement in service quality there has been almost silence about the profit-gouging in the private sheltered sectors. A focus on empowering the Competition Authority to investigate and root out monopoly profits and inefficiences would have been far more beneficial.

And so the politics of “doing nothing” – apart from the protection of vested interests accompanied by a bit or arm-waving – and the economics of “doing nothing” have taken hold.

Edgar – I look forward to further debates that you initiate on infrastructural financing. As to the final points you make:

1. I haven’t read on this thread (or, indeed, anywhere else) anyone suggesting that infrastructural investment is a panacea or that other problems will go away if we just up our investment levels.

2. Again, I haven’t read anyone arguing that financial markets don’t matter. Indeed, what I have read on this thread is that people take the issue quite seriously (as the many differing perspectives bear out) – so serious, in fact, that the issue deserves more than just assertions. Whether one argues on the basis of credit-constraint or credit-space or all the myriad of nuanced-positions, it should be done in an evidence-based manner.

3. I agree – investment is necessary but not sufficient; that is axiomatic. We have severe problems in our indigenous enterprise and managerial skill-base (what if we build the best infrastructure in the work and no one comes?), high levels of poverty and income inequality, business credit shortages, emerging structural unemployment, lack of transparency and accountability over our planning mechanisms, and, of course, the Government’s deflationary policies which are fiscally irrelevant but will act to depress future growth. No set of investments (or a single thread on any website) can address all theseand other important issues and, so, deliver the maximum level of supply-side benefits. And that is why questions over tax levels are best left to another thread, where research, experience and comparisons can be discussed in a constructive manner.

4. Inter-generational issues are an important theme. Davy Stockbrokers suggests we have wasted the last ten years (http://www.davy.ie/content/pubarticles/economy20100219.pdf ). If we make similar mistakes over the next decade, what are we bequeathing to the next generation – more debt, a degraded infrastructure and below-optimal living standards?

@Edgar Morgenroth,

“I have tried to get a debate on infrastructure financing going on a few occasions but it never got going properly – I will try again sometime.”

Good luck with this. It is an issue that is becoming increasingly important in most developed economies – in particular those that succumbed to a naive faith in a nonsensical combination of regulation and competition that, rather than improving economic efficiency, actually reduces it.

Ireland’s perverse twist in its adherence to this faith means that the problems are more difficult to resolve than in other countries. And many of those who are best equipped to participate in resolving the problems, by virtue of knowledge and experience, are either constrained by commercial considerations or are beholden to vested interests. Ultimately, this, perhaps, doesn’t matter very much since the small coterie which decides policy in this area would be unlikely to be aware of the effort – and, even if it were made aware, wouldn’t take the slightest notice.