Streetwise Professor

May 20, 2012

Reading For the Seven Dwarves

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 3:14 pm

The G8-perhaps with the conspicuous exception of Angela Merkel-apparently believe that if you say growth enough, like a mantra, it will magically appear.  Obama and Hollande and Monti and even Osborne (who seems a great candidate for the Upper Class Twit of the Year Contest: Jeez how British conservatism has devolved) appear convinced that some sort of stimulus funded by more debt is just the ticket to pull Europe out of the morass:

In an interview with CNN to be broadcast on Sunday morning, Mr Monti said: “We link back to the notion of demand … I think we should regard it more positively than the most conservative European authorities do.” [Yeah, he’s looking at YOU, Angela.]

But reflecting German resistance to authorise monetary easing from the ECB, Mr Monti added: “On the other hand, if it is an across-the-board crusade for more demand, then I believe that the German reluctance to that is not entirely unfounded.”

Obama is of course desperate for anything that pushes the inevitable reckoning beyond the first Tuesday in November.

Although the Seven Dwarves are importuning Merkel to give in and put German taxpayers to work supporting 55 year old Greek retirees and French bureaucrats, she will give them short shrift (and good for her!) and respond to the German electorate.   Obama doesn’t cast a vote in Thuringia or Bavaria, and she will base her calculations on those who do.

Germans are being pulled in opposite directions by years of indoctrination about the necessity of being Good Europeans on the one hand and deep-seated German aversion to profligacy on the other, so it is difficult to predict exactly how her electorate will react.  My sense is that ultimately Germans will recognize that shouldering the entire burden of funding Europe will be throwing good money after bad, and that Germany will not take one for the Euro team.  Though I would not be surprised if the ultimate decision comes next year, unless events force a decision earlier-which may well be the case.

In the meantime, Merkel might want to circulate this paper by Valerie Ramey to the members of the Anti-Austerity Cult:

This paper asks whether increases in government spending stimulate private activity. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls
significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use
two different methods to adjust for tax effects. Neither method suggests significant effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find
that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.

In other words, “stimulus” via government spending does not translate into growth.  Indeed, the Ramey analysis suggests quite the opposite.

Not that it will matter to the Dwarves, but their growth mantra-which presumes that more spending by already nearly bankrupt states will magically reverse Europe’s economic problems-is based on a highly dubious theory for which empirical evidence is either lacking, or in the case of the Ramey paper, empirical evidence utterly contradicts.  Will Merkel-and the German electorate-have the courage of their convictions and oppose the Dwarves? I am not certain, but when push comes to shove, I believe that she-and they-will do just that.

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  1. Are you surprised by the rhetoric spewed from these Keynesian freaks. They are committed to debasing their currencies in order to keep their social welfare/warfare ponzi schemes going long enough to avoid blame when it all collapses. You can include the Monetarists supply siders with the Keynesians who only want to curtail social welfare programs but want to continue bankrupting us with their constant wars. Only the Austrian Economists and Dr Ron Paul are serious about dealing with the problems we face and were correct in predicting the dilemma that we presently face.

    Comment by Bob — May 20, 2012 @ 7:41 pm

  2. It truly is mystifying that European leaders would seek “growth” as their way out.

    After all, since 2010, the British government has conclusively proven that the way to deal with a debt/GDP problem is to put the economy back into a recession!

    Comment by a — May 20, 2012 @ 8:35 pm

  3. Government:  Happy day! Here is $1 trillion to spend on yourself.
    Economy:  That’s wonderful. Where did you get the resources? Some new invention, or energy discovery? Did you find a huge amount of easy-to-get oil? Are you firing 100,000 government workers, and lowering our taxes?

    Government:  No. We’re borrowing some of it out of your savings. We’ll pay you back with the pieces of paper we print up in the future. And we’ll get some of it from higher taxes, from the future windfall you will receive when you spend more now.
    Economy:  So, you are taking it from me now and telling me to spend it on designer jeans, restaurant meals, and my neighbor’s mortgage payments? You must know that I will have to invest less.

    Government:  You would like to invest in machines and risky, new companies. But, increased spending is a direct investment in a vibrant economy. More donuts and sidewalks. Think how wonderful it will be to walk down a fresh, new sidewalk eating a warm donut.
    Economy:  Yes, that would be a pleasure. But, what do I do the next day?

    Government:  As needed, we will take more from you, and give it back to you, so you can spend it. When spending is high enough, everyone will be happy.
    Economy:  Happy and poor. Then, unhappy and poor.

    Comment by Andrew_M_Garland — May 20, 2012 @ 10:22 pm

  4. “…a highly dubious theory for which empirical evidence is either lacking, or … utterly contradicts.”

    Of course this is exactly the quality of “thinking” that underpins current attempts to manage the sky by taxing CO2. We may despair but we should not feel surprised.

    Comment by Green as Grass — May 21, 2012 @ 2:35 am

  5. Prof, that was brilliant linking to the Pythons. Here’s something germane to the theme:

    These guys truly did see in to the future.

    Comment by markets.aurelius — May 21, 2012 @ 6:54 am

  6. I’ve just skimmed the paper quickly but it doesn’t seem to filter out increases in gov spending done during period of high unemployment/financial crisis from others. It’s easy to believe that the multiplier may be below 1 on average, but does that tell us where it is at the present juncture?

    Also it would be interesting to see what the multiplier of deficit-funded tax cuts is. After all many keneysians are neutral on whether the deficit stimulus is implemented via tax cuts or spending.

    Comment by cig — May 21, 2012 @ 7:32 am

  7. @cig-A good point, but likely to be impractical given data limitations. Every unhappy economy is unhappy its own way, and so no two episodes are exactly comparable. In particular, since this “present juncture” is highly different from anything in the post-war data certainly, it is difficult to see how you could estimate from historical data a multiplier that is conditional on post-2007 circumstances. This is especially true in Europe at the present juncture.

    Not to go all Rumsfeld on you, but we have to go to these arguments with the data we have. That said, the Ramey paper casts doubt on the efficacy of stimulus, and any argument that “this time it is different” is without empirical support. You would have to posit some mechanism for how stimulus would work in the current circumstances that was not operative in earlier periods, and even then this would be a hypothesis that is untestable given the available data.

    Re your last point, Ed Lazear’s oped in today’s WSJ speaks directly to that issue.

    The ProfessorComment by The Professor — May 21, 2012 @ 9:42 am

  8. @markets-TFF! I thought I had seen every Python routine-hell, I thought I could repeat every Python routine-but that was a new one on me.

    The ProfessorComment by The Professor — May 21, 2012 @ 10:38 pm


    Comment by CF — May 22, 2012 @ 11:18 am

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