Friday, February 17, 2012

The case for fiscal stimulus

DURING the period of this recession, one of the fundamental disagreements among economic commentators is how relevant are the teachings of Maynard Keynes.

In other words, in a recessionary environment should one increase fiscal spending, in order to provide stimulus for the economy, or should one consolidate fiscal spending in order to reduce the fiscal deficit?

Those opposing fiscal stimulus, argued in countries like Jamaica, that because of the lack of resources, the only viable option was to in fact cut back on fiscal expenditure and by doing so assist in the reigning in of the ballooning fiscal deficit. This was seen by many as the only way of resolving the economic challenges faced by the country.

Some three to four years after the height of the recession, my view is that we have enough evidence to determine what has worked and what has not.

Approximately two to three years ago we saw different roads being taken by Europe and the US, on different sides of the Keynesian argument. The Eurozone went the way of fiscal austerity and the US the way of fiscal stimulus spending. The result is that the US has seen an improvement in their economic and social environment, while the Eurozone has seen a decline, including an increased threat to the Euro as a credible currency. The table shows trends in the unemployment and growth rates in the EU and the US since 2008.






Eurozone real GDP growth rate




-0.3% Q4

US real GDP growth rate




2.8% Q4

Eurozone unemployment rate





US unemployment rate





Note: The 2011 growth rate is the fourth quarter estimate

The table above clearly shows that the US has seen a faster recovery than the Eurozone, in these key measurements. This is despite the criticism Obama's administration faced about reckless fiscal spending, and the consequent increase in the fiscal debt, during the period of fiscal stimulus. Who is having the last laugh just before US elections now?

In fact, in the recent ECB February Inflation Report, Governor Mervyn King is quoted as saying "...ongoing problems in the Eurozone and fiscal consolidation at home combined to put brakes on growth". US Treasury Secretary Timothy Geithner, only a few weeks ago in a CNN interview said that it is not possible to grow by cutting expenditure in a recessionary environment.

Similarly in Jamaica we embarked, via the 2010 IMF agreement, on a policy of fiscal expenditure consolidation and new tax revenue measures in order to improve the fiscal situation. My argument at the time was that the approach was wrong and would lead to a contraction of the economy and fiscal revenues, as the fiscal side depends on the real economy and in the face of private sector spending retreat any contraction in fiscal spending would also negatively affect the economy and ultimately the fiscal accounts. The result is there for everyone to see.

How do we move forward though, as the economy is still faced with significant structural problems today and the fiscal challenges are even more chronic than in 2007, primarily because the economy is weaker and the capital markets are not as easily accessible as prior to the recession?

One reader wrote to say that my promotion of fiscal stimulus spending, and my promotion of JEEP type programmes, was tantamount to printing money to finance these programmes, which would ultimately lead to higher inflation and an unstable macroeconomic environment. If the reader had read the entire article, however, he would have seen that my argument is for value-added debt financing and not the printing of local currency, which would not be a real resolution to the problem.

One may argue that this will increase the debt to GDP ratio; however, my argument has always been that the level of the debt to GDP ratio is not as important as the trajectory of the ratio, and the use that the debt is put to. Again I refer to 1984 when the debt to GDP ratio went to 212 per cent before declining to 90 per cent in 1990.

It seems irrational to me that if one has a monthly debt payment of $100 per month and income of $50 per month (with non-discretionary expenses of $45), that you can cut expenditure enough to address the debt effectively, or before you die of starvation. While some better spending of income is needed, it should be clear that the only sustainable way to deal with the debt is to increase your income if the plan is not to default. This is what has happened in Greece, and the recent austerity measures will only make the situation there worse.

My own recommendation therefore continues to be that Jamaica has to (i) seek new debt to address value-added infrastructural projects around our areas of comparative advantage, such as tourism; and (ii) reallocation of some of the resources to focus on areas such as green energy jobs, crime reduction, law and order, and agro-processing facilities. At the same time the initiatives being implemented by Paulwell must be timely to ensure that we resolve our energy and consequently competitive challenges.

While proposing increased value-added debt, I do realise that there is a great risk if not implemented properly, but this risk increases the longer we wait to take the necessary bold decisions. The fact is that what we have been doing has not been working. Isn't it therefore time for us to realise that and take a hard look at how we make policy and fiscal decisions. Certainly new taxes and capital expenditure reduction are not optimal solutions.

One thing I can guarantee is that if we continue on the path we have always been on then we can only reap more of what we have been reaping. I can also guarantee that within the context of the current environment, the fiscal consolidation policies we have been pursuing will only lead to greater pain.

We therefore need to ask ourselves what we must do to change course and ensure that we meet the 2030 vision of the place of choice to live, work, and raise families.


D J Miller said...

Interesting analysis as always

Marc said...

Interesting post.

A few points:
- I am not sure that comparing the US to the EU is as apples-to-apples as it seems, if only because there is no monetary or fiscal union. So, the ECB can't print money to buy sovereign bonds like the Fed can.
- There are some EU countries that pursued counter-cyclical fiscal policy too (Germany, France come to mind) and their results were mixed. Germany's, worked out well (with GDP growth rebounding sharply after a 'fierce' contraction from the fall out of exports) and they are on solid footing now, but France is a different story. While the immediate impact of the recession was dampened a bit by loose fiscal policy, now they are encumbered with a significantly higher debt burden and a recently downgraded sovereign external debt. Much to their chagrin. As much as they like to think they were 'equally' part of the dynamic duo that ruled the EU - that was all just a facade as the ratings agencies made clear.

So, while Keynesianism seems to have worked for the US - less so because of Congress, but more so because of Ben Bernanke - that seems to have been the case because America has (as a former French finance minister put it) 'an exhorbitant privilege' where it can print money in the world's reserve currency. Anybody can print money, but how often have you seen such an expansion of the central banks balance sheet + record low short-term and long-term bond yields?

Because the rest of the world is such a hand-basket, the Treasury can keep borrowing at record lows, and the Fed can keep spending. Their day of reckoning will come, but it is farther out than the Republicans would have you believe.

As for Jamaica, the issue Jamaica ran into is that we had (and still have) some basic structural things that needed reforming. A central treasury management system anyone? How can one government entity be issuing bonds, that the taxpayer is liable for, without permission (or knowledge of) the Ministry of Finance?!? That's pure pattyshop.

Also, a public sector wage bill - ever increasing - is unsustainable no matter how low interest rates are right now.

We have to face some tough decisions. Those are, for too long we have had some core things that needed reform (see above), that will then allow us to reduce the fiscal deficit on an on-going basis, then we can invest for growth.

The good thing is, Jamaica's economy is small enough that we can get budgetary support from multi-laterals. Greece's structural issues were easily 2X or 3X as bad as Jamaicans were - Jamaicans don't like paying taxes, but you would be hard pressed to find a set of people that don't like paying taxes more than the Greek. Greece's fiscal situation was also not credible, as was seen by the constant upward revisions of their deficit once the current prime minister took charge.

So, the way I see Jamaica's situation is in two distinct phases:
- Re-finance existing debt (via cheap multi-lateral funds) and try to bring the existing rates down, while implementing structural reforms (tax reform, etc.) that make it easier to keep the fiscal deficit within a reasonable target.
- Then access more cheap funds, to invest for growth. Invest in infrastructure, schools, hospitals, roads, etc. Once these things kick in, and we start to see better growth (better than 2% reported to date - which is, in and of itself, almost a miracle and testament to the sound policies of 'semi-austerity'), the general debt stock will come down.

The first phase wasn't completed, and the current administration still has a lot to do. The last administration was doing a good job until they let the public sector wage bill slip from their hands.

Once the current administration can figure out how to manage those issues, then the long-term trajectory will look more stable.

Marc said...

By the way...sorry for the long got away from me :)

-- Marc Gayle

tyrone said...

Marc, you have some good points. Public sector wage bill is not the biggest problem in my view, what is needed is a public sector that earns its keep with improved service and productivity growth to support the economy. The Executive Agency model works in Jamaica well.

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