What stimulus?

NationalPost.com – FPComment – If there is a multiplier effect, there isn’t much to multiply
Posted: April 08, 2010.  William Watson

Did the stimulus work? What an interesting debate this has been between the Fraser Institute’s Neils Veldhuis and Charles Lammam, on the one hand, who argue that our governments’ various stimulus policies aren’t responsible for the recovery that now seems well under way, and several other commentators, including the Prime Minister himself, who takes both issue with their analysis and credit for the recovery.

If you’re like me, when you read Serge Coulombe’s comment on Wednesday that “[Veldhuis and Lammam’s] data are differentiated twice and it is well known in economics that differentiating data eliminates information,” you started feeling a little queasy. I found myself wanting to have a look at the plain-vanilla data.

So the chart above provides them. It shows the quarter-by-quarter change since the crash in the five main components of aggregate demand. What I get out of it is that even if you believe stimulus works, and Veldhuis and Lammam have shown why it may not, there just hasn’t been enough stimulus to explain the buoyant recovery now underway.

What does the chart say? In each quarter, the first of the six vertical bars is GDP. In the final quarter of 2008 GDP fell $62-billion (all the dollar figures are current, i.e., not inflation-adjusted dollars). The next quarter it fell another $52-billion and it fell again in 2009Q2 before finally growing in the third quarter of last year. That was a big, thumping hit that bottomed out with GDP $125-billion or 7.7 % lower than its peak in mid-2008.

The second vertical bar in each quarter is the change in the trade balance. That was most of the action — or disappearing action: it was down $45B — in the final quarter of 2008, reflecting the virtual lockdown of the U.S. economy because of the financial crisis. The external sector was a damper on growth for a full year before finally improving in 2009Q4.

The third vertical bar in each segment is business fixed investment (in structures, machinery and equipment). It sagged a little in 2008Q4 — it takes businesses time to change plans — but then took a big hit in the winter of 2009. It has been positive since, at least in current dollars, but feeble.

The fourth vertical bar is personal consumption. It fell $12-billion in 2008Q4 and another $4B in 2009Q1 but has since been positive. Those were sizeable hits in dollar terms but pretty minor in percentage terms, just 1.3% and 0.4 per cent, respectively. (When the Crash hit personal consumption was running at a shade over $900B a year, about 55% of GDP.) To my mind that’s surprisingly small. Granted, these numbers aren’t adjusted for inflation so the real decline was bigger. But still. With world finance teetering on a cliff, Canadian consumers didn’t flinch much.

Now we get to government spending, home of the stimulus. The fifth vertical bar in each quarter is government spending on goods and services, about 60% of which goes to salaries. With everything else collapsing, government consumption did continue to rise, but the increases were small compared to the heavy hits on the other components of demand.

That’s even truer when you look at the sixth and final vertical bar in each set. It shows the quarterly increase in government investment in fixed capital, which is probably what most of us have in mind when we think of infrastructure. It has been consistently positive through the recession (though again some of the increase is inflation) but it just hasn’t been very important. With the trade balance, personal consumption and business investment falling a combined $63B in 2008Q4, public investment provided an offsetting increase of just $2B. With the big three falling another $41B in 2009Q1, public investment rose just $1B.

Government investment has risen a little more lately. But even in 2009Q4, when it was up by $2B, the big action was a plus-$32B from trade, consumers and business investment. Even if there is a Keynesian multiplier effect, there just hasn’t been that much government spending to be multiplied. That’s not really surprising. Despite all the talk about “shovel-ready” there just aren’t that many big projects around that can be started at the drop of a hat — or collapse of a financial sector.

Does that mean government had no helpful effect in bringing about the recovery? No. Taxes automatically eased back and employment insurance kicked in as the recession hit and these automatic stabilizers doubtless help explain why private consumption didn’t sag more. Moreover, the sight of central bankers and finance ministers lining up like the Radio City Music Hall Rockettes to backstop even the shakiest private investment probably also helped stopped the decline in business investment — though an IMF study published this week suggests that when short-term stimulus creates the widespread belief that public debt will be permanently higher its stimulative effect largely disappears.

If your reaction to the foregoing is that it’s too Keynesian for your taste, please understand that even we who at the financial brink in fall 2008 did rediscover our inner Keynesian nevertheless realize there is a time and place for desperate measures. By far the most interesting line in last month’s federal budget was the little-noticed one indicating that $5-billion of planned stimulus spending didn’t take place in 2009. If that spending comes on line this year, and if any kind of multiplier effect kicks in, that may well be a multiple too far. We may or may not have needed stimulus. We certainly don’t need over-stimulus.

Financial Post
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