The Great Debate – The Real Story?

The Great Debate© is presented by to expand our understanding of various topics of interest. In this Great Debate©, the topic is whether the government should introduce a second stimulus. In a NYT Op-ed article, Nobel Laureate Professor Paul Krugman argues the first stimulus did not solve the economic ills because it was too small. Steven Hansen counters.   We present Professor Krugman’s opinion in its entirety, then the response of Steven Hansen.

The Real Story


Next week, President Obama is scheduled to propose new measures to boost the economy. I hope they’re bold and substantive, since the Republicans will oppose him regardless — if he came out for motherhood, the G.O.P. would declare motherhood un-American. So he should put them on the spot for standing in the way of real action.

But let’s put politics aside and talk about what we’ve actually learned about economic policy over the past 20 months.

When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high — but for very different reasons.

One group — the group that got almost all the attention — declared that the stimulus was much too large, and would lead to disaster. If you were, say, reading The Wall Street Journal’s opinion pages in early 2009, you would have been repeatedly informed that the Obama plan would lead to skyrocketing interest rates and soaring inflation.

The other group, which included yours truly, warned that the plan was much too small given the economic forecasts then available. As I pointed out in February 2009, the Congressional Budget Office was predicting a $2.9 trillion hole in the economy over the next two years; an $800 billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task of filling that hole.

Critics in the second camp were particularly worried about what would happen this year, since the stimulus would have its maximum effect on growth in late 2009 then gradually fade out. Last year, many of us were already warning that the economy might stall in the second half of 2010.

So what actually happened? The administration’s optimistic forecast was wrong, but which group of pessimists was right about the reasons for that error?

Start with interest rates. Those who said the stimulus was too big predicted sharply rising rates. When rates rose in early 2009, The Wall Street Journal published an editorial titled “The Bond Vigilantes: The disciplinarians of U.S. policy makers return.” The editorial declared that it was all about fear of deficits, and concluded, “When in doubt, bet on the markets.”

But those who said the stimulus was too small argued that temporary deficits weren’t a problem as long as the economy remained depressed; we were awash in savings with nowhere to go. Interest rates, we said, would fluctuate with optimism or pessimism about future growth, not with government borrowing.

When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent when The Journal published that editorial; it’s under 2.7 percent now.

What about inflation? Amid the inflation hysteria of early 2009, the inadequate-stimulus critics pointed out that inflation always falls during sustained periods of high unemployment, and that this time should be no different. Sure enough, key measures of inflation have fallen from more than 2 percent before the economic crisis to 1 percent or less now, and Japanese-style deflation is looking like a real possibility.

Meanwhile, the timing of recent economic growth strongly supports the notion that stimulus does, indeed, boost the economy: growth accelerated last year, as the stimulus reached its predicted peak impact, but has fallen off — just as some of us feared — as the stimulus has faded.

Oh, and don’t tell me that Germany proves that austerity, not stimulus, is the way to go. Germany actually did quite a lot of stimulus — the austerity is all in the future. Also, it never had a housing bubble that burst. And with all that, German G.D.P. is still further below its precrisis peak than American G.D.P. True, Germany has done better in terms of employment — but that’s because strong unions and government policy have prevented American-style mass layoffs.

The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round.

I know that getting that round is unlikely: Republicans and conservative Democrats won’t stand for it. And if, as expected, the G.O.P. wins big in November, this will be widely regarded as a vindication of the anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and his Keynesian economic doctrine was proved wrong.

But politics determines who has the power, not who has the truth. The economic theory behind the Obama stimulus has passed the test of recent events with flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware that there were political constraints — initially offered a plan that was much too cautious given the scale of the economy’s problems.

So, as I said, here’s hoping that Mr. Obama goes big next week. If he does, he’ll have the facts on his side.

Facts and Opinions

by Steven Hansen

I am not an economist by education – but an Industrial Engineer. Most engineering disciplines are hard sciences where theories must be proven through controlled experiments – and then confirmed through application of that theory. When contradictions occur during application, studies are undertaken to identify the reasons.

You will not read of opposing proven theories in engineering. The theories are tested and applied through literally millions of cycles. A theory works or it does not. Proven engineering theories meet the test of being fact.

There is no such thing as a “proven” economic theory. There has been no controlled experiments on any theory as you cannot identify and control all of the dynamics. The closest you can get to proof is that a theory “seems” to work.

And any proof must be confirmed by repeating experiments hundreds or thousands of times. Economists “prove” theories by studying one or more (usually much less than 10) events. The dynamics surrounding most events are significantly different.

So what are the facts?

1) We stimulated the economy much more than $800 billion. You must throw in TARP, Fed intervention of $2 trillion, plus a whole series of piecemeal legislation. The total intervention was significantly more than $2.9 trillion hole the CBO said we had in our economy.

2) What is the correlation between the size of economic shortfall and stimulus? Stimulus by definition is a boost – not a replacement for – economic activity.

3) Did all or most of those who said the stimulus was too big predicted sharply rising rates? I know some did. Could it be true that if the stimulus was “large enough” there would have been rising rates? This is standard economic debate – say what you want because no one can prove you wrong.

4) The economic dynamics in Germany are too different than the USA. Comparisons are inoperative.

So, as I said, here’s hoping that Mr. Obama goes big next week. If he does, he’ll have the facts on his side.

There are no facts to support a position that additional stimulus will work, nor facts to support that it would not work. The “facts” here are opinions – and everyone has one..

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