So what does stimulus actually mean?

A reader sends in this question:

“What do governments actually mean when they say that we’re going to announce a 1 trillion dollar economic stimulus package? Does it mean that they’re going to spend that much money? Or they’re just going to give it to the industries? (if so what does that entail?)”

Keep the following in mind:

  • I’m going to assume that the person who asked the question hasn’t learnt macroeconomics in a formal setting just yet, and will therefore answer the question accordingly
  • I will describe a macroeconomic model using words, and keep it fairly simple
  • I will use examples from earlier crises
  • Let’s get started!

 

  • Think of the Indian economy as a patient, and think of monetary and fiscal policies as medicines that are going to be administered by doctors. The RBI governor is a doctor to this patient, as is the Finance Minister.
  • Any move pertaining to regulation of banks (allowing banks to ask for EMI’s later, reduction of interest rates, forbearance of loans) is medicine administered by the RBI.
  • Any move pertaining to reduction of taxes, introduction of subsidies, amnesty schemes for taxes due in the past, spending on specific projects (construction of roads bridges etc), changes to government employees salaries/pensions, payouts to firms or individuals (literally giving them money) is medicine administered by the finance minister.
  • Under normal circumstances, one doctor is plenty enough. In fact, macroeconomists often end up saying that if fiscal policy is going to provide the medicine, monetary policy should stand ready to counteract any excesses.

    There is a dilemma as to whether these two policies are complementary, or act as substitutes to each other for achieving macroeconomic goals. Policy makers are viewed as interacting as strategic substitutes when one policy maker’s expansionary (contractionary) policies are countered by another policy maker’s contractionary (expansionary) policies. For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa. If they behave as strategic complements, then an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of the other.

  • But when the patient is as ill as is the case now (and is going to get sicker in the days to come!), well then monetary and fiscal policy are not substitutes: both need to be at play at the same time.
  • For example, in the 2008 recession, American policymakers resorted to both monetary and fiscal policy measures (all countries did, to be clear. I’m just using the American example because its data is easier to find and present)
  • The monetary policymakers announced, among other things, TARP. By the way, astute readers might want to point out that this seems to have been run by the Treasury Department, not the Federal Reserve. True, not arguing with that. It’s complicated! Also, watch this movie.
  • And, among other things, the American government also announced ARRA. The original website is no longer up, but you can see this, or read this.

 

Now, all that being said, we’re going to take a look at fiscal policy alone from here on in. It is not that monetary policy isn’t important (oh dear lord, it is!) but the question is more focused on fiscal policies.

To understand the answer to this question, let’s go back to an earlier post of mine, and quote from it:

Let’s break this tweet by Paul Krugman down.

  • The government has decided that it will give away money. Ergo, fiscal policy.
  • To whom should it give the money? It can give the money to firms, or to households.
  • If it gives the money to households (in India for example, this would have been through Direct Benefits Transfer), might that help people more?
  • Or should it give the money to firms instead?
  • Payroll taxes, which is what is being spoken about in the tweet, is tax paid on behalf of employees to the government, by firms. Here’s Wikipedia:

    Payroll taxes are taxes imposed on employers or employees, and are usually calculated as a percentage of the salaries that employers pay their staff.[1] Payroll taxes generally fall into two categories: deductions from an employee’s wages, and taxes paid by the employer based on the employee’s wages. The first kind are taxes that employers are required to withhold from employees’ wages, also known as withholding tax, pay-as-you-earn tax (PAYE), or pay-as-you-go tax (PAYG) and often covering advance payment of income tax, social security contributions, and various insurances (e.g., unemployment and disability). The second kind is a tax that is paid from the employer’s own funds and that is directly related to employing a worker. These can consist of fixed charges or be proportionally linked to an employee’s pay. The charges paid by the employer usually cover the employer’s funding of the social security system, Medicare, and other insurance programs. It is sometimes claimed that the economic burden of the payroll tax falls almost entirely on the worker, regardless of whether the tax is remitted by the employer or the employee, as the employers’ share of payroll taxes is passed on to employees in the form of lower wages that would otherwise be paid.

  • So when there is a payroll tax holiday, firms no longer have to pay these taxes. So who is benefiting here? Firms or the employees of firms? To the extent that the firm no longer has to pay these taxes, it has more money with itself. It can either keep this money and use it for other things, or it can pass on this money to the employees. What will actually happen is tricky to predict, and trickier still to measure!
  • For example, imagine the Indian government says to the Gokhale Institute of Politics and Economics (GIPE) that the Tax Deducted at Source (TDS) from the professors salaries need no longer be given over to the government. (To people who know their macro, I know it is not the same thing. Treat this as an illustrative example)
    • If GIPE was due to pay me a 100 rupees every month, it would deduct 10 (that’s the TDS) and pass it on to the government. That need be done no longer.
    • But the government doesn’t say that this money should be given to the professors instead – GIPE can do with it whatever it wishes.
    • Will (should) GIPE pass on this money to the professors? Or use this to pay other people employed by GIPE? Or just keep it with GIPE (who knows when the college will reopen, hoarding cash may be a good idea). Or… anything else you can think of, really!
  • So “giving” to industries really can mean a variety of things. And it really depends on what industry chooses to do with this money. You could apply conditionalities and say you will only get the money if:
    • It’s passed on to employees
    • You qualify because your firm falls in an important sector (employs a lot of people, is important from a social viewpoint, is critical to combat the virus etc)
    • Anything else you can think of
  • Or the government could spend the money itself! Build roads, bridges, dams, employ thousands more teachers, temporary employees – but all of this is assuming we can control the spread of the virus, of course. Without that, all of this is difficult, if not impossible to achieve.

 


So the correct answer to the question that the reader asks is: all of the above. At this point in time, a good fiscal policy move will be to spend, and give tax benefits to firms and households. This is roll out the big guns territory, no half measures will do.

Homework:

A useful exercise to do: go through the fiscal stimulus announced by our government, and try and pinpoint which parts are directly in the hands of the people, which in the hands of the firms, and which is spending by government on building out infrastructure etc. Here’s one article to help you along.

Homework Part Deux:

Are we Rawlsian?

Homework Part Trois:

Are we Rawlsian enough?

 

MMT and the corona virus, courtesy Yash Agarwal

Yash Agarwal (here is his Twitter page) messaged yesterday, asking about MMT and whether it could be used to tackle the current crisis. He has shared a video as well, and asked a rather specific question, both of which we will get to shortly.

But first things first, what is MMT?

MMT stands for modern monetary theory. For there to be a “modern” monetary theory, there must have been a monetary theory, right?


 

OK, Lerner: His argument was that countries that (a) rely on fiat money they control and (b) don’t borrow in someone else’s currency don’t face any debt constraints, because they can always print money to service their debt. What they face, instead, is an inflation constraint: too much fiscal stimulus will cause an overheating economy. So their budget policies should be entirely focused on getting the level of aggregate demand right: the budget deficit should be big enough to produce full employment, but no so big as to produce inflationary overheating.

The excerpt is from Krugman’s blog/column in the NYT, but if you want the academic paper behind this, here you go.

Here’s the short version of the Lerner argument: so long as you don’t borrow from abroad, and so long as you print your own money without any backing (such as gold), well, there can never be no crisis. Just, literally, print your money and throw it at the problem. The one thing you gotta keep in mind is you want to do this until aggregate demand is “just” right. Too much of AD, and you’re in inflationary territory. Too little and you never solved the crisis – print more money in that case.

So today, given the low interest rates that are likely to prevail in the economy, just have the finance minister and team spend, spend and spend, until aggregate demand rises and the economy is back on track. Build more schools, lay more roads, build more bridges – spend, spend and spend. That, best as I understand it, would have been the Lerner position.

And what about the debt and the deficit once things are back to normal? Well, that’s the problem with the Lerner doctrine. It involves running, then, a primary surplus – which means cutting subsidies and raising taxes. And no, I don’t see that happening.

If you want the modern version of this monetary theory, which is MMT, a good place to begin might be this blog post I wrote a while back.


But they key thing, best as I can tell, about MMT is that you must not worry about deficits, especially during a crisis. Print more money and spend your way out of it.

Here’s a more recent take on the issue:

The world is changing that is for sure. Governments around the world are promising to spend billions to address the coronavirus crisis and no-one (other than a few so-called progressives – see below) are talking about how governments will pay for the interventions. Everybody knows how. They have always known. The shams about governments not having enough money to provide adequate housing, schooling, health care, employment, other services, and a sustainable response to climate change are now exposed for all to see. The game is well and truly up. Everybody can now see that governments just have to announce billions of intervention and it will happen. Forget all the ‘complexity’ about accounting arrangements. Forget all the stuff that we will also drown under massive tax burdens if the government dares to help some disadvantaged person get a leg up in life. Forget all the stuff about bond markets punishing profligate governments with insolvency. Everybody can now see that the bond markets are the beggars and the government rules. Even in the Eurozone, it is obvious that the ECB is able to fund fiscal deficits of any size – ‘there is no limit’. Only the Modern Monetary Theory (MMT) economists have consistently outlined the rationale for what is going on at present. And that point is increasingly being recognised although not always in ways I think does our work justice.

That’s mostly rhetoric (and I do not mean that as a criticism), the meat is found later on in the article. In particular, note the 2×2 matrices that are to be found further down, of which I present one below:

Original can be found here

Essentially, MMT says that if a country has monetary sovereignty (and India does), and if a country has an aggregate demand crisis (and India does), then proceed full steam ahead with MMT. Go full steam ahead on expansionary fiscal policy, and don’t worry about finding the money to do this, or about the debt: just create the money!


 

Here’s Stephanie Kelton on the topic, in conversation with Michael Moore:

 

For a more theoretical look, especially at the operational aspects from a global viewpoint, read this article by William Buiter:

Much of the US response will come in the form of “helicopter money,” an application of Modern Monetary Theory (MMT) in which the central bank finances fiscal stimulus by purchasing government debt issued to finance tax cuts or public spending increases. The US economy is deteriorating at a spectacular rate, partly because of the direct health impact of the COVID-19 pandemic, but mostly as a result of social-distancing mandates that are preventing people from producing and consuming.


So ok, let’s say we’re going to do MMT: what exactly might this entail for, say, the USA?

What is more important is a set of policies that tackles the health crisis head-on while also mitigating the economic uncertainties faced by households and their communities. These include:
..
(1) full coverage of medical costs associated with testing and treatment of COVID-19;
..
(2) mandated paid sick leave and full coverage of associated costs;
..
(3) debt relief for families;

..
and (4) swift deployment of testing and treatment facilities to underserved communities. We will probably still need some demand stimulus, but these four steps require immediate attention.


I learnt about their article by reading about Amol Agarwal’s take on MMT, available here:

After being ignored (and humiliated), is this the MMTers moment in the sun? Will their ideas get a hearing? One would say that we should keep all options open and not be bound by the shibboleths of economics. The speed at which the pandemic has shifted gears and become an economic crisis needs all possible policies which need to be executed at even faster speed. My gut feel is most of the economies will eventually be implementing ideas from MMT without calling it so. The Governments are being pressed to introduce fiscal support and will be calling their central banks to finance the support. MMTers might not mind their not being given due recognition. First they are used to being ignored. Second, they may well think that as long as humanity benefits, a rose by any other name would smell as sweet.


Now (phew, that was a long introduction!) here’s the video that Yash shared:

And here’s his question:

I just watched this and I was wondering if it would be correct to state that the modern monetary theory is practically possible just for the United States of America since it issues the global reserve currency?

The answer is no: so long as you have your own currency (where the “you” in question is a sovereign government), and you are only borrowing domestically, you can go ahead with MMT.

And I agree with Amol Agarwal: right now, we need all the propping up of AD that we can get, and so we should do “whatever it takes”. And that right soon!

That doesn’t mean there won’t be problems later – there may well be – but now is about now. Spend!

Econ101: Policy Responses to a Pandemic

If you haven’t played it already, go ahead and give this game a try: The Fed Chairman Game. I have a lot of fun playing this game in class, especially with students who have been taught monetary policy. It usually turns out to be the case that they haven’t understood it quite as well as they think the have! (To be clear, that’s the fault of our educational system, not the students.)

But the reason I started with that is because the game always throws up a scenario that mimics a crisis, and asks you what you would do if you were the Chair of the Fed.

In this case, policymakers the world over are now staring at a very real crisis, and they need to be asking themselves: what should we do?


 

There are two broad answers, of course: monetary policy, and fiscal policy.

The Federal Reserve has cut interest rates to zero, and while it has other tools to stimulate the economy, a crisis like this requires fiscal as well as monetary responses. The legislation passed thus far has been important, but another round of fiscal policy will be required immediately to fully address this crisis.

A robust fiscal response can provide income support to households, ensure broad and continuous access to safety net programs, provide incentives for employers to avoid layoffs, provide loans to small businesses, give liquidity cushions to households and firms, and otherwise stimulate the economy.

That’s a write-up from Brookings. The specifics follow in that article, but the article makes the point that more of the lifting will need to  be done by fiscal, rather than monetary policy. And that is true for a variety of reasons,  which the article does not get into, but long story short – fiscal, more than monetary.

But, ok, fiscal policy of what kind? Should we give money to firms or to workers? Here’s Paul Krugman with his take…

And here’s Alex Tabarrok with his response:

So what’s the correct answer? Well, as we’ve learnt before, and will learn again, macro is hard! In an ideal world, all of the above, but as is manifestly clear, we are not in an ideal world. If we must choose between giving money to firms or to people, to whom should we give it? My opinion? People first, businesses second. This is, of course, a US centric discussion, what’s up with India?


 

Here’s, to begin with, a round-up from around the world – you can search within it for India’s response thus far.

Calls are getting louder for governments to support people and businesses until the new coronavirus is contained. The only questions are how much money to shovel into the economy, how to go about doing it, and whether it will be enough.

Already, officials from Paris to Washington DC are pulling out the playbook used in Asia for slowing the spread of Covid-19: they’re restricting travel and cracking down on public gatherings. While those measures have the potential to reduce deaths and infections, they will also damage business prospects for many companies and cause a synchronized worldwide disruption.

Here’s the FT from two weeks ago about the impending slow down:

Venu Srinivasan, whose company TVS is one of India’s largest makers of motorcycles and scooters, said the business had lost about 10 per cent of production in February owing to a lack of Chinese-made parts for the vehicles’ fuel injection system. He added that TVS has now managed to find a new supplier.

But Mr Srinivasan said he was bracing for India’s recovery to take longer than anticipated. “One would have expected a V-shaped recovery, but instead you have an L shaped recovery,” he said. “It’s been the long haul.”

R Jagannathan in the LiveMint suggests this:

This is how it could be designed. Any unemployed urban youth in the 20-30 age group could be promised 100 days of employment and/or skilling options paid for by the government at a fixed daily rate of ₹300 (or thereabouts, depending on city). At an outlay of ₹30,000 per person annually, the unemployed can be put to work in municipal conservancy services, healthcare support, traffic management, and other duties, with the money also being made available for any skill-acquiring activity chosen by the beneficiary (driver training for Ola-Uber, logistics operations, etc). All companies could be given an opportunity to use the provisions of the Apprentices Act to take on more trainees, with the apprenticeship period subsidized to the limit of ₹30,000 per person in 2020-21. If the pilot works, it could be rolled out as a regular annual scheme for jobs and skills. Skilling works best in an actual jobs environment.

 

He also mentions making the GST simpler, which the Business Standard agrees with:

Certainly, the rationalisation of GST will also affect government revenues. However, a simpler and more transparent system would allow greater collection and reduce evasion. The government will receive a windfall this year from lower crude oil prices. The moment to move on the structural reform agenda is now. The GST Council has done well to address the inverted duty structure in mobile phones. Further rationalisation will give confidence to the market that the government is serious about reforms. It was promised that GST would remain a work in progress, and that the GST Council would act often to improve it. So far, however, the changes have been marginal and haphazard. A more structured and rational approach, which outlines a quick path to a single rate, would pay dividends for the economy in the longer run. It would also be an effective way to manage the immediate effects of a supply shock such as is being caused by the pandemic.

Also from the Business Standard, a report on the government now considering (not happened yet) relaxing bad loan classification rules for sectors hit by the corona virus. That’s pretty soon going to be every sector!


 

Assorted Links about the topic – there’s more to read than usual, please note.

Here is Tyler Cowen on mitigating the economic impacts from the coronavirus crisis.

Here’s Bill Dupor, via MR, about the topic:

First, incentivize behavior to align with recognized public health objectives during the outbreak.

Second, avoid concentrating the individual financial burden of the outbreak or the policy response to the outbreak.

Third, implement these fiscal policies as quickly as possible, subject to some efficiency considerations.

Again, via MR, New Zealand’s macro response.

Arnold Kling is running a series on the macro response to the crisis.

Claudia Sahm proposes direct payment to individuals:

This chapter proposes a direct payment to individuals that would
automatically be paid out early in a recession and then continue annually
when the recession is severe. Research shows that stimulus payments that
were broadly disbursed on an ad hoc (or discretionary) basis in the 2001 and
2008–9 recessions raised consumer spending and helped counteract weak
demand. Making the payments automatic by tying their disbursement to
recent changes in the unemployment rate would ensure that the stimulus
reaches the economy as quickly as possible. A rapid, vigorous response to
the next recession in the form of direct payments to individuals would help
limit employment losses and the economic damage from the recession.

Here are the concrete proposals, the entire paper is worth a read:

Automatic lump-sum stimulus payments would be made to individuals
when the three-month average national unemployment rate rises by
at least 0.50 percentage points relative to its low in the previous 12
months.
• The total amount of stimulus payments in the first year is set to
0.7 percent of GDP.
• After the first year, any second (or subsequent) year payments would
depend on the path of the unemployment rate.

 

Macroeconomics IS HARD!

Economics in the times of COVID-19, there is already a book. I learnt about it from Tim Taylor’s blogpost. I have not read the book, but will soon.

The NYT, two weeks ago, on the scale of the problem facing policymakers.

 

RoW: Links for 2nd October, 2019

I thoroughly enjoyed reading each of the five links today, both for how informative they were, but also for how thought provoking they were. A rare treat, this selection.

  1. James Fallows, from 1993 (!) on How The World Works.
    ..
    ..
  2. Adam Mintner on Asia’s haze problem.
    ..
    ..
  3. Tyler Cowen on his recent visit to Karachi.
    ..
    ..
  4. Housing and the middle class in China.
    ..
    ..
  5. I’m cheating a little, but this qualifies as an essay, right?