Pakatan Rakyat has promised to balance the government budget…eventually. Barisan Nasional has committed to balancing the budget by 2020. Given the government debt situation and whether you believe in political manifestos, it all sounds good, right?
Problem is, I find it hard to fully justify this as a policy objective.
President Harry Truman of the US was once reputed to have said, “Give me a one-handed economist! All my economists say, On the one hand…on the other.”
Here we see a corollary to that truism – for every economics research paper, there’s two (or more) perspectives.
So, on the one hand (excerpt, emphasis added):
IMF's economist: budget cuts may hurt growth less nowWASHINGTON: Belt-tightening in advanced economies may not be as harmful to growth now as it was during the height of the financial crisis, but governments should still be careful about drastic cuts, an International Monetary Fund research paper found on Thursday.
Businessweek is highlighting the IMF’s nervousness over the impact of fiscal austerity in Europe (excerpt):
More From Olivier Blanchard, the IMF's Dovish Economist
Under Olivier Blanchard, its chief economist, the International Monetary Fund has transformed itself from a strong voice for strict austerity to a strong voice against strict austerity. The latest example is an explanatory box in the IMF’s World Economic Outlook. In it, Blanchard and IMF economist Daniel Leigh present research showing that deficit reduction has harmed growth far more than is commonly understood.
The research (in box 1.1) is technical, but the big idea is that Blanchard and Leigh compared forecasts of nations’ economic growth with what actually happened after countries tightened their belts. They found consistently that growth came in worse than expected, which means that the belt-tightening was more harmful than economists believed it to be—by a lot. Economists have assumed that cutting the government deficit by 1 percentage point cuts about half a percentage point off economic output, but the actual decline is more like 0.9 percentage points to 1.7 percentage points, Blanchard and Leigh write.
Good luck finding coverage of PR’s Alternative Budget (hereinafter referred to as AB; link here) in the mainstream media. And the commentary from the other side has been, shall we say, less than complimentary. I for one, however, am not going to call it “stupid”. There is some gold in the dross.
[For foreign readers, what’s being discussed here is not the official government budget, which will be tabled this afternoon. Rather, this is the “shadow” budget presented by the opposition and distributed on Sept 26th]
I’ve made some preliminary comments in my previous post if you care to read those (too lazy to repeat myself).
Comments will be stream of consciousness stuff, because I haven’t the time today to organise things, what with the “official” budget this afternoon.
New on the World Bank Policy Research Working Paper Series (abstract; emphasis added):
Fiscal multipliers over the growth cycle : evidence from Malaysia
Rafiq, Sohrab; Zeufack, AlbertThis paper explores the stabilisation properties of fiscal policy in Malaysia using a model incorporating nonlinearities into the dynamic relationship between fiscal policy and real economic activity over the growth cycle. The paper also investigates how output multipliers for government purchases may alter for different components of government spending. The authors find that fiscal policy in Malaysia has become increasingly pro-cyclical over the last 25 years and establish that the size of fiscal multipliers tend to change over the growth cycle. A 1 Malaysian Ringgit rise in government (investment) spending leads to a maximum output multiplier of around 2.7 during growth recessions, and around 2 in normal times. The returns to government spending in Malaysia are greater when the focus is on public investment, as opposed to consumption. Changes in tax policy are less effective in stimulating economic activity than direct government spending. These results provide empirical backing to conjectures in the recent literature implying that procyclicality in fiscal policy reduces the effectiveness of fiscal actions in emerging markets.
First – whatever they may say, this feels like an election budget. While it doesn’t feature some of the more desirable aspects of Pakatan’s Alternative Budget (e.g. review of IPP contracts, wider scope for the Competition Act), there’s an awful lot of “handouts”, if you want to call them that.
Book vouchers and abolishment of fees for national and national type schools, the assistance for taxi drivers, free medical care for the elderly, there’s a little bit of something for everyone – at least going by the measures announced in the speech proper. The one-off assistance to low income households is smaller than Pakatan’s proposal (RM500 versus RM1000), but the scope is far wider covering households earning RM3000 or less compared to RM1500 or less. Smokers and drinkers ought to be happy – no increase in sin taxes either.
What’s going on in the US is dumb, what’s going on in Europe even dumber. In the presence of an outsize public debt, fiscal consolidation works – but only if you have economic growth. If you don’t, then cutting expenditure and raising taxes makes things worse, not better.
Greece and the other PIGS are in a bind primarily because of the straitjacket imposed by the necessity of keeping a nominal high exchange rate relative to what their economies need. The US is in a bind because signs of economic uncertainty boost the US dollar, which is the exact opposite of what should happen to a “normal” economy, as Ryan Avent points out (excerpt):
Via Ryan Avent and Paul Krugman, Goldman Sachs has a chart showing the impact of the US fiscal stimulus of 2008-2009:
Basically from the last quarter of 2009 onwards, fiscal policy acted as a brake to the economy, not as a boost. And monetary policy was not much better.
If you want a more wonkish look at this, there’s an interesting paper on NBER I pointed to last year. And Malaysia’s fiscal “stimulus” of the same period was not much more effective.
More and more, in a globalised world with many trade linkages, the evidence suggests that the macroeconomic orthodoxy of the past thirty-forty years is actually correct (abstract):
How large is the government spending multiplier ? evidence from World Bank lending
This paper proposes a novel method of isolating fluctuations in public spending that are likely to be uncorrelated with contemporaneous macroeconomic shocks and can be used to estimate government spending multipliers. The approach relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of public spending, and (2) actual spending on World Bank-financed projects is typically spread out over several years following the original approval of the project. These two features imply that fluctuations in spending on World Bank projects in a given year are in large part determined by fluctuations in project approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. World Bank project-level disbursement data are used to isolate the component of public spending associated with project approvals from previous years, which in turn can be used to estimate government spending multipliers, in a sample of 29 aid-dependent low-income countries. The estimated multipliers are small, reasonably precisely estimated, and rarely significantly different from zero.
So the PM says:
PM: Strengthening economic fundamentals better than stimulus packages
PUTRAJAYA: It is better for the government to strengthen economic fundamentals rather than introduce stimulus packages frequently to overcome the economic slowdown, the Prime Minister said.
Datuk Seri Najib Tun Razak said the country needed to avoid introducing stimulus packages too frequently because it would increase the government's deficit.
However, Najib said that stimulus measures, especially for local investors to increase investment, needed to continue.
"If we do this and projects with big multiplier effect on the economy are implemented, then even with a slight drop in foreign demand, we can still achieve our 6% target," he said…
[Warning: this is a long and wonkish post]
I’ve mentioned before that I didn’t think that last year’s stimulus spending had much of an impact (here and here for instance). I think it’s time to examine that question in more detail, especially in light of yesterday’s Federal Open Market Committee statement, which makes the case for further monetary policy support for the US economy due to slowing US and global growth. In other words, is there a case for further fiscal stimulus to keep growth going in the Malaysian economy?
etheorist stated a week back that he began blogging to fight misconceptions over the Keynesian fiscal multiplier. We’re about to find out what he meant.
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