Thursday, August 12, 2010

The (Non-)Impact of Stimulus Spending: Injecting A Dose of Reality

[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.

First a recap of what happened during the recession: the government introduced two fiscal stimulus packages to combat the recession in 2008-2009. The first, introduced in November 2008 for implementation during 1Q 2009, totalled RM7 billion of additional direct spending (details here).

The second stimulus package, AKA the 2009 “Mini budget” allocated RM60 billion, but that total included RM5 billion in national savings bonds, RM7 billion in private finance initiatives and RM20 billion in credit support guarantees, leaving just RM28 billion in direct spending (details here).

That gives an additional RM35 billion in direct spending, spread over two years. You can check the current status of expenditure here.

Now comes the interesting bit. Based on budget 2009, planned government expenditure was to reach RM204.7 billion, comprising both operating and development expenditures – but actual expenditures hit RM206.1 billion, a net difference of just RM1.4 billion (RM billions):

01_exp 02_devt

So, what happened to the two stimulus packages? The first has been fully disbursed based on reports, while the second has reached RM13.9 billion as of July 2010. If the latter were consistently spent over the past few quarters, that suggests only RM7-RM8 billion was actually spent in 2009. Adding together, that means there should have been something on the order of an additional RM14 billion in government expenditure in 2009, instead of the RM1.4 billion we actually saw.

In other words, 90% of the stimulus effect of the additional spending in 2009 was offset by consolidation in government spending in other areas.

As to why there was a fiscal deficit when actual spending didn’t deviate much from planned spending, most of it came from a sharp fall in revenue (RM billions):


…which was RM17.6 billion (or about 10%) below the 2009 budget forecast. Incidentally, this also explains the jump in national debt in 2009.

Figuring out the real impact of the stimulus packages depends on two things: the degree to which stimulus spending (which was presumably largely investment) displaced public consumption spending; and the difference in multiplier effects of the two types of government spending.

Going back to Keynesian theory, which to be more precise should really be called neo-Keynesian theory (Keynes, to my knowledge, never referenced the concept Actually, yes he did), the multiplier effect is the cascading impact of an initial spending shock to the rest of the economy (this IMF Staff Position Note provides definitions and estimates from a wide range of research – warning: pdf link). So if RM1 is spent and the economy expands by RM2, then the multiplier is 2.

Different spending types (e.g. income tax cuts, direct spending, investment allowances) will have different multiplier effects, and the structure of the economy is important as well – the multiplier effect is vanishingly small in a small open economy with an independent central bank and fully floating exchange rate, and will be high in a closed economy with an accommodating central bank and a fixed exchange rate.

Different model assumptions also give wildly divergent estimates – new classical models invariably give a multiplier of zero due to crowding out effects, New Keynesian models give positive but fairly low multipliers, while structural neo-Keynesian models give the highest estimates (ref: this paper).

I’m going to use estimates generated by this paper (warning: pdf link; shorter non-pdf version here) to measure the 2009 impact of Malaysia’s stimulus packages – Malaysia is one of the countries included in this SVAR analysis, although country specific effects are not broken out separately. I’m also going to be really charitable here and ignore the paper’s results on trade openness and flexible exchange rates, both of which are characteristic of the Malaysian economy – multipliers in these circumstances were effectively zero to slightly negative.

[Digression: how can you get a zero or negative multiplier for money spent in an economy? The three main channels for a multiplier less than unity are: savings, where the income generated is not spent; second, where spending leaks into imports (e.g. cement, food); and third where government spending displaces private spending by either competing for scarce private investment funds, or through higher long term interest rates.]

The long-run estimated cumulative multiplier for public consumption in developing countries is 0.79, but just around 0.35 for 2 quarters and 0.7 for a full year. The long run multiplier for public investment is a little lower at 0.75, but has higher impact multipliers at about 1.1 for 2 quarters and 1.3 for 4 quarters.

So here’s my assumptions on this back-of-the-envelope calculation: I’m classifying both stimulus packages as investment, and they displace the same amount of government consumption on a 1-to-1 basis – that means the positive multiplier from the increase in investment is partially offset by the negative multiplier of lower consumption; also, the first stimulus package of RM7 billion has a full year impact, while the second stimulus package (also RM7 billion) has a 2 quarter impact in 2009.

Putting these together give:

Boost to GDP = 7 x (1.3-0.7) + 7 x (1.1-0.35) = RM9.45 billion

As a percentage of 2009 nominal GDP, that’s approximately positive 1.4% and an effective cumulative multiplier of 0.675. Since not all of that spending is actually in investment projects (retraining funds should be classified as consumption, for example), that’s effectively the upper limit of the effect of the stimulus packages on the economy in 2009.

However, 2009 nominal GDP actually dropped 9.9%, which means that all that spending covered a little more than a tenth of the potential drop in GDP. Since I assume the remainder of the second stimulus package was largely subsumed into the 2010 and 2011 government budgets, the impact this year and next will be even less. In other words, Malaysian fiscal stimulus in 2009 was (i) late, (ii) not nearly big enough, and (iii) emasculated by fiscal consolidation.

I recall talking to a well-known local economist right in the depths of the recession, who told me with an absolutely straight face that public investment in the 1990s had a multiplier of 20x or more, but we’re only likely to get a fiscal multiplier of 2x or 3x from the mini-budget. I’m still waiting for that boost to kick in.

Technical Notes:

  1. Data on Malaysian 2008-2009 fiscal stimulus packages from Economic Stimulus Malaysia
  2. Data on Malaysian Government revenue and expenditure from Bank Negara Malaysia’s Monthly Statistical Bulletin
  3. Data on planned government revenue and expenditure from various issues of the Malaysian government Economic Report
  4. Spilimbergo, Antonio, & Steve Symansky and Martin Schindler, "Fiscal Multipliers", IMF Staff Position Note SPN/09/11, May 2009
  5. Cogan, John F., & Tobias J. Cwik, John B. Taylor and Volker Wieland, "New Keynesian versus Old Keynesian Government Spending Multipliers", European Central Bank, Working Paper No 1090, February 2009
  6. Ilzetzki, Ethan, & Enrique G. Mendoza and Carlos A. Végh, "How Big (Small?) are Fiscal Multipliers?”, unpublished, May 2010
  7. Ilzetzki, Ethan, & Enrique G. Mendoza and Carlos A. Végh, "How big are fiscal multipliers? New evidence from new data", VoxEU, October 2009


  1. Can you see me smiling?

    More seriously, is classifying the stimulus as investment justifiable?

    I don't remember any significant stimulus spending aimed at investment. Most of the direct spending was/is just consumption in one way or another.

  2. Thought you might like this post.

    Call it a mea culpa - you were right last year and I was wrong.

    I used the investment multipliers to show a "best" case scenario - which was already not so very good.

    You also might like to download the paper I linked to as the 6th reference - the impulse response graphs show very clearly the lags involved in fiscal spending, as in your post the other day.

  3. Nevertheless, I'm quite surprised that the amount of actual stimulus is really small. I had expected it to be eventually considerably big, regardless of lag.

    What I don't understand is why there was a drop in regular spending? More to the point, I don't understand why stimulus spending displaced typical public spending.

    It'd be odd if the government had decided to be spendthrift amid be stimulative at the same time. Might as well not be spendthrift and not announce stimulus earlier, notwithstanding the psychological and the political impacts.

  4. In the last sentence, I meant to write:

    It'd be odd if the government had decided to be spendthrift and be stimulative...

    I get too excited easily.

  5. I suspect two things are going on here:

    1. Because the value of food and commodities were depressed during the depths of the crisis, that meant the amount spent on subsidies was less than intially budgeted for.

    2. I think as the recovery took hold in the 2H2009, the government decided that the game wasn't worth the candle, and started consolidating expenditure. Since they couldn't go back politically on the stimulus measures (looks too much like waffling), they cut discretionary expenditure instead - flat rate gratuity instead of bonuses for the civil service for instance.

  6. if that's true, then it's almost like an automatic stabilizer, except that it works in the opposite.

    Maybe this is a good argument to dismantle the subsidy program and fund the construction of a proper automatic stabilizer. At least, with a proper stabilizer, the argument against discretionary spending can be made stronger.

  7. Hafiz, you read my mind. Yes, given the lag effects of discretionary stimulus, automatic stabilisers would be a superior alternative.

  8. Keynesian fiscal policy to stimulate economy by spending? The results you can see it from US Fed Reserve since bubble until now!

    What Malaysian government should do now instead is, encourage more FDI, decrease spending, increase productivity especially our commodities and tightening hot money from the recent US QE2.

    We can expect what will happen down the road to our country, inflation. Stock market rally, real estate continue rising (especially when government 100% loan guarantee for first home owner policy become effective).

    Given no control to it, the real estate market will become hardly sustainable when effect from US/Europe financial crisis which has high possibility to deteriorate anytime from now, reach Malaysia.

    The timing now is best to sell your properties/stocks, reap the profits, and take it to buy precious medals.

  9. Sorry, what has the Federal Reserve got to do with fiscal policy?