stimulus or austerity n.
Skip this Video
Loading SlideShow in 5 Seconds..
Stimulus or Austerity? PowerPoint Presentation
Download Presentation
Stimulus or Austerity?

Loading in 2 Seconds...

play fullscreen
1 / 30

Stimulus or Austerity? - PowerPoint PPT Presentation

  • Uploaded on

Stimulus or Austerity?. Presentation for THE PRESIDENTIAL ELECTION OF 2012 Hiram College, November 16-17, 2012. Uğur Aker Prof. of Economics Hiram College. Source: http:// How To Deal With Recessions. Do nothing. Use monetary policy.

I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
Download Presentation

PowerPoint Slideshow about 'Stimulus or Austerity?' - nadda

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.

- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
stimulus or austerity
Stimulus or Austerity?

Presentation for


Hiram College, November 16-17, 2012

Uğur Aker

Prof. of Economics

Hiram College



how to deal with recessions
How To Deal With Recessions
  • Do nothing.
  • Use monetary policy.
  • Use fiscal policy.
do nothing
Do Nothing
  • Inflation will go down.
  • If ε > 1, consumption spending will rise increasing
  • the demand for goods and services, and hence for
  • resources.
  • Diminished uncertainty due to lower inflation
  • coupled by higher consumer spending will spur
  • business expansion (investments).
  • Exports will become more competitive and add to
  • demand for resources.
do nothing1
Do Nothing

Length of time to get back to “full employment” may be “too long.”

Pervasive bankruptcies may devastate communities.

If government services are dependent on public revenues, the pain on the population will be exacerbated.

Borrowing by firms and individuals during a recession becomes very difficult, closing another door to weather the blow.

monetary policy
Monetary Policy

The need for a “lender of last resort” to insulate

banks from runs and inevitable bankruptcies that

freeze the whole financial system, caused the

establishment of the Fed, US Central Bank.

Central Banks increase or decrease the amount

of money in the system and as a result, lower or

raise the short term interest rate.

monetary policy1
Monetary Policy

During recessions Central Banks increase the amount

of money in the system and lower the short term

interest rate.

In mild recessions this approach seems acceptable to

spur consumption and investment spending.

During expansions that trigger inflation, raising interest

rates is the policy response of the Central Banks.

fiscal policy
Fiscal Policy

Keynesian answer to the Great Depression was to

counter the drop in consumption and business investment

spending by having government to increase spending

and decrease taxes.

The ensuing deficit and the increase in national debt was

supposed to be reversed during boom times.

In fact, the concern was that as the economy grew and

tax rates remained constant, tax collections would exceed

spending and there would be a “fiscal drag.”

fiscal policy1
Fiscal Policy

Keynes wanted an accommodative monetary policy to

accompany a fiscal stimulus. By keeping the interest

rates constant, the fiscal stimulus would not crowd-out

private sector spending.

Governments found this approach very appealing

politically and utilized it son and off since WWII.

The different price experience in the 20th century

compared to the 19th century can be ascribed to the

activist government practices.

fiscal policy2
Fiscal Policy
  • The last half century also saw a objections to the activist
  • policies.
  • Implementation lag was too long, with Congress piling
  • up self-serving projects into law.
  • Spending lag meant the recession was already over
  • when spending took place.
  • Late unnecessary stimulus fueled inflation.
  • People lowered their consumption spending to save for
  • future taxes.
  • Deficits raise the interest rate and displace private
  • sector with more government control of resources..
how recessions occur
How Recessions Occur?

The preferred approach to business cycle research is using

Dynamic Stochastic General Equilibrium models.

DSGE models use random demand or supply shocks to alter

the economy from its full employment path.

Demand shocks are drops in spending by consumers,

businesses, government, and foreigners on our exports.

Supply shocks are any increase in the economy-wide costs

of production.

how recessions occur1
How Recessions Occur?

A complementary approach concentrates on the response of

the Federal Reserve. To counter the rising inflation of the

booming economy, the Fed increases interest rates and slows

down the economy. The higher interest rates reduce the

spending on the output and recession occurs.

1981 82 recessions
1981-82 Recessions

In spite of the stimulative effects of Reagan tax cuts and

military spending increases, the overnight interest rates

were pushed up to close to 20% by the Fed and the economy plunged into two back-to-back recessions.

GDP growth in the United States in the early-1980s. The short recession at the start of the decade, followed by a brief period of growth and the deeper recession in 81–82, have led to this period being characterized as a W-shaped recession.

Percent Change From Preceding Period in Real Gross Domestic Product (annualized; seasonally adjusted); Average GDP growth 1947–2009

Source: Bureau of Economic Analysis

recessions from financial meltdown
Recessions from Financial Meltdown

Over-leveraged, heavily indebted economies face risk of

default. The indebtedness can be either to domestic or

external lenders. The debt can be sovereign or private.

When default risk rises, banks holding the debt as assets

become vulnerable and bankruptcies are imminent.

Bank bailouts and injections of money to counter the freezing

of credit may soften the blow.

recessions from financial meltdown1
Recessions from Financial Meltdown

Central bank money injection lowers the interest rate and

should spur borrowers to take loans and engage in spending.

At the same time, the banks are flush with reserves and should

be willing to part with their excess reserves.

If neither the borrowers nor the banks are fulfilling their

normal functions and the injection of money already lowered

the interest rate to zero (liquidity trap), the only tool the

government has left is fiscal policy (stimulus).


how far the stimulus
How Far the Stimulus?

If inflation is not increasing, then the expected burdens of

the stimulus are not in the horizon.

Inflation will increase the nominal interest rate and will

allow the Central Bank to utilize its monetary policy further.

Inflation will also signal pressure on resources, or expansion

of the economy.

impact of stimulus
Impact of Stimulus

In the past, studies covering the period after WWII, did

not necessarily provide uncontestable results. A sizable

group claimed to come up with multipliers less than one.

That means for one dollar spent by the government the

income of the economy increased by less than one because

other sources of spending dropped.

For instance, in February 2009, in a short note entitled “Voodoo

Multipliers,” Robert Barro claimed that stimulus will have a

multiplier of 0.7-0.8.

impact of stimulus1
Impact of Stimulus

About the same time, Mark Zandi published his multipliers.

He claimed that unemployment insurance, food stamps, and

infrastructure spending all had multipliers of greater than 1.5.

impact of stimulus2
Impact of Stimulus

Alesina and Ardagna show instances where the multiplier is

negative: reducing government spending actually increases

output. The transmission mechanism is through the fall in

interest rates due to a reduction in risk. Tax increases do not

give the same results.

impact of stimulus3
Impact of Stimulus

Auerbach and Gorodnichenko find fiscal tools to be more

effective in recessions than in expansions. According to

their calculations, reducing taxes during recessions do not

budge the total output; increasing military spending does.

Christiano, Eichenbaum, and Rebelo find multipliers to be

around one when the federal funds interest rate is positive

but they are about three when liquidity trap is existent.

In October 2012, IMF declared that fiscal multipliers were

two to three times higher than thought just a couple of years

ago. That meant the negative impact of austerity on the

economy was larger than previously thought.

what about the national debt
What About the National Debt?

A common objection to the deficits and piling of the debt is

the extra burden the future generations will carry to pay down

the debt. This cost to the future generation has to be weighed

against the sacrifices of the present generation.

If the unemployment rate is 50% higher than normal, is it

worth the future generations to pay extra taxes to have their

parents and grandparents employed with all the psychological,

economic, and social benefits?

And if the real interest rate is zero or negative, why doesn’t the

government borrow to spend on high return projects? The children

will benefit mightily.


Alesina, A. and S. Ardagna, The Design of Fiscal Adjustments,

NBER Working Paper #18423, September 2012.

Auerbach, A. and Y. Gorodnichenko, Measuring the Output Responses

to Fiscal Policy, NBERWorking Paper #16311, August 2010.

Christiano, L., Eichenbaum, M., and S. Rebelo, When is the

Government Spending Multiplier Large? NBER Working Paper #15394,

October 2009.

Rose, F., “The Art of Immersion: Why Do We Tell Stories?” Wired, 03.08.11

Shermer, M., “Patternicity: Finding Meaningful Patterns in Meaningless

Noise,” Scientific American, November 25, 2008


Voltaire, Candide, 1759

Keynes, J.M., The General Theory of Employment, Interest, and Money, 1936

(Robert Sahr)

Del Negro, M. andF. Schorfheide, “DSGE Model-Based Forecasting,”

Federal Reserve Bank of New York Staff Reports, No. 554,March 2012

Reinhart, C. M. and K. S. Rogoff, This Time Is Different: Eight Centuries of

Financial Folly, Princeton University Press, 2009.


Barro, R., “Voodoo Multipliers,” Economists’ Voice,, February, 2009