Question: What Variable Should The Fiscal Stimulus Target? - An Awkward Corner

Question: What Variable Should The Fiscal Stimulus Target?

Niranjan Rajadhyaksha - Sunday, March 01, 2009 10:34 AM

Government around the world have been running up higher fiscal deficits in a bid to support their economies. But should there be an explicit variable that they should target?

Christina Romer, a fine macroeconomist and chief of Barack Obama's Council of Economic Advisors, says her president is keen that the stimulus should protect jobs.

"The first issue is what it would mean for the policy to work. The President gave a very concrete metric: he wanted a program that would raise employment relative to what it would be in the absence of stimulus by 3 to 4 million by the end of 2010," she said in a recent speech titled The Case For Fiscal Stimulus.

I see faint echoes of these sentiments in various other government fiscal programmes, though I am not sure what the Indian government is really up to.

I have three observations here.

First, some hair splitting. How do you calculate the number of jobs lost in case there is no fiscal stimulus? Romer mentions Greg Mankiw's pointed --- and, to me, convincing --- critique.

"Some on the blogosphere (such as the best man at my wedding, Greg Mankiw) call this metric meaningless: they complain that because we never observe the outcome under the no stimulus baseline, it isn’t verifiable. But it is, in fact, the intellectually sound and appropriate metric to use," she says.

Second, if the focus is on protecting jobs then should we really be surprised that the Obama administration has slipped in policies that will make American companies hire local workers? In other words, how do you protect domestic jobs while respecting free trade in these times?

Third, a more theoretical question. We have seen long debates in monetary economics about whether a central bank should target an intermediate variable such as interest rates or money supply or target a final variable such as inflation?

The balance has swung to direct targets over the past decade, with increasing instability in the demand for money making it unclear to what extent changes in money supply affect prices. So, explicit inflation targets have been written into deals between quasi-independent central banks and parliaments in many economies.

Will a similar debate erupt in fiscal economics, where a direct target such as employment gets more importance than an indirect target such as GDP?

Finally, I read something in the blogosphere around two months ago that linked fiscal programmes with one of the key findings of economists such as Andrew Oswald, who has shown during his research in happiness economics that having or not having a job is an important determinant of happiness --- more than higher consumption.

I cannot remember who the writer was --- does anybody reading this know? --- but I thought it was an interesting point to consider.

Comments are welcome.

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13 Comment

From tca

March 1, 2009 11:35 AM
if fiscal policy is about the calibrating role of G in the Keynesian identity, and if goverments are the largest buyers of goods and servics, why don't they simply place orders directly with firms and fill their order books? we will not need all this fiscal policy clap-trap then. in the old days, by the way, the sovereign filled order books by going to war?

From Vivek

March 1, 2009 4:10 PM
About your question at the end, I don't know about Andrew Oswald but was reading a related article on Bloomberg this weekend about James Tobin: http://www.bloomberg.com/apps/news?pid=20601109&sid=ajz1hV_afuSQ&refer=home

From V.B.N.Ram

March 2, 2009 9:07 AM
Would an individual's " happiness quotient " vary depending on whether at all, he or she has a job and would it further fluctuate depening on the extent of its likeability, or the lack of it: would, in my view, be determined by how one defines " happiness" After reading NR's above analysis, I delved into the internet, in an attempt to get educated on the issue raised. An economist Richard Easterlin was one of the first to study statistics over time, on the reported level of happiness. His data was derived from the United States. Easterlin's 1974 paper"s main objectives were, to suggest that individual happiness appears to be the same across the poor countries and rich countries and second that economic growth does not raise well being ( in essense, when one measures the gorss national happiness of Bhutan and finds out that it is much higher than some nations having a much higher per capita income and a higher purchase parity )one arrives at the same conclusion as Easterlin. He suggested that one should think of people as getting utility from a comparision of themselves, with others close to them, happiness is relative, the modern stress on higher total national income is misplaced. According to his reserch related to the United States, higher income was not systematically accompanied by greater happiness. I would define my own happiness as the extent of my comfort level, or the lack of it, of events and the surrounding environment.

From sumita

March 2, 2009 3:39 PM
In search of a single target again? I was hoping inflation targeting was out of favour now for monetary policy! Anyway, fiscal policy is budget management so deficits have to be reined in: India’s fiscal stimulus is according to this international comparison small at less than 1% of GDP but its budget deficit is amongst the highest..http://www.voxeu.org/index.php?q=node/3156 If you have to have huge deficits in these distressing times, link spending to outcomes, and gear activity towards social equity – measured by on the ground improvements in the quality of life for the poorest. I am sure there are enough blueprints out there that can boost govt spending for say, housing and slum improvement (of course, this may reduce future happiness by reducing chances for an Oscar), IT spending for smart cards for PDS, sanitation etc…Right now, companies need business and people need jobs; so as TCA has been arguing, this will provide for both, improving the life of the poor would have also given electoral gains, but it is too late in the day for that now. How do you protect domestic jobs and free trade at the same time? You don't. You give up free trade, citing exceptional need of the hour! It’s been done all the time through history.

From Gulzar Natarajan

March 3, 2009 8:54 AM
Fixing any target, on any (direct) parameter, would pre-suppose estimations of potential-actual GDP output gaps (an indirect parameter), itself a hazardous estimation (as can be seen by the very wide range of estimates by different parties, that the recent Obama budget has come up against - http://www.nytimes.com/2009/02/28/business/economy/28recession.html?_r=2&hp). People like Paul Krugman (http://krugman.blogs.nytimes.com/2008/11/10/stimulus-math-wonkish/) and Martin Feldstein (http://www.nber.org/papers/w14684.pdf) have calculated the fiscal stimulus numbers by starting from the unemployment rate projections (and then use Okun's law) or the decline in aggregate demand to estimate the GDP output gap and thus the stimulus numbers. Once the stimulus numbers are estimated, then use multipliers to allocate betwen the varying spending and tax cut alternatives. But such divergences in estimations and hazards may not be a major factor in normal slowdowns, as compared to the depression like slowdown of now, thereby making estimations of direct parameters easier. About point no 2 Paul Krugman (http://krugman.blogs.nytimes.com/2009/02/01/protectionism-and-stimulus-wonkish/) got it spot on - "if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere". in other words, if fiscal policy is not co-ordinated across economies of the world, then there is a strong possibility and economic case for protectionist policies! For various reasons, and for a long time now, fiscal policy had been sidelined in its application by monetary policy. But the present crisis has surely changed that. And I agree with niranjan that the as the debate about designing fiscal stimuluses intensifies in the coming months, evolving new designs for fiscal policies may lead to more clarity on the parameters to be applied. But I am inclined to feel that estimations of the stimulus numbers are more likely to be closer to the mark if done based on the output gap than more direct parameters like unemployment etc.

From Vidya Mahambare

March 4, 2009 10:42 AM
A problem with direct targets for the fiscal policy such as full employment would be that they are unlikely to be credible either in the normal circumstances or in exceptional circumstances such as todays. Would anyone ever believe that a government can provide a job to each and every person who is willing to work? If not, any such target would loose its credibility and hence, the confidence in the policy. Not workable in reality, I fell.

From V. Anantha Nageswaran

March 7, 2009 4:58 PM
I do not know the answer to the question. But, I concede that it is an important question. The absence of an obvious answer makes the question all the more important. Yes, the government will not know the counterfactual. But, it is true of any economic policy measure or any decisions human beings make. What would have been the outcome under other alternatives that include doing nothing. The movie 'Sliding doors' tried to tackle that theme. Fascinating. But, that does not provide answers to governments, of course. I guess, in the end, governments engage in fiscal policy with an implicit agenda of preserving if not boosting total employment. The difficulty in defining a numerical target does not make it less important. But, I am not able to see why free trade must necessarily clash with this goal. I know it happens but is not necessary that it should happen. The real reason why governments undertake fiscal stimulus is that governments have to be seen as acting, regardless of the efficacy of actions. In other words, action is more important than ensuring efficacy let alone measuring it versus a specific target. So, in a nutshell, fiscal policy is being undertaken because governments are expected to. That applies to many things like central banks cutting rates. The tool-kit has to be widened after a debate. There is no debate on sustainability of such action nor on the target of such actions. As Sumita writes above, government intervention - not necessarily fiscal - might be more effective if it removes some of the existing impediments to private sector activity. The crisis could give them the cover to do so.

From aanteladda

March 9, 2009 7:01 PM
Great question to raise. your Third: We are again at the juncture where fiscal and monetary stimuli will have to be co-ordinated to deliver results and these results must be measured in increases in production and productivity (the former being the conventional measure,the latter up for discussion). The monetarists have had the field too long, it is time for a new balanced scorecard of measures. First: Even under steady conditions, estimating these macro-economic indicators has always been a very interesting experiment with truth or whatever part of it is available, and remains a challenge. Second: Jingoism is a consequence of insecurity and that is what we will see a lot more of, as we are in America and the UK. TCA is absolutely right - it was WWII that brought us out of the previous recession. But, I thought that is what America was doing in Iraq and Afghanistan all these years. True Keneysian 'dig holes and fill them up', but Not in My Backyard. Finally, your reference to happiness economics - originally discussed as part of the 'third way' at the London School of Economics and led by Prof.Layard. This was a fascinating exercise in three ways. One, it unpeeled economics to its basics and restarted from first principles. Second, it managed to redefine value away from 'utility' as measured by price and thirdly it continues to pull away from metrics (as finance homes in)back to the tracking of behaviours. Interesting you notice it in this context - Happiness as a reward or measure of value in the new economy would be an interesting debate - but would we ever have consensus?

From V. Anantha Nageswaran

March 10, 2009 12:55 AM
I think I have a slightly more intelligent contribution to make, having thought more about the question in a 12-hour long flight to Europe. I do not think that governments should target particular variables or explicit goals. It should concentrate on getting its efforts and inputs right. If it sounds like Bhagvad Gita, it is. In economics, we have little control over outcomes given lags and given unpredictable responses from other participants in the economy, based on how they perceive their incentives and (dis) incentives from the government intervention. That is, in policymaking, the road to hell is paved with good intentions. Given that the current extraordinary fiscal intervention is due to the crisis and that the crisis had reduced capital flows to India and that such capital flows pushed growth rates above 9% supporting investment spending, the gap for the government to fill becomes obvious. It is to shore up infrastructure through investment spending since private capital would take time to return to India and domestic investment is hurt by stretched balance-sheets. The key to note is that the exact growth outcome (variable) is hard to measure given the impossibility of constructing counterfactual scenarios. Therefore, the government's task is to identify the critical private demand component that would go missing in a crisis - one that would have the maximum short-run adverse impact on growth - by its absence and seek to fill it. p.s: Happiness economics should be left to the West for they have climbed the Maslow's material hierarchy. For developing countries, happiness will come through, for now, through higher growth. Unless deliberately anti-employment creation policies are pursued, growth will create jobs in developing countries.

From Gulzar

March 11, 2009 7:04 PM
talking about targets, the IMF advocates (http://www.imf.org/external/pubs/ft/spn/2009/spn0903.pdf) a clear articulation of a "long-run target for the ratio of the fiscal deficit to GDP and therefore implicitly for the ratio of public debt to GDP", as is being done by Chile. This would help anchor inflationary and thereby interest rate expectations. The paper also suggests that during fiscal expansions, the monetary policy rate should be held constant at its pre-stimulus value for one or two years (as opposed to the forward-looking Taylor-type interest rate rule that during normal times adjusts nominal policy interest rates in response to one-year-ahead forecasts of inflation), thereafter returning to the conventional interest rate rule to anchor inflation in the long run.

From Vidya Mahambare

March 13, 2009 10:00 AM
I would tend to agree with V. Anantha Nageswaran above that the government should focus on raising that component of GDP, the private counterpart of which has got most adversely affected in the current crisis, in general investment and in particular infrastructure investment. Even in more normal circumstances the direct targets for the fiscal policy cannot be employment or growth per se (as I mentioned earlier), but could be something intermediate such as education, health, removal of disincentives for job creation, infrastructure or more so, making sure that enforcing/maintaining the quality of infrastructure - these would tend to improve the quality of inputs – labour and capital – and help sustain the trend growth rates. As for employment, the part of the reason services have boomed as we know is that the labour market is much more flexible in the service sector. Of course, we need to think about a safety net for labour who loses jobs when demand falls, but that does not mean that we should not create jobs in the first place. In fact, the fiscal policy implicitly has had these intermediate targets for a long time, but given that the populous nature of most governments these targets are rarely achieved. As the current crisis shows the nature of the monetary policy would also change going forward. The arguments against the current status of the monetary policy however, cannot be used as the evidence for the direct intervention of the fiscal policy.

From aanteladda

March 14, 2009 6:27 PM
There is no doubt that governments have a larger role to play in the downturn, and their greatest contribution will be in filling the investment gaps left by the receeding private investors. I beleive that they will also have to support the gap in demand for services for a while too, while the economy finds its new rhythm and balance. This is an opportunity for the governments to focus on re-examining their systems - physical, regulatory and at the policy making level. The recent frenzied pace had governments rushing to keep pace with the demand for each of these services,and the slowdown gives them an opportunity to do just that. The tools they use to do so must have the twin targets of supporting investments and creating demand while re-inventing these systems. The ultimate goal of course being sustainable long term (high) rates of growth (at least till we climb Maslow's mountain!) This begs the next two questions: 'What needs to be done?' and 'How do you know it is working?' Here I have to agree with myself and other commentators - Direct targets for fiscal policy can really only be set in terms of inputs. The results (phal) of these policies are based on complex inter-relationships, unpredictable and very difficult to measure. The correlation of any stimuli to growth may be measurable, the causality truly is not. Intermediate targets such as jobs, health (delivery numbers), education and skills initiatives are great examples of the categories of targets that can be measured. (The underlying assumption here being that there is a direct causal relationship between these measures and the goal - growth/living standards/happiness). To add my tuppence and answer the original question at the very begining of your post: Should there be an explicit variable that they should target. Yes,it has to be explicit. They will be measured by other economies, by the press, by the people and if they are to be honest about their progress, they must let us know what they are working towards. I add another question: Can it be a single variable? I think not. I think they (or some of us!) will have to work to creating a composite that is like a 'balanced scorecard' and I know that there are others like me who would love to take this forward.

From N.Ramagopal

March 16, 2009 5:09 AM
Nageswaran states: " Unless deliberately anti-employment creation policies are pursued, growth will create jobs in developing countries". But how do we explain the phenomenon of jobless growth in India? see the paper "Growth Sans Employment" in EPW http://epw.in/epw//uploads/articles/13259.pdf I find it difficult to believe that Indian policy was "deliberately anti-employment "

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