Perception on recovery is false

by PIM of SPAIN | November 12, 2009 at 09:10 am

133 views | 38 Recommendations | 16 comments

The perception that a recovery through financial stimuli creates a multiplying effect for growth, from which the government easily can exit, is false.

The common idea that almost everyone believes is that government economists can improve the functioning of an otherwise free market economy. Which as a result leads people to believe that the feds have pulled off a recovery and that now the economy is on the road of revival by getting stronger as time goes by, followed by the feds safe exit from their stimulus efforts.

The big question in most investors' minds is: how quickly will the feds exit? As long as they keep up their stimulus efforts, investors expect rising prices and results for everything, but the dollar.

Those who think the feds will be able to exit quickly believe growth will come without too much inflation. Those who think the exit will come slowly expect higher rates of inflation.

This perception is false too. From the beginning to the end it is a delusion of grandeur!

The theory behind the recovery concept is that government spending and stimulus from the Fed has a "multiplier" effect. That says, the feds money goes into the economy and from there it goes into the private economy with multiplying effects on spending, creating growth in consumption and investment of its own. If there were no multiplier effect the whole exercise would be a waste of money and time, because it is known that government spending in itself is a cost to an economy, not a source of real wealth, because it is taxpayers’ money that’s spent. Government spending, generally, is a drag on prosperity. The Communist Soviet Union was proof of this. The question remains however, can extra government spending at critical moments "prime the pump" so that it is multiplied by the private sector? The answer is NO.

"Our new research," writes economist Robert Barro in The Wall Street Journal, "shows no evidence of a Keynesian 'multiplier' effect...the available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise the GDP by less than the increase in government spending."

Next question: In the current situation; is there any evidence of growth beyond the government's own stimulus efforts? From what is witnessed so far –see the result from ‘cash for clunkers’-, the answer is 'NO.'

Consequently the idea of recovery →multipliers→growth and an exit from it is wrong.

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Roy C

at 09:20 on November 12th, 2009

We shall see, won't we?

A couple of terrorist acts; bankruptcy in functional terms for some big states such as California and New York; people not getting care in hospitals because of shortages of medicine and personnel as foreign-born doctors and nurses leave the US; actual food shortages because the farmers can't get enough money back from selling their crops from an inflated dollar that raised the price of oil, fertilizer and the cost of the distribution necessary to get a farm product to market: all these things await us.

Hugh Askew

at 09:32 on November 12th, 2009

"..... and thus spending stimulus programs will likely raise the GDP by less than the increase in government spending."

The "less than" part is the bite that bureaucracy gets to eat.

albertacowpoke

at 09:36 on November 12th, 2009

Another good Analysis Peter.

PIM of SPAIN

at 09:55 on November 12th, 2009

And the 'less than' goes into the bonuses of the bankers too, mind you. Hope this explanation will help others -who still do believe in the massaged statistics - to understand what really is going on nowadays.

snuffysmith

at 10:16 on November 12th, 2009

Couldn't agree more. Thanks for posting this.

Gordon Clark

at 11:43 on November 12th, 2009

I agree that when a government is puling out of a stimulus plan this can be problematic. I think a big issue associated with when is what the circumstances of their exiting are.

But it is in the multiplying effect that the taxpayers dollars become multiplied, no?

If the biggest public spending issue of a financial crisis is consumer and investor expectations then isn't it logical for a government to limit the damage by providing security in an increasingly doubtful economy by providing stimuli? - especially if it is a theoretically and pragmatically successful solution such as the multiplying effect?

rng

at 12:27 on November 12th, 2009

You are at least consistent. Consistently wrong though

Blanace Sheet Recession and the role of govt stimulus http://www.japanreview.net/review_bsr.htm Not even in US textbooks yet

Martin Wolf FT

Paul Krugman NYT

I could go on, but I don't need to. You can continue to write this stuff daily, but the indices make a mockery of what you assert again and again. Repetition doesn't make you correct. I guess we just have to have patience until you can see the writing on the wall. At least others can read the sources as quoted and understand. That is the difference between economics over politics, it is definitive. One cannot argue the indices are improving, one can only argue whether it is a sustainable trend. Denying tangible measures is denying fact.

jazzyzazzy

at 14:40 on November 12th, 2009

hmmmmmmmmm.dont know what to believe these days tho;

Roy C

at 15:39 on November 12th, 2009

Maybe we are wrong, RNG, but with Pim's approach, we would not be in this difficulty.

rng

at 17:07 on November 12th, 2009

The evidence just keeps mounting http://my.nowpublic.com/world/financial-panic-over-warren-buffet-says

I won't argue with you about it could have been avoided or at least mitigated, but once we were in there was only one way out, and out is where we are heading

Rory Cripps

at 18:40 on November 12th, 2009

rng: The American economy has experienced ups and downs on a periodic basis--especially since 1913. The GDP (and prior GNP) charts, along with the other economic data charts all look quite similar at first blush. One thing that we notice nowadays, however, is the increasing amount of time that it takes for full recovery, i.e., for economic equilibrium (at least that which is accepted in the U.S. as "economic equilibrium") to occur. The problem with the current recession is that, in many respects, it resembles economic conditions that occurred throughout the Great Depression. And for that reason, it may take much longer for the American economy to rebound on all fronts than it took in prior recessions. In my opinion, the fact that politicians take credit for improving the economy is a joke. And the fact that politicians blame other politicians for screwing up the economy is a joke too! It's a bunch of nonsense that the politicians can make hay out of in order to get elected or re-elected. They get away with the BS because the American electorate, in general, has no idea of how the economy functions. The only thing that the electorate knows is that the economy is either good or bad at the time that a particular president is in office and they often base their vote on that . . . .

rng

at 08:59 on November 13th, 2009

Agreed in most. In past recessions/depressions many country could export their way out which was why recovery was faster. In globally connected economy it is a little different as each one hurts the other so there is no magic export market to dump product on. So recovery take much longer

I agree with you that the electorate by and large has no clue how it all works. In a planned economy, politicians can make claim to influence the economy such as a Norway, France etc which is why they are coverings faster. With a "brain" driving it is possible to direct the economy more quickly.

In America, in this particular instance, stimulus spending was a requirement as a balance sheet recession had occurred which is a rare phenomena. The stimulus is what put an emergency brake just ahead of the cliff, we still went down it but a little slower and wearing seat belts. Climbing back up the cliff is not going to be easy, and will take longer than falling down it, but the climb has begun

Hugh Askew

at 20:07 on November 12th, 2009

Agreed, Mr. Cripps. However, the President does get to pull the trigger on a lot of things that do affect the economy. The head of the Federal Reserve being a major one.

As far as Buffet is concerned, he makes good long term investments based on the long term prospects of the American economy. Short term, his record is not nearly as good. By his own admission he has made some memorable mistakes. He lost what, 8-10 billion last year? Hardly chump change.

tikun

at 08:13 on November 13th, 2009

Are you trying to totally scare me out of what's left of my retirement dollars? LOL

rng

at 08:27 on November 13th, 2009

New unemployment claims this month lowest since January 2009. Just another indice to add into the mix

As I said to Roy. I am not defending anyone or anything that got us here. However, there is only one way out and the signs are adding up day over day to the fact that we are finally beginning the rebuild. How fast that will be? That is a valid question, but when anyone keeps saying there are no recovery indicators in contradiction to a wide body of evidence sourced from within and outside govt data, then that is BS and that needs to be pointed out.

On the obscene fees of the financial sector. Buffet is worth @$65Billion depending on when you measure it. Some new work by an economist in his book says that had Buffet used professional fund managers rather than managed is own investment - he would have only retained $5-6 billion, the rest would have gone in fees over the decades. I can't remember the guy's name who did the work, I heard it on an LSE podcast recently, but this guy is adamanant that with the investment tools in the public domain, the average investor doesn't need the fund managers and can manage a portfolio for better return themselves. It was a really interesting lecture.

tikun

at 11:58 on November 13th, 2009

rng,

I would agree about not using managers. However, many people are so invested emotionally to their money that it is difficult for them to make "objective and disciplined" decisions.