So, I’ve been debating an economist called Mark A. Sadowski over at Scott Sumner’s TheMoneyIllusion blog. The debate started on my blog when we were debating the effects of the QE programs on my post a few days back but it has since moved on to macro-theory and a brief discussion of how fiscal deficits work and it has finally fallen onto the topic of being something like an empirical discussion of the budget deficits in the US versus those in the Eurozone.
In one comment Sadowski wrote the following,
Raw general government deficits imply that fiscal policy in Spain Ireland and Greece was far more expansionary than in the US from 2003 to 2009 and has been substantially less contractionary in Spain and Ireland than in the US since 2009. This contradicts what you have said about their relative fiscal stance far more severely than the cyclically adjusted measures.
This is in response to a comment I made to the tune that whether the deficit spending comes from active fiscal policy or from automatic stabilisers matters little. I think I should probably clarify this: it is certainly correct that the source of the spending largely doesn’t matter, however when trying to conceptualise how large one budget deficit was relative to another it certainly does matter.
For example, Sadowski is largely correct that Spain’s absolute fiscal stance is laxer than the fiscal stance in the US but in Spain’s case it is driven purely by the automatic stabilisers. What we see in Spain is a very specific dynamic that runs something like this.
1) In 2008 the Spanish budget deficit opened up as the automatic stabilisers kicked in. It reached its height in 2009 when the deficit was around €116429m.
2) The Spanish government then undertook austerity measures to shrink the deficit.
3) These austerity measures largely failed and today we do not see much change in the euro value of Spain’s budget deficit. At the end of 2012 the deficit was still €109572m.
In the US, however, the dynamics were entirely different and this was due to the fiscal stimulus undertaken in 2009 and the relatively lax fiscal stance that was taken after this. The US dynamic runs something like this,
1) In 2008 the US budget deficit opened up as the automatic stabilisers kicked in. But shortly after this, in 2009, the Obama administration launched an $831bn stimulus program.
2) This program added to the deficit in the coming years substantially over and above the effects that the automatic stabilisers had on the economy. The CBO estimates that 90% of the impact of the program had been felt by the end of 2011.
3) If we take the US Treasury’s measures of the deficit in these years we will see roughly how much the stimulus supplemented the automatic stabilisers. The Treasury measures were as follows:
2008 – $455bn
2009 – $1,417bn
2010 – $1,294bn
2011 – $1,299bn
2012 – $1,089bn
Now, if we follow the CBO and allow that 90% of the $831bn stimulus program had been spent by the end of 2011 this means that $748bn was spent in this period. Given that this was a three year period we can average out that the stimulus added around $249bn a year to the deficit. We can express how much the stimulus increased the deficit in each year in percentage terms as follows:
2008 – 0%
2009 – 17.6%
2010 – 19.2%
2011 – 19.2%
2012 – ?%
So, what does this tell us? Let’s think of it this way. The Spanish recession caused an endogenous increase in the deficit and then began to try to cut this same deficit. They failed. The endogenous deficit that was run in Spain was keeping the economy from falling into a protracted depression but it was not sufficient to return the economy to even modest growth.
In the US the endogenous deficit that opened up was supplemented by a stimulus program that added to this deficit by about 18% a year between 2009 and 2011. Thus on top of the endogenous deficit that we would have seen anyway — and which would have merely kept the economy from falling into a depression, as it did in Spain — the US added an extra 18% which gave the economy the momentum to return to modest growth. A good deal of this, as I said to Sadowski, was due to the impact this additional demand had on investment in those years which has almost recovered in the US to pre-2008 levels — see here.
Here is a nice way to think of this: automatic stabilisers will merely stabilise your economy. They will make up for the shortfall in demand to the extent that your economy will not fall into a total depression. But they need to be supplemented with stimulus to generate a cyclical upswing as we saw in the US. This explains why the US is experiencing modest growth right now while countries like Spain are stuck in a rut.
Update: It appears that the above post was incorrect in its assertion that there was no stimulus in Spain after the 2008 crisis. In fact, there was. I am currently addressing this in the comment section (see below) and will likely have some more posts on this in the coming days.
Update II: As promised here is the post exploring why the US stimulus worked where the Spanish stimulus did not.
“Here is a nice way to think of this: automatic stabilisers will merely stabilise your economy.”
That depends how they are designed. Half the problem we’ve had is that the auto-stabilisers put in place after WWII have been run down over time, so that they can barely stabilise the economy.
Crazy ideas like caps on welfare spending make it more likely that the auto-stabilisers will fail in the future.
As they did, if you think about it, during the boom times by failing to reign in private borrowing and spending on non-productive assets.
Ideally it should be the automatic stabilisers – both fiscal and monetary working on more than mere interest rates – that should do the heavy lifting and dampen the cycle. Preventing excess and cushioning failure.
Very likely that stabilisation function should be pulled out into a new government department that does nothing else other than operate the prescribed automatic stabilisers. That makes the function explicit and separate from anything else that the Treasury and Central bank decide to do.
If you do that then other discretionary elements are just redistribution and can be ‘balanced budget’ in design.
“For example, Sadowski is largely correct that Spain’s absolute fiscal stance is laxer than the fiscal stance in the US but in Spain’s case it is driven purely by the automatic stabilisers.”
Spain had a discretionary fiscal stimulus equal to 6.7% of GDP. Out of 43 announced stimuli packages as of March 2009 this was larger as a percent of GDP than any stimulus with the sole exception of China’s. By comparison the US discretionary fiscal stimulus was only 5.5% of GDP:
Click to access Fiscal_Stimulus_Plans.pdf
In short the whole premise of your post is completely wrong.
But even beyond that, this is not the correct way to measure fiscal policy stance because not every discretionary reduction in the fiscal balance is advertised as a “discretionary fiscal stimulus”. That’s why measures like the IMF’s Cyclically Adjusted Primary Balance (CAPB) are so useful.
I cannot source the figures in this paper. Can you please provide a link to an announcement by a government official stating the exact size of discretionary fiscal stimulus? I cannot find it anywhere.
Isabel Ortiz appears to have gotten the $113.3 billion total for Spain’s fiscal stimuli from the International Labor Organization (ILO). You can find a link to a Word document containing the ILO’s spreadsheet (which has additional details) here:
Note that the ILO took special care to exclude financial efforts (bank injections, buying assets, loan guarantees etc.) from fiscal efforts (public spending on goods and services, tax cuts, spending etc.).
That’s a pretty dodgy source. Everywhere I look I’m getting 40bn euros or 3.7% of GDP. See here:
Anyway, I think this can be accounted for by the fact that the downturn in Spain was far, far deeper than in the US. See:
The ILO is a United Nations (UN) agency and Dani Rodrik is a professor at the John F. Kennedy School of Government at Harvard University. It’s interesting what organizations and people you consider “dodgy” and “shabby” (e.g. the IMF).
The Wikipedia entry was unsourced. Thus I corrected it and cited the ILO/Rodrik spreadsheet mentioned above. It now reads 8.1% of GDP as that is the figure given by spreadsheet, and €90 billion ($113.37 billion) is in fact 8.1% of Spain’s 2008 GDP.
As for the BBC, popular media frequently makes mistakes. In this particular case there’s no possible way that Italy did a fiscal stimulus of €80 billion as the source you cite claims. The most I’ve seen mentioned by any reliable source is €5 billion.
Your graph of GDP compares nominal US GDP to real Spanish GDP, which only makes sense if your intention was to exagerate the decline in Spanish GDP relative to the decline in US GDP.
To make a consistent claim one should really compare nominal to nominal or real to real. In the 2008-09 recession real GDP declined by 4.3% in the US and by 5.0% in Spain from peak to trough, so there’s almost no difference:
More importantly, what is this supposed to explain about the size of Spain’s discretionary fiscal stimulus? It’s totally irrelevant.
Spain passed three large fiscal measures in 2008 to address the worsening state of its economy. By many accounts the third one alone, the Spanish Plan for Economic Stimulus and Employment (Plan E) contained measures totalling to €165 billion or over 15% of Spain’s 2008 GDP. Even totally excluding the financial efforts in these three measures, it’s very unlikely that the fiscal stimulus portion was anything less than €90 billion.
And in the final analysis, evidently you have now moved from debating the existence of Spain’s fiscal stimulus to debating its size. Your post clearly implies that Spain did not do a fiscal stimulus. At what point does a retraction occur?
P.S. Spain also has one of the weakest systems of automatic stabilizers in the European Union (EU), and by some estimates it is even weaker than the US system. How did the general government deficit soar by so much more in Spain than in the US between calendar years 2007 and 2009 (13.1% of GDP vs 10.3% of GDP according to the IMF) if the decline in GDP from peak to trough was so similar and Spain did not do a discretionary fiscal stimulus?
First of all, for the record, I still find those two measures dodgy. Why? Because estimates (remember we’re distinguishing between estimates and measures?) are based on a host of assumptions.
And as to the ILO link you are providing, it is an unpublished word document linked to on a blog — would I cite that in a study? No. Or at the very least I’d be clear about what I’m citing.
Onto the Spain vs. US issue. When you map the real GDPs we still see a substantial difference. See:
Indeed, we don’t see much difference between nominal and real in this regard. So, that’s not so much of a problem.
Were there other factors driving Spanish investment down that were not there in the US? Yes. And I think I could guess at what they were (i.e. the housing crash was larger). I will try to investigate these in the coming days. I took a glance just now and I think that my intuition was right.
But I have altered the above to say that there was a Spanish stimulus in 2008. I think that is beyond debate.
P.S. Your graph was off too. If you check you’ll see that you indexed the dates differently on the two measures. This actually makes no minor difference as you’ll see if you fix it. I guess we all make mistakes, eh?
“Were there other factors driving Spanish investment down that were not there in the US?”
How about much higher interest rates?
Well, perhaps, Philippe. But the case I’m trying to make is that interest rates didn’t play that large a role. If we do find that I can’t make a pure demand-driven argument then I’d assume that the fall had far more to do with uncertainty around bank bailouts than it had to do with interest rates.
“Your graph was off too. If you check you’ll see that you indexed the dates differently on the two measures. This actually makes no minor difference as you’ll see if you fix it. I guess we all make mistakes, eh?”
Um, I did it that way intentionally. They are indexed such that peak real GDP is 100. US real GDP peaked in 2007Q4 and Spanish real GDP peaked in 2008Q1.
In fact, if you do it on an annual basis, to make it a fair comparison you really should index US real GDP to 100 in 2007 and not 2008, since US real GDP peaked in 2007. On an annual basis US and Spanish real GDP declined by 3.1% and 3.8% peak to trough respectively:
Thus even on an annual basis the difference in the decline from peak to trough in real GDP is insignificant. This is even more the case when one considers the US decline occured over two years instead of just one. (To be excruciatingly clear, US potential real GDP likely grew by more over two years than Spanish potential real GDP grew in one.)
If I’m going to admit that I’m wrong I think you should probably do so too. Otherwise it comes off as slightly embarrassing….
I’d like to oblige you but I’ve got literally hundreds of FRED graphs where I index peaks exactly same way. See for example this one on nominal GDP for six EU members:
Or this one on employment in the US and the UK that I created only just yesterday:
Indexing peaks to 100 for each country makes assessing relative peak to trough declines a very simple matter. And thanks to FRED it’s incredibly easy to do.
And when you’ve got a large number of countries, each with different peak date, which country’s peak date are you going to say is more important than the others? Logically you could rank them according to size of the economy, but if you’re going to do it that way then a graph comparing annual real GDP should use 2007 for the US and Spain and not 2008:
Is that an improvement? Not in my opinion.
What I meant is that this graph gets basically the same result as the one I linked to a moment ago. The Spanish recession is clearly deeper by about one index point.
What’s more, the Spanish stimulus came online sooner. It was announced in November 2008 while the US stimulus was in February 2009. Plus the Spanish stimulus was spent over two years while the US stimulus was spent over one year. That means that the stimulus did more “propping up” in Spain than in the US which indicates that the Spanish recession was far deeper. I glanced at the fall in housing investment and it seems much more acute than in the US. I will do something on this in the next few days.
Measured on an annual basis, peak to trough real GDP declined by 3.1% in the US and 3.7% in Spain, so the US recession was 82% as deep as Spain’s. Measured on a quarterly basis, peak to trough real GDP declined by 4.3% in the US and 5.0% in Spain so the US recession was 86% as deep as Spain’s.
Both the US and Spain did more than one fiscal stimuli. Different institutional accountings include some and not others. Both the OECD and the IMF include the 2008 US fiscal stimulus which was signed into law in February 2008 and distributed as a tax rebate in 2008Q2.The ILO appears to be counting all of the fiscal stimuli that Spain enacted in 2008, whereas the IMF and the OECD do not.
As you apparently note, Spain’s Plan E started before the US’s ARRA but seems to have been almost entirely distributed over 2009 and 2010. ARRA funding started in March 2009 and evidently there are some programs which do not conclude until the end of the 2019 fiscal year. But according to the CBO’s most recent detailed estimates approximately 88% of ARRA was distributed in the 2009-11 fiscal years with 48% in the 2010 fiscal year alone. (US Federal fiscal years start on October 1.)
Hello, I’m a newcomer and have just discovered your excellent blog Pilkington. What NeilW said seemed to me much like Keynes’ split current and capital budget proposal in the early to mid 1940s. Stripped from nonsensical divisions, to have a public financed planned ahead budget of investments with social returns (in opposition to cash returns) over the long run to maintain full employment seems to me much more a “fiscal stimulus” than what we have seem lately. Current budget would operate more like what NeilW said about automatic stabilisers. That is, we could have a budget to be managed as a gatekeeper or as a floor beyond which income would not fall.
If “fiscal stimulus” is meant to stabilise the economy around the full employment, that is the way, in my view, fiscal stance should take. Meanwhile, it seems true that any demand that fills the gap between (full employment) income and expenditure might generate an “cyclical upswing” we know that this is also not enough to sustain full employment. In sum, more than “fiscal stimulus” we need a fiscal institutional framework designed to maintain full employment permanetly.