The case for (small) Canadian fiscal stimulus

Saturos asked me to comment on a Nick Rowe comment on a Stephen Gordon post:

Saturos: the Sumner Critique (that if the central bank is serious about targeting inflation or NGDP then monetary policy is all that’s needed and the central bank will offset any change in fiscal policy so the fiscal multiplier is zero) is probably correct, in my view. But “probably” isn’t always good enough. If the downside risk is big enough, and fiscal ammunition is cheap enough, there is a lot to be said for giving the bear both barrels at once, just to be sure it’s dead, even if you think the monetary barrel is probably all that’s needed. And in Canada, unlike the US, the Federal debt/GDP ratio was low and falling going into the recession, and there was no “structural” (in the political sense of “structural” — i.e. deep-seated) deficit. So fiscal ammunition was cheap. We were going to need to loosen fiscal policy eventually anyhow, to prevent the debt/GDP ratio going negative. 2008 seemed like a good time to do some of that loosening, on micro grounds as well.

I end up in roughly the same place as Nick, but from a slightly different direction.  Let’s start with the fact that if you are ever in a situation in the US where it looks like fiscal stimulus may be helpful, then you aren’t doing NGDP futures targeting.  I favor a policy where the one year  (or perhaps two year) forward NGDP level is always expected to be right on target.  In that sort of world no one would ever even suggest fiscal stimulus.  What would be the point?  The reason people have recently suggested fiscal stimulus is that they (quite rightly) saw that one year forward NGDP was likely to be far below the policy goal.

Of course (contrary to the pesky blogger “Unlearningecon”) the Sumner critique applies equally well to cases of full employment and less than full employment.  All that matters is that the central bank is targeting AD, whether via the Taylor rule, inflation targeting, or NGDP targeting.  The target may be too low, but if there is any target then fiscal stimulus won’t boost AD.

However, for smallish open economies like Canada you could argue that the global recession was a sort of real shock, which might mean that NGDP targeting is not enough.  I find many people are confused about this issue, so let’s start with a simple example of a big global recession that is 100% caused by a negative nominal shock combined with sticky wages.  Now take a tiny country that only produces one good, windshield wipers.  It will see a huge drop in demand for its exports.  And more importantly, even though the global recession is (by assumption) 100% due to sticky wages, no amount of wage cuts in that small economy will prop up the windshield wiper industry, as this product is basically useless  except as an input into car production.  Even if you reduced windshield wiper prices to zero, it wouldn’t reduce car prices enough to materially impact car sales.  This country will suffer a real recession of high unemployment regardless of its demand policy.  Windshield workers must be retrained to do other jobs.

Of course Canada isn’t exactly a small country, but that thought experiment does have some bearing on the Canadian experience, particularly in the manufacturing heartland of Ontario where there are many factories closely tied to US industries like autos.  People often say “if the US catches a cold, Canada gets pneumonia.”  Actually the reverse is true.  We caught pneumonia and Canada got a cold.

Since Canada was hit by a global real shock, one can argue that some fiscal stimulus was justified.  The shadow price of labor would fall with higher unemployment, and of course global real interest rates also fell sharply.  It’s a good time for Canada to build some infrastructure.  Of course it’s also a good time to build some private housing, and NGDP targeting makes that happen.

Does this argument apply to the US?  Not quite.  In Canada it’s quite possible that mild fiscal stimulus was the optimal policy.  Not so for the US.

First a brief digression.  The actual name of China is not “China,” it’s “the central country.”  That’s the translation of its Chinese name.  Today America is the central country (but not for much longer.)  In America the optimal policy is never fiscal stimulus.  Our optimal AD policy is NGDP targeting, and if we do that then any global problems will have an insignificant effect on our macroeconomy.  Remember the recession of 1997-98?  I don’t either.

Our obnoxious national arrogance is at least slightly justified—we really are the center of the world economy.

PS.  I’ve always wondered about country names.  Why is it that weak countries like Myanmar, Sri Lanka, and Cote D’Ivoire can force us to call them by weird names, but powerful countries like Zhongguo and Deutschland are not able to do so?  If Germany agrees to a bailout of the PIIGS, then they should demand to be called ‘Deutschland’ in the future.  And we should all be willing to appease them.



23 Responses to “The case for (small) Canadian fiscal stimulus”

  1. Gravatar of Tomasz Wegrzanowski Tomasz Wegrzanowski
    3. June 2012 at 10:32

    Frequently used words change more slowly than infrequently used words.

    Just like most common verbs stay in their old irregular forms, commonly used country names will keep whichever name they took first.

    It’s not about power – if you had some nearby tiny country, it would keep its irregular name. European languages all renamed Ceylon to Sri Lanka, but keep calling their neighbours with funny medieval names.

  2. Gravatar of Saturos Saturos
    3. June 2012 at 11:28

    So this is the old supply-side argument for infrastructure spending – what Nick called “micro reasons”. Of course that argument is only valid as long as rates and labor costs remain low. But governments have trouble pulling out of their commitments…

    I think the fact that our names are public property rather than private idiosyncracies is itself a testament to our influence. English is the dominant language, not because we dictate how it should be used but because everyone has been willing and able to appropriate its use in their own way.

  3. Gravatar of J.V. Dubois J.V. Dubois
    3. June 2012 at 11:29

    This is why I like to read Market Monetarist blogs. They seem to present a contrary argument and even defend it if it makes sense.

    Anyways I still have my doubts about your cure for the windshield economy. I still do not see the reason why fiscal stimulus is better here (in supply side recession). Is it that you see government as more suitable for changing the skillset of the workers compared to private sector? I could understand this argument in a different light – such as starting projects that can be more advantageous due to current circumstances (governent bonds cheap etc.) which can be quite different for small country with supply problems (or problems that seem to be supply-side). But it is very different from concept of fiscal policy being actually responsible for aggregate demand.

    This kinds of interest me as I live in Slovakia which is a very small and very open country where the large part of economy is focused on production of cars (and other sub-components) . If global/european car sales tank would you really suggest using fiscal stimulus in my country? If Euro gives you trouble while thinking about this, think about some other small countries with their own currency like Czech Republic or Hungary. I would really love to see your response. Thanks.

  4. Gravatar of Mike Sax Mike Sax
    3. June 2012 at 11:36

    “If Germany agrees to a bailout of the PIIGS, then they should demand to be called ‘Deutschland’ in the future. And we should all be willing to appease them.”

    If they do I’Ll go all the way: “Deutschland, Deusthcland, Uber Allies!”

  5. Gravatar of Mike Sax Mike Sax
    3. June 2012 at 11:37

    However to take an outlier, does the Sumner Critiqute apply if Mariner Eccles is the Fed Chairman?

  6. Gravatar of Saturos Saturos
    3. June 2012 at 11:38

    Actually, I think Nick’s point is that he’s still not 100% sure that central banks can always hit NGDP targets, in which case fiscal policy boosts velocity where monetary policy can’t (but the central bank does want higher NGDP). He probably thinks it’s wise not to have too much faith in one theory as long as it hasn’t actually been implemented yet.

  7. Gravatar of Negation of Ideology Negation of Ideology
    3. June 2012 at 11:40

    I think the case for fiscal stimulus is stronger at lower levels of government debt relative to the monetary base. I can imagine a country with zero or very low federal debt, and a central bank that owns most or all federal backed loans, plus most or all state and local debt, resorting to fiscal stimulus to avoid having to buy private debt. Then it could borrow from the central bank to cover the deficit.

    With publicly held debt in the US around $10 Trillion and a monetary base around $3 Trillion I don’t see a strong case for fiscal stimulus. There’s another $3 Trillion in state and local debt, plus well over a trillion doallrs in federally guaranteed loans if we run out of Treasuries to buy.

    If the monetary base gets up to $14 Trillion or so and NGDP is still below trend then maybe we should start talking about fiscal stimulus.

  8. Gravatar of J.V. Dubois J.V. Dubois
    3. June 2012 at 11:42

    I would just add – there is a lot of literature where they tried to measure the impact of the fiscal stimulus. Basically there are two factors that push fiscal stimulus into the negative area (besides Sumner Critique) – flexible exchange rates and open economy that cause leaks in the stimulus. See here for instance: That is contrary to what you say in this article (that USA is in bad position for fiscal stimulus)

    But then you talk about supply-side recession so I am not sure here as on the other hand you ended up with policy recommendations for USA dealing with demand recession.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    3. June 2012 at 12:51

    “If Germany agrees to a bailout of the PIIGS, then they should demand to be called ‘Deutschland’ in the future. And we should all be willing to appease them.”

    In Poland, Germany is called Niemcy, which loosely translates as “Dumbland” (as in “mute”).

    If Germany agrees to a treaty barring them from seeking reparations for lands seized following a war of total destruction and extermination that they started, then I suppose Poles may consider referring to their neighbor by a somewhat more flattering term.,1518,445513,00.html

  10. Gravatar of Rajat Rajat
    3. June 2012 at 13:01

    Australia tried doubled-barrel stimulus in 2009 and ended up with a lot of over-priced school halls and ‘COLAs’ (covered outdoor learning areas). Out of $A16bn spent, at least one-third was wasted (buildings built for government schools cost 50% more than the same buildings built for private schools, who exercise more autonomous decision-making), and that’s before you ask whether school halls were the best use of resources at the time. As you suggest, private housing would have been a better use of funds, but an incipient house building recovery was crowded out by the RBA’s rate rises in late 2009 and early 2010.

  11. Gravatar of ssumner ssumner
    3. June 2012 at 13:33

    Tomasz, That makes sense.

    Saturos, Yes, and as said I don’t think this argument applies to the US.

    JV, No, I think you misunderstood me. I oppose using fiscal policy to boost AD under any circumstances, even in Canada. I’m just suggesting that there might be a few more projects that pass cost/benefit during a recession.

    It might make sense for Slovakia to do a bit more road construction during recessions, and less during booms. Of course that assumes they can time these things properly, which is also doubtful. Most governments do the opposite–spending more in booms.

    Mike Sax, Not if he’s pegging the gold ratio, (which is roughly what he was doing.)

    Saturos, I’m also not 100% sure they can hit NGDP targets, but that doesn’t matter. I am 100% sure that they can hit expected NGDP targets, and if expected NGDP is on target, why do fiscal stimulus?

    Negation, That seems reasonable.

    JV, The lower effectiveness of fiscal stimulus under flexible rates is a prediction of the Sumner Critique, I’ve made that observation before, and it is supported by the data. In order for a central bank to target any nominal aggregate you must have flexible rates.

    Mark, Glad to hear that. But I’d guess that’s just a symbolic issue.

    Rajat, Sounds like the Aussie fiscal stimulus was not needed, and they weren’t even at the zero bound for interest rates, so even Krugman would have opposed it.

  12. Gravatar of Michael Michael
    3. June 2012 at 13:45

    Re: the country names, power factors into it. Weak countries aren’t forcing name changes on us; there’s a segment of US society that seeks to demonstrate moral worthiness by sticking up for groups too weak to stick up for themselves. It’s not possible for Americans to show sensitivity on behalf of the Germans.

    Interestingly, on this analyis, China seems to have spent some time on the other side of the line, when their capital city’s English name was changed from Peking to Beijing.

  13. Gravatar of kebko kebko
    3. June 2012 at 14:01

    The problem comes when public opinion and special interests inevitably converge on the form of stimulus: public support of windshield wiper production.

  14. Gravatar of marcus nunes marcus nunes
    3. June 2012 at 14:21

    The “Tug of war” between those that say “cut” and those that say “Rev up”:

  15. Gravatar of Alan Cole Alan Cole
    3. June 2012 at 20:20

    “If Germany agrees to a bailout of the PIIGS, then they should demand to be called ‘Deutschland’ in the future. And we should all be willing to appease them.”

    What is the historical track record on appeasing Deutschland?

  16. Gravatar of Philo Philo
    3. June 2012 at 21:09

    You write: “It’s a good time for Canada to build some infrastructure. Of course it’s also a good time to build some private housing, and NGDP targeting makes that happen.” And, by the same token, you must think it would also be a good time to start building some industries other than windshield wipers (more generally, auto parts), especially industries that wouldn’t require a lot of long-lived capital investment (which would eventually–when conditions returned to normal–turn out to be somewhat *mal*investment); and NGDP targeting would also make this happen. In the comments, you add: “I’m just suggesting that there might be a few more projects that pass cost/benefit during a recession.” I think you mean that the lower real interest rate would make all sorts of projects attractive that wouldn’t normally be so, *provided our expectations about the future returns to these projects remained what they are in normal times*.

    But doesn’t the lower real interest rate reflect increased pessimism””lowered expectations–about the productivity of investment, so that these projects may not really be more attractive in spite of the lower real interest rate?

  17. Gravatar of Saturos Saturos
    3. June 2012 at 22:47

    Rajat, don’t forget the pink batts…

  18. Gravatar of Rajat Rajat
    4. June 2012 at 03:05

    Saturnos, indeed!

  19. Gravatar of Bill Woolsey Bill Woolsey
    4. June 2012 at 04:19

    In your window wiper story, it is a sectoral shock.

    Now, if Canada only produced windshield wipers and all windshield wiper producers were in Canada, and imported everything, then futile efforts to keep nominal GDP on target imply infinite import prices and zero export prices for the foreigners.

    As you mentioned, as the price of imported windshield wipers for the foreigners fall, even to zero, this only results in a small increase in quantity demanded.

    So, what happens? As the prices of imports approach infinity, then the first guy who produces an import competing good makes up the entire shortfall of nominal GDP (and with high enough import prices–then some.)

    Realistically, if there is any import competing industry at all, then those prices rise enough to offset the decease in the real volume of windshield wiper production.

    The signal and incentive is to expand import competing output and other export goods too. If there are none ,starting new ones is very profitable. Since those new ones will be ones where you will be taking market share from foreign producers, you don’t have the situation where you already dominate the industry.

    Anyway, what really happens then is that you get a contraction in the windshield wiper industry, and expansions in other industries. Because of the difficulty of expanding output and employement quickly, real output falls, the price level of domestic output rises (of the import competing industries even for export industries with more elastic demands.

    Still, you end up with some booming industries and other contracting industries. It is a sectoral shift problem.

    And, of course, if you want to protect your exchange rate, then you are blocking the adjustment process.

  20. Gravatar of ssumner ssumner
    4. June 2012 at 06:03

    Michael, Yes, I thought of the capital city names changing–same for Bombay.

    kebko, Good point.

    Marcus, Yes, I just laugh when I see regressions like that.

    Alan, That was a joke.

    Philo, I mostly agree, but the lower rate may reflect global pessimism, that is unrelated to the small country (which is assumed to have good NGDP policy.)

    Bill, You said;

    “Anyway, what really happens then is that you get a contraction in the windshield wiper industry, and expansions in other industries. Because of the difficulty of expanding output and employement quickly, real output falls, the price level of domestic output rises (of the import competing industries even for export industries with more elastic demands.”

    Yup, that’s my argument in a nutshell.

  21. Gravatar of OneEyedMan OneEyedMan
    4. June 2012 at 08:20

    When a country is important enough that everyone talks about it is needs a name that everyone can pronounce. When only elites and specialists refer to a country any naming convention can be sustained.

  22. Gravatar of Saturos Saturos
    4. June 2012 at 09:26

    Oh yeah, I forgot to make my main point here: what Scott advocates here shouldn’t really be called “stimulus” at all. It’s an increase in deficit spending, but not for the purpose of raising AD.

  23. Gravatar of ssumner ssumner
    5. June 2012 at 12:38

    I agree with both of you

Leave a Reply