World Bank and the Ricardian Confusion

Yifu Lin came out to explain away the confusion. Only he didn’t:

I have no disagreement with Paul about the possibility of an expansionary effect of a temporary fiscal stimulus. But if the effect exists and the stimulus does not increase productivity as in his example, there will also be a contractionary effect after the exit of stimulus and the increase of tax to retire the public debts. At the end the issue of underutilization of capacity, which my paper attempts to address, will still be there.

The problem with this reasoning is that it ignores the fact that in a liquidity trap, people are saving excessively in order to hold higher-quality assets, due to the lacking of investment opportunity in a slump. The role of fiscal policy is two-fold: 1) to prevent further economic downturn by providing money; and 2) to provide investment opportunities by investing in the economy, so people would stop saving and return to investing. The US stimulus fell short of the second goal because it was nowhere enough to allow the US to get out of that liquidity trap.

Once the economy is out of the liquidity trap, i.e. people are making investment, then the stimulus can be withdrawn gradually. The withdrawal won’t have a large contractionary effect because private investment are beginning to fill the hole now, and a graduate withdrawal will hamper the effect even more.

Public debt is an important issue but what we have to worry now is high unemployment and slow growth, and these two factors contribute to the debt problem by reducing tax revenue. High employment also means less consumption and less productivity and that will only postpone recovery and reduce private investment. Debts can be paid for by growth. The better solution is to utilize Special Draw Rights, and establishing an international debt management regime to write down or rollover the debts for some countries (which was supposed to be IMF’s raison d’être), and not to reduce a countries capacity to employ fiscal policy, like what the ECB is asking for.

That said, I have no quarrel with Lin’s point about investing in ‘bottleneck-releasing productivity-enhancing and self liquidating instead of “digging a hole and paving a hole”’. That is indeed what we should do, as it will bring , especially when we are investing in clean technology, social and human capital. It is just that when the World Bank is voicing concerns about the effectiveness of fiscal policy and using the Ricardian equivalence as support, it is not giving a lot of confidence to the public and policy makers about Keynesian economics. Lin’s message is unclear, and unclear message at this stage will hinder the recovery of the global economy, as it does nothing to break the neo-liberal stranglehold.

http://wp.me/pXZbk-au

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