Stimulus will Be Testing Ground for Theories

One thing that I have noticed among professional economists is that the ongoing recession and perhaps the oncoming depression has taken away the possibility of ideological neutrality. Again, while I am not a citizen of the US, it is noticeable that the more reasonable blog writers are debating what the administration of the incumbent could have done differently while debating whether president-elect Obama will have more or less options.

In the view of a number of respectable economists, the main argument is whether a recession such as is being faced by most of the large economies in the world today has obvious policy remedies. For instance, the economists that conventionally favor government intervention would argue for the government to institute a large stimulus package to get consumption going and avoid more job losses than would otherwise occur. In opposition to these Keynesians are the monetarists who maintain that the most appropriate approach is to concentrate on reducing taxes further in order to enable banks to lend to entrepreneurs who may then spur economic activity. In the view of the monetarists, the failure of the present businesses or banks should not be used for more intervention than is required.

Going back to the US, it is clear that in spite of his conservative orientation, president Bush and policy advisers designed the large plan totalling US$ 700 billion to cushion banks from further collapse. There's much to say for the design and the size of the package as the numbers are not informed by any scientific rule. To a large extent, the Treasury and the Federal Reserve Bankers are making educated guesses about what is required. In spite of this, it is clear that this is hardly enough and the incoming administration is arguing for a proper stimulus plan in order to forestall catastrophic contraction and job losses. The Obama team is defining this as a programme designed in the fashion of the New Deal that was put together by president Roosevelt.

Judging from the press, a number of economists who are possibly market purists keep arguing that the New deal was not only a waste of public resources but also harmful overall. William Anderson's post on the Foundation for Economic Education's site here sets out the arguments. In fairness though, there are also professional economists such as Martin Feldstein who advised President Reagan who favour a measure of government intervention today. As stated in this story, the conventional narrative has been adjusted and it appears that public spending in tandem with tax cuts is considered a reasonable response for the moment.

While my orientation id decidedly libertarian on many issues, I think that Keynesian response is reasonable in light of the fact that there's been a significant reduction in employment and that contraction of the economy is clearly evident. In spite of this, I am less clear what the size of the stimulus ought to be but agree with Paul Krugman in the statement that it would be better to err on the side of a larger rather than a smaller one. He explains the stimulus arithmetic on his blog post here.

Finally, one of the positive things that emerges is that the arguments are well-placed and the policy responses properly debated. this means that the major economies are now a virtual laboratory for testing the ideas and to help in resolving the arguments when the expected results show. All we can do is wait and see whether the pure monetarists are vindicated. Teachers and students of macroeconomic theory will greatly benefit from this.