Needed: Steady Hand on the Tiller

At the APEC meeting in Peru on November 23, Stephen Harper said "it may well be necessary to take unprecedented fiscal stimulus." This seemed to signal a change from his repeated statements that the economy was fine and a stimulus was not needed. Then on November 28, in the economic update, he did an about-face and said that stimulus was not needed; avoiding a deficit was all-important; and he was announcing $4.3B in cutbacks for 2009. That statement also made the bizarre and surely unsupportable prediction that the government would have a surplus in 2008 and 2009.

In the week following the economic update, Canada's non-partisan pre-eminent political news outlet, the Hill Times, speculated whether Harper was mentally unbalanced.

The erratic behavior of our government is not easing. Today our prime minister said on TV that we may be heading into a depression (not just a recession), and he promised a huge fiscal stimulus. Meanwhile, cabinet ministers are all over the map giving confusing and confused signals. Industry Minister Tony Clement said it was important to move fast. Finance Minister Jim Flaherty said it was important to move slow.

As any first year Economics student should know, economic behavior is based on expectations, and expectations depend on confidence. Particularly in times of economic vulnerability, we need confidence that the government knows what it's doing and is on the right track. These flipflops and wild-ass statements are hurting the economy, and so are jeopardizing the lives and prosperity of Canadians.

It's not just that there is no consistency in policy. It's also that the government is exposing its fundamental ignorance of how the economy works. In times of recession when interest rates are already low, a fiscal stimulus package reduces the budget deficit while budget cutbacks increase the deficit. This is a well-known phenomenon (link, link).

To be effective, the fiscal stimulus must start early in the downturn. The longer the government delays, the worse the recession will be.

Furthermore, during a downturn you can't hurt by over-stimulating. You can only hurt by under-stimulating. As Nobel laureate Paul Krugman says, "if fiscal expansion is too little, that’s the end of the story. If it’s too much, the Fed can head off inflation by raising rates. ...we should err on the side of too much." (In another post, he gives back-of-envelope math for how to calculate how big the stimulus should be.) After the economic downturn, we need to worry about inflation: not now. Now we need fiscal stimulus: a lot, and quickly.

There are all kinds of arguments for and against every type of stimulus. Some arguments are valid and some are disingenuous. It's valid to worry about infrastructure projects that have a long lag time: they won't provide stimulus when it's needed and may even cause inflation after the downturn. But it's not so valid to worry about whether consumers spend or save a cash rebate. If they save it, the stimulus effect is not not negated but merely delayed (if they pay off credit card debt today, they'll be freer to spend in a month or two), and since rebates are a very fast stimulus method, even a delay might still be faster than other sorts of spending.

None of this is rocket science. Every international economic organization and every western country has figured it out and has implemented stimulus packages: every country but Canada. Harper and Flaherty, with their vast civil service full of economists, could surely create a coherent economic policy. The fact that they're not doing that seems to be due to the PM's obsession with political one-upmanship and ideology. He's so busy trying to bankrupt the Liberal party that he's bankrupting Canada. And maybe there's something to the notion that he's mentally unbalanced, too.

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