Friday, January 02, 2009

Fiscal Stimulus Part 2: Size

According to the Financial Times, the IMF is recommending that fiscal stimulus should be 5-6% of GDP. In other places the IMF has said they recommend 2%, so there is some confusion: perhaps the smaller figure means that the combined stimulus of all developed countries should be 2% of global GDP.

Some other recommendations:

- Paul Krugman estimated that the US needs a package of about 4% of GDP; that was back on November 10, and things have gone way downhill since then.
- Barack Obama's proposed two-year US$700B stimulus package works out to about 2.5% of US GDP (on top of previous stimulus).
- China is planning a $586 billion stimulus package, which is about 6 per cent of its GDP.
- Germany and Britain are each proposing stimulus packages that are about 1% of their GDP.
- The Canadian Centre for Policy Alternatives is calling for a 2% stimulus package (about $32B).
- The Conference Board of Canada recommends a $13 billion stimulus package.

Five to six percent of Canadian GDP is $65B-$96B, depending on how you measure GDP. That puts Curiosity Cat's recommendation of $80B right in the middle of the range.

Paul Krugman argues that the fiscal stimulus package must be big:
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. So there’s an asymmetry. In reality, we can’t be sure how much bang we’ll get for the buck. What the asymmetry means is that we should err on the side of too much.

Or as IMF Economic Counsellor Olivier Blanchard said recently:
In normal times, the Fund would indeed be recommending to many countries that they reduce their budget deficit and their public debt. But these are not normal times, and the balance of risks today is very different.

If no fiscal stimulus is implemented, then demand may continue to fall. And with it, we may see some of the vicious cycles we have seen in the past: deflation and liquidity traps, expectations becoming more and more pessimistic and, as a result, a deeper and deeper recession. If, instead, a fiscal stimulus is implemented but proves unnecessary, the risk is that the economy recovers too fast. Surely, this risk is easier to control than the risk of an ever deepening recession.

I would put it even more starkly. What is needed is not only a fiscal stimulus now but a commitment by governments that they will follow whatever policies it takes to avoid a repeat of a Great Depression scenario. If they do so, the fear that people and firms have today will fade, and demand will pick up.

See also: Fiscal Stimulus Part 1

No comments: