Keynesianism works in Australia

by John Quiggin on June 3, 2009

The economic crisis has, as we’ve been discussing, raised a lot of interest in Keynesian economics, but so far it’s been based more on the obvious bankruptcy of alternatives than on successful examples of Keynesian fiscal stimulus. Although there were some big financial bailouts late last year, few countries engaged in large-scale fiscal stimulus before the first few months of this year (Obama’s package was passed in February, and is only now being implemented, so we can’t expect to see evidence of impacts on GDP until late this year).

Australia went early and hard with a substantial cash handout to households in December 2008, followed by another round of cash stimulus delivered a month or two ago, and then a large-scale infrastructure program. The national accounts for the March quarter (which should include the effects of the first round of stimulus) have just come out, and show growth of 0.4 per cent, compared to a 0.6 per cent contraction in the December 2008 quarter[1]

On the face of it, this is a big success for Keynesian fiscal policy. And, there’s pretty general agreement that, despite some qualifications and plenty of concerns about the future, the prima facie interpretation is the correct one.

The outcome was helped by fortuitous growth in farm exports and by the fact that, since Australia doesn’t have much of a capital goods producing sector, declining investment is largely offset by declining imports of capital goods. But there is general agreement that the outcome would have been much worse without the stimulus.

The longer-term concerns are of two kinds. First, independent of Australia’s policy choices, there are more negative shocks to work their way through the economy. People are losing jobs, and that will translate into lower demand and weaker future growth. And the full impact of the slowdown in Asia hasn’t yet hit our commodity export sector, which has been relying to a fair extent on contracts signed in the good times. These concerns are significant, but don’t affect the argument that fiscal policy has been successful.

The second concern is that we may be buying short term relief at the expense of longer term pain. As regards the purely fiscal stimulus, this concern seems overstated. The government has announced a broadly feasible plan to return the budget to surplus as the economy recovers, though higher taxes will almost certainly be necessary. That presumably means a somewhat slower recovery, but the implied growth path looks a lot better than the one without fiscal stimulus.

The bigger concern relates to the housing market. Australia had as big a bubble as any country and, although prices have come back a bit, the bubble has definitely not burst. The government has used subsidies to prop up the bottom end of the market and these are to be phased out over the rest of this year. Since we never had really bad lending practices, households should be able to absorb a 20 per cent fall in prices reasonably well. But a bigger fall will cause trouble.

Overall, though, this is the first data point of the current crisis, as regards the effectiveness of Keynesian stimulus, and it is definitely a positive one.

fn1. Please ignore silly stuff about two negative quarters constituting an “official” recession. Also, these aren’t annualised in the way that is usually done in reporting US national accounts.

{ 18 comments }

1

Glen Tomkins 06.04.09 at 12:39 am

Good Luck!

I hope you folks aren’t too vulnerable to the shocks that are likely still to come from collapsing US markets, and the US real economy, because we almost certainly have further to fall.

2

P O'Neill 06.04.09 at 12:41 am

When is the Wall Street Journal editorial page apology coming?

3

StevenAttewell 06.04.09 at 2:40 am

Nicely done. Now all we need to do is replace the majority of U.S economists with Australian Keynesians, and we’re on our way…

4

engels 06.04.09 at 3:01 am

I propose an academic exchange: the AEA majority is shipped to Oz and fed to the crocodiles.

5

Neil 06.04.09 at 3:44 am

What have you got against crocodiles, Engels?

6

dsquared 06.04.09 at 6:37 am

Doesn’t this mean that “the great moderation” might be due for removal from the “discredited economic doctrines” list?

7

Kenny Easwaran 06.04.09 at 6:52 am

From your description it sounds like the only stimulus to arrive in time to affect the relevant quarter’s growth rates is the cash handout – and didn’t the US try that in April or May of last year? I seem to recall getting a $600 check from the government. But perhaps that came too early to have an effect at the relevant time, and I also don’t know the size of the Australian handout. (Speaking of which, since I was living and working in Australia in December of last year, is there any way that I should have gotten some of that cash?)

8

notsneaky 06.04.09 at 7:01 am

Hmmm, dsquared does make a good point here. If, what are essentially “consensus” (barring the usual suspects, and subject to the caveat that “consensus” in economics is always a lot less consensusy than in other endeavors) policy prescriptions are successful at counteracting a good chunk of the present crisis, then the whole idea of the “great moderation” is still not that far fetched, even in the light of recent events.
Or in other words, if the Australian experience shows what CAN happen with prudent policy making (assuming that it does in fact do this) then the end of the “great moderation” is not a failure of theory but of policy.

9

John Quiggin 06.04.09 at 8:18 am

On the Great Moderation, I don’t think it survives in the form it was presented. Here was my anticipation of this possible outcome in the original post

But even if the recession ends by mid-2009, as is suggested by some optimistic forecasters, crucial elements of the Great Moderation hypothesis have already been refuted. Over the period of the Great moderation, all the major components of aggregate output (consumption, investment and public spending) became more stable. By contrast, if a deep recession is avoided in 2009, this will be the result of a massive fiscal stimulus, with a huge increase in public expenditure (net of taxes) offsetting large reductions in private sector demand.

That still leaves open much weaker versions, like that of notsneaky. I’ll respond a bit more on that later.

Kenny, I think the stimulus last year had some effect – it dampened a recession that was already under way, but it had pretty much been exhausted by October 08, and then there was nothing for quite a while.

10

StevenAttewell 06.04.09 at 3:40 pm

Also, wasn’t the premise of the Great Moderation that the business cycle had been tamed by monetary policy, such that Keynesianism was no longer needed?

11

bob mcmanus 06.04.09 at 7:37 pm

10: Sort of. One thing that separates even (late?) Milton Friedman from his predecessors was the acceptance that gov’t had a role in macroeconomics and that monetary policy can and should be used to tame the business cycle and as counter-cyclical management. To a degree, Friedman was a Keynesian.

This post, or the Australisn experience, does seem to me to be evidence for Neo-Keynesianism, as I understand N-K. My impression was that temporary tax cuts or transfer payments had low multipliers and were relatively poor stimulus because consumers, knowing the measures were temporary, would save a larger proportion or repair balance sheets. This would be as compared to say infrastructure projects or measures like BI or ELR that would create changes in the MPC.

My most basic premise, and one I thought contradicted the N-K consensus, was the gov’t institutions, overt and permanent, provided the basic security and confidence needed for economic growth. A gov’t that taxed and then handed the checks to Goldman-Sachs, or taxed and passed the money to consumers. or cut taxes, would not really reduce perceived private risk and uncertainty.

12

cak 06.04.09 at 8:47 pm

How do we know the Australian economy wasn’t set to rebound before the stimulus? It seems the entire country was treated at the same time. I don’t see any convincing reason to believe the stimulus truly caused the economy to rebound based on the information that was provided. There may be more depth here than I realize but what I’ve seen thus far in the post is unsatisfying for the conclusion that is drawn.

13

John Quiggin 06.05.09 at 12:52 am

cak, you do understand what a data point is, don’t you?

14

cak 06.05.09 at 1:01 pm

Yes. What I can’t get my hands around is how to measure the causal effect of fiscal policy when we lack the counter-factual state of the world without the fiscal policy. From my point of view there is no way to tell, based on one data point, whether the policy was a success or failure.

15

john c. halasz 06.05.09 at 9:31 pm

16

John Quiggin 06.05.09 at 10:53 pm

Umm … the linked claim regarding imports neglects the fact that the decline in imports matches a decline in investment. If you want to ignore one you should ignore the other. And the post notes the point about long-term contracts.

17

John Quiggin 06.06.09 at 12:40 am

18

Jock Bowden 06.07.09 at 8:33 am

I think it is pretty safe to say that without the dominance of monetary policy in Australia over the past 15 years, and the huge Howard/Costello budget surpluses, Australia would be in a far less fortunate position , similar to its peers.

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