Monday, April 21, 2014
Exit from comment view mode. Click to hide this space

Why Stimulus Has Failed

NEW DELHI – Two fundamental beliefs have driven economic policy around the world in recent years. The first is that the world suffers from a shortage of aggregate demand relative to supply; the second is that monetary and fiscal stimulus will close the gap.

Is it possible that the diagnosis is right, but that the remedy is wrong? That would explain why we have made little headway so far in restoring growth to pre-crisis levels. And it would also indicate that we must rethink our remedies.

High levels of involuntary unemployment throughout the advanced economies suggest that demand lags behind potential supply. While unemployment is significantly higher in sectors that were booming before the crisis, such as construction in the United States, it is more widespread, underpinning the view that greater demand is necessary to restore full employment.

Policymakers initially resorted to government spending and low interest rates to boost demand. As government debt has ballooned and policy interest rates have hit rock bottom, central banks have focused on increasingly innovative policy to boost demand. Yet growth continues to be painfully slow. Why?

What if the problem is the assumption that all demand is created equal? We know that pre-crisis demand was boosted by massive amounts of borrowing. When borrowing becomes easier, it is not the well-to-do, whose spending is not constrained by their incomes, who increase their consumption; rather, the increase comes from poorer and younger families whose needs and dreams far outpace their incomes. Their needs can be different from those of the rich.

Moreover, the goods that are easiest to buy are those that are easy to post as collateral – houses and cars, rather than perishables. And rising house prices in some regions make it easier to borrow even more to spend on other daily needs such as diapers and baby food.

The point is that debt-fueled demand emanates from particular households in particular regions for particular goods. While it catalyzes a more generalized demand – the elderly plumber who works longer hours in the boom spends more on his stamp collection – it is not unreasonable to believe that much of debt-fueled demand is more focused. So, as lending dries up, borrowing households can no longer spend, and demand for certain goods changes disproportionately, especially in areas that boomed earlier.

Of course, the effects spread through the economy – as demand for cars falls, demand for steel also falls, and steel workers are laid off. But unemployment is most pronounced in the construction and automobile sectors, or in regions where house prices rose particularly rapidly.

It is easy to see why a general stimulus to demand, such as a cut in payroll taxes, may be ineffective in restoring the economy to full employment. The general stimulus goes to everyone, not just the former borrowers. And everyone’s spending patterns differ – the older, wealthier household buys jewelry from Tiffany, rather than a car from General Motors. And even the former borrowers are unlikely to use their stimulus money to pay for more housing – they have soured on the dreams that housing held out.

Indeed, because the pattern of demand that is expressible has shifted with the change in access to borrowing, the pace at which the economy can grow without inflation may also fall. With too many construction workers and too few jewelers, greater demand may result in higher jewelry prices rather than more output.

Put differently, the bust that follows years of a debt-fueled boom leaves behind an economy that supplies too much of the wrong kind of good relative to the changed demand. Unlike a normal cyclical recession, in which demand falls across the board and recovery requires merely rehiring laid-off workers to resume their old jobs, economic recovery following a lending bust typically requires workers to move across industries and to new locations.

There is thus a subtle but important difference between my debt-driven demand view and the neo-Keynesian explanation that deleveraging (saving by chastened borrowers) or debt overhang (the inability of debt-laden borrowers to spend) is responsible for slow post-crisis growth. Both views accept that the central source of weak aggregate demand is the disappearance of demand from former borrowers. But they differ on solutions.

The neo-Keynesian economist wants to boost demand generally. But if we believe that debt-driven demand is different, demand stimulus will at best be a palliative. Writing down former borrowers’ debt may be slightly more effective in producing the old pattern of demand, but it will probably not restore it to the pre-crisis level. In any case, do we really want the former borrowers to borrow themselves into trouble again?

The only sustainable solution is to allow the supply side to adjust to more normal and sustainable sources of demand – to ease the way for construction workers and autoworkers to retrain for faster-growing industries. The worst thing that governments can do is to stand in the way by propping up unviable firms or by sustaining demand in unviable industries through easy credit.

Supply-side adjustments take time, and, after five years of recession, economies have made some headway. But continued misdiagnosis will have lasting effects. The advanced countries will spend decades working off high public-debt loads, while their central banks will have to unwind bloated balance sheets and back off from promises of support that markets have come to rely on.

Frighteningly, the new Japanese government is still trying to deal with the aftermath of the country’s two-decade-old property bust. One can only hope that it will not indulge in more of the kind of spending that already has proven so ineffective – and that has left Japan with the highest debt burden (around 230% of GDP) in the OECD. Unfortunately, history provides little cause for optimism.

Exit from comment view mode. Click to hide this space
Hide Comments Hide Comments Read Comments (30)

Please login or register to post a comment

  1. CommentedDallas Weaver, Ph.D.

    There are many moving parts and what the government does for stimulus is only one. The government is also busy preventing jobs from being created while benefiting the highly educated government employees.

    It must be kept in mind that the "median" worker is a high school educated individual closer to the bottom level of graduates than the top.  This individual had a very inferior and limited education.  The types of jobs suitable for someone not in the educated elite usually require physically doing something like building, maintaining non-virtual things (example, construction work).  However, any new jobs of this sort generally require  approval, permits, permissions, etc. from many bureaucrats among the educated elite of our society.  These elite decision making bureaucrats  have a self-interest in delaying,  not approving, a project.  Giving an approval could eliminate their job demand.  For a bureaucrat, a full in-box means full employment and power over supplicants.

    An excellent example is the proposed 50 million gallon per day desalinization plant in water-short Huntington Beach, California.  To date, the employment generated by this project has been limited to hundreds of the educated elite of our society as PR agents, lawyers, planners, politicians, commissioners,  EIR experts, bureaucrats, etc. over the last ten year trying to get through the permit maze in order to actually build and operate the facility on an industrial site presently occupied by unused and unsightly oil tanks.  Hundreds of "median" workers will be required to build and maintain the facility, but they won't get those jobs until the project is approved by bureaucrats who have already spent a decade bleeding money out of the project for their salaries and show little signs of getting off the desalination project teat. 

    Another example would be 10,000+ direct jobs that could be available in So. California, if  regulators permitted offshore aquaculture to produce fish/shellfish to feed the 30 million people in the local area.  These additional jobs for the less educated "median" worker created by modern technological advancements in aquaculture have been prevented by the self-interest of the educated elite bureaucratic, political and activist communities.  Much of this technology has been developed in the US, but is being forced offshore by our regulators denying/delaying applications of the technology north of the border. 

    Our regulatory system is preventing the application of technology invented in this country from creating the jobs for the "median" worker.   We  have the innovation to create jobs, but can't get permits, approvals, etc.    Unfortunately until something becomes a profitable industry, truly innovative ideas typically lack the political power or ability to force bureaucrats to do their jobs or to eliminate opposition by activists or existing economic interests who will be harmed (put out of business) by the innovation.  Imagine getting permits for a new innovative chemical production facility using new process technology in today's regulatory environment.  You can't prove that something new is zero risk, and all the existing producers and bureaucrats will have "concerns" about unknowns, so the project will end up in China.   

    Permit and regulatory times for most projects are much longer than the construction times.  Given that construction workers (median workers) currently have a double digit unemployment rate, simply cutting the bureaucratic backlog would solve a lot of our jobs problem.  Just a 10% per year decrease in regulatory delay times could drop construction labor unemployment by over 10% (when regulatory delays are longer than construction time) and create full employment in this sector.

    Perhaps it's time to take an obverse approach to Nancy Reagan's dictum:  "Just Say Yes."

  2. CommentedTom Shillock

    If most of the gains in GDP since 1980 had not been skewed to the upper 1 percent then the rest of society would have provided demand sufficient to spur normal growth. Lack of demand resulted from lack of income or access to cheap money. Greenspan and Bernanke knew that the lower orders lacked the income to increase demand so they reduced interest rates and encouraged a debt fueled stimulus bubble. A monetary distortion was used to temporarily offset the effects of a fiscal distortion that had been underway since 1980. If one ignores this history as Rajan does then one ends up posing a myopic issue.

  3. CommentedGanesan Srinivasan

    There is considerable evidence on mismatch of skills to fill increasingly technically oriented jobs. Retraining of workers is often easier said than done. Also ontributing to this quandry is that universities graduate so many students in soft skill majors, who then find it difficult to land jobs in an increasingly technical environment. There needs to be a complete rethink of the the education / training / retraining policies that will hopefully lessen the harsh impact of these type of recessions in the future.

  4. Commentedananda gundurao

    I wonder why a stimulus has necessarily to be govt driver; govt, insteady can draw people out to spend by creating capacity for such expenditure. For example, India has a huge demand for housing; but most people can not afford to buy house in urban areas. The govt is the biggest land holder. Today, land cost is major component of housing cost. Govt might as well lease land on a nominal price to apartment owners, creat large scale housing in the affordable range of 400 to 700 sq ft and allot it to salary earners and small business people over 25 to 30 years of EMI. this housing can be high quality, with necessary infrastructure thrown in and built through professional construction companies. We can easily absorb few million houses for a decade. This can generate huge demand, tax collection and related multiplier effect of employment generation.

  5. CommentedPatricia Flanagan

    This article fails to take into account that government spending is fundamentally different from private sector spending. Governments deficit spending injects money into the economy while private sector spending merely redistributes what money is already circulating in the economy minus the money that is removed to pay for imports. New private sector money that doesn't come from government is created out of thin air by private banks much like the money that was created out of thin air by the federal reserve to bail out the banks. The rub is that all of this money must be paid back with interest. Thus the ballooning government deficit is truly the life blood of any economy who still has their own currency and didn't buy the clap trap peddled by the IMF and the World Bank. Horrors of horrors, governments printing money to serve the public interest not to bail out crooked financial entities.
    Any country who prints money to fund their public purpose, will surely face currency devaluation. And is this such a terrible thing where the only game being played in the global sandbox is competitive currency devaluation?
    Economists like to tout the meme of self interest as a virtue of free markets. It is time for countries to reassert control of their economies for the interest of their inhabitants and not the interest of marauding corporations.

  6. Commentedniels kristian schmidt

    The sum of micro is macro. So understanding macro, requires insight into the micro economic actions and dispositions of humans. And macro political effects can only be understood if micro economic effects are understood first. For it is the sum of these micro economic reactions that constitute the macro economic effect. Rajan's article has some good points in that direction. Many economists talking about aggregate demand are too primitive in their approach to economics.

  7. CommentedGeared Economy

    What is missing in this article is a more fundamental view upon the relation between currency/employment and consumption: what we do not spend we do not have to earn
    Creating too much money by central banks will eventually create a problem between generations see also

  8. Commentedgene wong

    regarding "sustaining demand in unviable industries.."what if those industries employ mostly those lower income former borrowers whose debt rajan won't mind writing down..?Regarding possible jewelry inflation post general tax cut, what if the jewelers now buy products/services from the aforesaid former borrowers, whose demand is thus unrepressed..?Hopefully this is how a virtuous circle work and govt assistance acts only as a bridge(to use el-erian's opt repeated phrase).Finally it is unclear the stimulus has actually failed ,given we don't know what counterfactual to compare it to.. ie without it things could have been much worst.

  9. Commentedsimon Vrouwe

    Great article, I have read your book Fault Line too, it is balanced. But as in the book, between the lines I discover some similarities with the business cycle theory of Austrian Economics. A boom created by overinvestment due to credit expansion, then the (unavoidable) recession/depression needed to liquidate the mallinvestments. Goverments and central banks trying to prevent recession/depression by credit expansion and stimulus, postphoning the misallocations of resources. I think that deep in your hart you sympathise with the Austrian view.

    What I miss, also in your book, is a analysis of the monetary system, which I think is at the core of our problems. But that is dangerous territory for any respected economist.

    1. CommentedFlint O'Neil

      Rajan, just like in his book Fault Lines, does seem deeply Austrian at heart, but reconciles himself with Mercantilist/Industrial policy in developing countries. What makes me curious is how this fundamentally differing view of market structures can be supported theoretically by an Austrian theorist? Is there room within the Austrian dogma and theory for the pragmatic application of Industrial policy?

  10. CommentedPaulo Sérgio

    If this is true, isn't the recapitalization of the financial industry with government money another form of governments standing in the way of more natural growth?

    The question is more complex than at first appearances because in whatever economy, the financial industry sponsors much of the private invention, industrialization and so on --- unless private venture capital is ready to take over from open capital markets and banking and so on.

  11. CommentedJonathan Lam

    Gamesmith94134: Why Stimulus Has Failed

    If we acknowledge the falsehood on the shortage of aggregated demand can be compensated on supply through the fiscal or monetary stimulus; perhaps, we can take examples stimulation was not resolution at all, like the ClubMed, or Green industry. They illustrated the economy would suffer its boom and bust sequence, eventually they became unsustainable. There is no error on stimulation or industry that was chosen; but the fault fell on the margin of affordability that expectation did not turn into reality that growth turned into its fundamentals and valuation conflicts.

    Every change must apply its principle of substitution on fundamental like what, how, who, and why; and such change constitutes an expectation on growth; but its counterpart is the tangible value as in balance as in ratio production and consumption, exchanges on import and export, marginal affordability, long-term and short-term outlooks. At some point, fundamental and valuation interchange through the internal and external transitions. So, we have macro and micro economics and billboards, in which, we often examine the compatibility and plausibility through the statistical calculation. However the fine line would fall on the price supportive elements and its bargains throughout the transition like CPI or Currencies exchanges.

    In the case of ClubMed, we may question if the northerner travels to South, based on its favor of the locale or pricing? Currently, we are certain that it was not the five-star hotel in Milan or Madrid we overly assumed. Do the houses in North Africa could use a solar panel to preserve energy they cannot afford? It is lesser likely applicable to the principle of substitution. It was a mismatch in the price supportive elements. Especially, many airline companies were sacrificed to promote tourism during the energy crisis in exchange of the hotels that were over-built. Perhaps, it was a laugh on the poor who willed to conserve energy in giving his live saving to put a solar panel on his roof while he must spend his earning in a day by day basis with no savings.

    All investments purposed a profitable return either in long-term or short-term, so, we questioned the sub-prime rate housing and the present sub-prime rate bonds too. Of course, US dollar demands stimulation by its depreciation on dollar or piled up its dollars on stack and asset capital to seek its price support. However, it create the conflicts with the global financial system that demands a reevaluation on US dollar since the productivity did not change with its tide on cash flow on fiat money, like Dollar, Euro, or Yen which are alienated by its people’s support.
    “The advanced countries will spend decades working off high public-debt loads, while their central banks will have to unwind bloated balance sheets and back off from promises of support that markets have come to rely on.”, said Mr. Rajan.
    And I said,” watch out for the tide change if you build sand castle on beaches.”
    May the Buddha bless you?

  12. CommentedRobert Pringle

    Well said. But governments can do more to encourage a "spontaneous" increase in demand for "good", new products and services to help overcome the malinvestment legacy. They won't just step aside. What is clear is that central bankers are about to dig us all more deeply into the hole - just like last time, as Bill White has pointed out - all over again; but Gordon Brown, despite his old-fashioned impulses, is onto something - see

  13. CommentedJonathan Lam

    Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!

    Mr. Gert van Vugt,

    You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.

    Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.

    How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;

    • The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.

    • The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.

    • And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.

    If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.

    It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.
    I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.

    May the Buddha bless you?

  14. CommentedAyse Tezcan

    Debt-fueled demand! Who do you suggest created this behavior in the first place Sir? The snake oil salesmen and passive supporters of this mentality Laissez-faires free-marketers... now you are providing solutions to the problem this philosophy created? Good luck with finding buyers.

  15. CommentedJohn Hawkins

    This fits in with my views, I have long held the opinion that we in the west are junkies addicted to the cocktail of consumerism and self importance.

    I see little desire to change , indeed the desire, craving, is to return to the pre bust party.

    Sad really.

  16. CommentedProcyon Mukherjee

    May be the headline, “Stimulus has failed’, is a strongly worded repartee and a better summary would be “Limited impact of the Stimulus”. The stimulus did what it could effectively do; the rest would depend on a host of other factors that make economies grow. How different is the situation of U.S. from Japan, where for almost a decade stimulus money is being extended with almost no change in growth rates? The difference is still in the strong balance sheet of large corporations who have continued to derive benefits from a situation where consumption factors are muted, but this has not translated into wide spread job growth. The crucial issue is not the quantum of stimulus, but the application of the same for boosting job growth and there one would see that a lot of corporate accounts have benefited by replacing old debts by new ones, buying back stocks, and perking up cash pile. It is time this has to flow into fixed asset investments in the domestic economy. Isn’t it time the CEOs instead of endorsing a gloomy future of U.S. (if one goes by the Harvard Business School Research by Porter on U.S. competitiveness) start to act decisively in favor of staking their companies’ future by investing in the domestic economy?

  17. CommentedMark Simmelkjaer

    Very interesting read. All stimulus is not created equal. Government policies must be aimed at easing worker transitions (i.e. from Housing construction to say healthcare) instead of propping up the bubbles of the future.

  18. CommentedFrank O'Callaghan

    Very important point! Not all demand is the same and not all stimulus is the same. The concentration of wealth and reward at the top of the income range is a cause of the crisis. Stimulus has gone to the rich. It is needed by the rest.

  19. CommentedMerijn Knibbe

    A little about the 'solution' you propose. An market is about demand and supply - and you do not talk about demand at all. Weird. In recent times, The first thing demand was, indeed, fuelled by increasing private debt levels. We both know that this road has been closed - at least when it comes to mortgage debts. One reason debt levels (compared with GDP) increased is the increase of mortgage debt which did not lead to new nominal production and income (in the sense of the national accounts) but to higher house prices. It lead to inflation in the non-GDP economy, instead of the GDP economy. But it has to be paid back using nominal GDP-income, which did not increase because of this debt - quite another situation than debts which are used to finance investments and the like. Unlike debts which fuel aggregate demand, these mortgage debts did not lead to a matching increase of income but only to a inflationary increase of perceived (housing) wealth, which becomes a problem when Ponzi financing stops and house prices decrease (as the Dutch are experiencing, at this moment). The same real houses and nominal incomes, but much higher mortgages. Don't underestimate the amount of monetary financing of the housing market, in the Netherlands alone this amounted (official statistics) to about 600 billion Euro over the last twenty years, i.e. total Dutch GDP (which did not lead to inflation or current account deficits as it was, on a net basis, squirreled away in pension funds, deposits and non-financial company savings). Look here for a graph of monetary financing of dutch mortgages (billioins):

    Also, the structure of the Eurozone leads to imbalances which can only be counteracted by a fiscal sovereign which is also a monetary sovereign - and which does not exist in the Eurozone. In 1992 Wynne Godley already made a detailed prediction of the present mess:

    To underscore the depth of the Eurocrisis you might consult this graph about (the disappearance of) money in Greece:

    Again: this Moneygeddon is not caused by the lazyness of the Greek or something like that - but by the structural and ideological forces which were analysed by Godley, back in 1992. Read the guy.

    Which leads to the last point: were does new final demand have to come from? You state that it will miraculously appear when new sectors spring into existence. But 'demand' needs money and income to pay for the products of these new sectors, there is nothing (nothing) in your analysis which suggests how this money and income comes into existence, in a situation of high indebtedness where people (at least in the Eurozone) are paying of debts and therwith destructing money (consult the ECB monetary statistics) or spend their money on stamps and other safe assets instead of production generating final demand (you might want to read chapter 17 and 19 of that famous 1936 book on this). Please, explain. Will households do the spending? The government? Non-financial companies? One of the more remarkable aspects of new classical thinking is the neglect of money - which is mirrored in your 'solution'. Please, explain what will happen, as intertemporal optimization is of course a fata morgana. What we should do is of course make mortgage debts more flexible, i.e. couple them to the value of incomes and houses using for instance negative interest rates (remember: the money lent was newly created by the banks and the borrowers together, it was not somebody else his or her money before it was lent as it did not exist before the act of borrowing/lending!) and to increase wages. This might indeed lead to the income and spending power which will allow new dynamic sectors like 'care for the elderly' to grow. Believe me: this is in countries like Germany one of THE growth sectors, at the moment. And the long run is quite short, for its customers...

  20. Commentedcaptainjohann Samuhanand

    In India there is demand for housing as the number of homeless numbers tell but they cannot afford it and also the demand is there in the urban centres where poor go for work but cannot afford the price.We have enough cement,steel, low wage labour but the cost of land in urban areas is high.It is here Government should step in as in China and creat infrastructure around urban centres which will match the Urban quality so that affordable housing could be built and also unemployment is solved

  21. Commentedsrinivasan gopalan

    Dr Rajan's perceptive piece on why stimulus has failed, in so far as it confines itself to the advanced countries, has no answer to the economic slowdown India has been faced with for the past two years. India too did two doses of stimulus in the post-2008 world economic slowdown but those stimulus vanished in the thin air with the country remaining stuck in a slowdown mode for the last couple of years. India's public debt to gross domestic product has not dwindled while the fiscal consolidation moves remained in the back burner despite the authorities' tall talk of the overwhelming need for fiscal consolidation. As Mr Rajan is in the unenviable slot of India's finance ministry chief economic adviser, his forthcoming survey on the Indian economy to be published a few days ahead of the 2013-14 Union Budget is keenly awaited for all the astute ideas he holds on the global economy. Borrowing per se, either by an individual or by a nation, is not bad as long as the ability to repay the loan contracted through sustainable earning capacity is not lacking or found slackening! The learned professor of finance perhaps may throw up some wrinkles on how to get the Indian economy moving as the country has launched its ambitious 12th five year plan in April 1, 2012. G.Srinivasan, Journalist, New Delhi

  22. CommentedMeenakshi Srinivasan

    Stimulus has failed because Home economics always teaches that only when there is something in the pot can it be dished out. All that stimulus did was print more money that did not exist and circulate it and make everyone feel that there was a "Hurricane Greenback" that flooded their cities and hence make them feel "rich".

    It goes back to the basics- spend what you have earned, not borrowed from future expectations. A bird in hand is worth 2 in the bush. But then, my introduction to finance course taught me how I could create equations to show the "value of time" and slap a value on it and gamble and see how many more agree with me and put their money along with mine to make everyone believe the same.
    Then one day, it just might pay the dividends we thought it would or we can come to the realization that it was the Story of the Emperor's New Clothes all over again!

  23. CommentedVenu Madhav

    I need help as I am not sure why I am stuck with this in my mind. The population was 312MM in United States in 2012. Average size of a household is 2.6, and that means there would be 120MM households; while today there are already 132MM, ok that could be due to the variability/deviation factor from the average especially looking at cities and sub-urbs with growing employment in contrast to other parts; but still how much demand would that really create? Rather than restrict the construction workers to the shores, business savvy companies should have bid for projects offshore to keep the QoQ statements black, because there are so many infra projects happening worldwide. Last but not least, how much of the stimulus really went into SME focused SBIR/STTR projects to create employment versus like Dr. Rajan pointed the unyielding and bubble bursting zones?

    Thus I agree with Dr. Rajan on his position of the situation and also seek help to clear my quandary.

  24. Portrait of Pingfan Hong

    CommentedPingfan Hong

    Why stimulus has failed? Krugman would say, because the size of stimulus has been too small, in comparison with the size of the shock brought by the financial crisis on aggregate demand. How would you argue with him?

    It is very interesting to see the new Japanese government adopt both an expansionary fiscal policy and a extremely easing monetary policy, despite its highest public debt to GDP ratio in the world. This new policy mix has made Japan now different from other major developed economies, where macroeconomic policy features a combination of fiscal tightening and monetary easing.

    If Japan can succeed in boosting the growth while reducing its debt, it will disprove the views you are holding here; otherwise, if Japan fails, the consequence will be dire: the expansionary fiscal policy will explode its already unsustainable debt, sending Japan into a debt crisis.

  25. CommentedBrent Beach

    Most of the stimulus efforts have gone toward recapitalizing the wall street banks who created the last couple of bubbles. We know they will create another bubble if they can, taking their billions in bonuses along the way. This type of stimulus is certainly counterproductive.

    Unfortunately, not helping those banks may have taken most pension plans down the drain as well. Was there a choice?

    Failure to investigate, indict and prosecute the people behind the fraud is the worst part. Yest, save the pension funds and the banks, but punish the banksters.

    The other part, the innocent bystanders in all of this, how to limit damage to them? Austerity would punish them more.

    Given the choice, stimulus is the only possible course.

    Smart stimulus amounts to picking winners, a dangerous obsession.

    General stimulus right away, find out where the economy then heads (something you cannot predict) then get out in front and start to lead.

    Makes sense to me.

  26. CommentedManfred Dix

    Raghuram Rajan's article sounds awfully close to me to a defense of Austrian Economics, a la Ludwig von Mises. Even though Mr. Rajan might not want to portray it that way. [Austrian Econ is not all too popular these days in the venerable halls of the top departments of Economics, where Mr. Rajan circulates.]

  27. CommentedMerijn Knibbe

    The elderly plummer example is not really good. Stamp collecting is exactly the kind of thing - a flight into safe assets, remember that stamps are a kind of money - which makes the circular flow of money go of track. Money is not traded for new production - but for existing assets, which interrupts the circular flow and leads to lower expenditure on production and therewith to a lower propensity to invest. Remember that Greek households at this moment are paying down debt (which is of course the safest kind of safe micro asset - but which in our fiat money system this leads, macro, to money destruction...)

  28. CommentedRichard Foosion

    1) You appear to be saying a group has cut spending, therefore a program aimed at generally increasing demand is suboptimal, because it includes many more than the affected group. However, if the group cuts its spending, then others, perhaps all, have less income. It makes sense to target the second order effect rather than just the first order group.

    2) The notion that stimulus to close the gap has driven policy is rather strange. Austerity appears to be the driving force, not traditional Keynesian stimulus.