Guest Post: Why Stimulus Has Failed

Tyler Durden's picture

Authored by Raghuram Rajan, originally posted at Project Syndicate,

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.

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moonstears's picture

That pic is of a freshly trained, American clothed "Iraqi Guard". Then again, maybe French black ops guy?

aaxiom's picture

I wish they would include the teaser pics in a larger size within the articles. 

economics9698's picture

You lose about 2.2 private sector jobs for every 1 government job.



trav777's picture

none of this monetary crap really matters...aggregate energy input does.  That is what's driving this "mess."

Those who think 'well if we could just default on the debt or pay it off' that everything will GO BACK TO THE WAY IT WAS are fools and delusional ones at that.  You're living in denial if you believe that return to the happy motoring status quo of luxury is possible at this point.  2005 isn't coming back.

LawsofPhysics's picture

Indeed, moreover, please ask him to define "private sector". Is this the same people in the "private" sector that have been socializing their PRIVATE losses via BAILOUTS? In addition, many are still sucking from the government tit as "private" entities.  Totally fucking stupid.

michael_engineer's picture

Yeah , what Trav and LOP said!!!

Bicycle Repairman's picture

The time tested remedy from the 1930-1945 period is to destroy most of the factories around the world and leave American ones standing.  Also it helps to actually seize the easily obtainable oil/energy. 

Just throwing $$$ at the MIC doesn't work.  If you cannot see that after 12 years, stop looking.

trav777's picture

the US didn't "seize" anything.  We let the Sauds nationalize Aramco, FFS

Sudden Debt's picture

and you need 2.2 government jobs to be as productive as 1 private job

Island_Dweller's picture

You can find most pics on the internet using this site:

Here's a larger picture of the teaser found using tineye.

Just right click on the teaser and "view Image" and then copy the address and paste it into tineye where it says "enter image address"

forwardho's picture

Ah yes the all important "bow stance"

Used when only sticks are left for ammunition.

For the life of me I can see no connection to post?

THX 1178's picture

shooting one's self in the foot

Proofreder's picture

Obvious.  An image reflecting poor planning with the

Wrong Tool.

Incorrect Aim, no judgement skill - but the recoil will raise the stock, that's for sure.

Same thing the FED is doing.

Perfect Illustration.

secret_sam's picture

Our armymen have always loved playing cowboys and indians, but usually they pretend to be the cowboys...

aaxiom's picture

Using the weapon in that manner is about as effective as the stimulus has been for the economy. I still want a larger image. I like it.

Island_Dweller's picture

see my post above to find a larger image

Mad Mohel's picture

Looks more a like a kid having a quick piss with his buddies.

Liquid Courage's picture

Mad Mohel ... your avatar. That's not a bowl of 4sk**s, is it?

Pardon me while I puke and cringe at the same time.

LawsofPhysics's picture

Why?  Simple, the capital has consistently been mis-allocated and mal-invested in order to keep the same corrupt and failed business models and money masters in power and control of the earth's resources and productive assets.  The elites know traditional growth models are dead, but they want to maintain power and control, period.


Easy to do when you own all the world governments. Fucking duh.

A Lunatic's picture

The majority of these supposedly learned analysts presuppose a benevolent government attempting to foster growth and prosperity. This makes no sense.........

Kobe Beef's picture

Once you change your presuppositions to malevolent governments controlled by a global crime syndicate attempting to institute oligarchical collectivism, the current state of economic affairs makes perfect sense. Welcome to the NWO.

Cognitive Dissonance's picture

"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."

Rule number one. When digging a hole keep digging.

Rule number two. If the hole is too deep keep digging.

Rule number three. When in doubt refer to rule number one, but whatever you do never stop digging.

Spastica Rex's picture

In my adult life of about a quarter of a century or so, I've watched the qualities and habits associated with "leadership" change. A firm refusal to consider potential negative consequences associated with decision making  is now a job requirement. Contemporary leaders must also never question their own self worth.

Reaping and sowing.

Liquid Courage's picture

MBA = Manipulative Bullshit Artist

hooligan2009's picture

thats "Master" Bullshit Artist and yes, I have one. Thought it would come in handy after the 1987 crash. Who would have thought.

Just Ice's picture

And by all means, never, ever admit you've perchance made a mistake.

PUD's picture

Peak debt in a money as debt system. Peak planet. Peak population. The law of exponents.

kridkrid's picture

PUD and pods and end the thread.

Umh's picture

Pud is right; in that sooner or later we will run out of shit, however with his attitude he just might quit looking when he gets to the edge of his yard. Fatalism seems to be the mode in which he operates.

Sudden Debt's picture

Stimulus might have failed but I bet if they do it again just like the first time that this time will be diferent and that it will work.

and if not... third time is a charm


eaglerock's picture

According to Krugman, stimulus has not worked because we haven't spent enough.  Seems to me that's like me coming back from Vegas and telling my wife I lost money because I didn't gamble enough money.

pods's picture

There are countless analyses within our debt-issued-with-interest money system of why things are not working anymore.

The whole premise that you can sustainably operate within a system that is destined to crash is a huge waste of time.

It's the FUCKING math, period!


kridkrid's picture

Exactly. The article was a complete waste of energy. It was an attempt to fit a narrative into the events that have taken place, framed in language that is familiar and comfortable for most. It is much more simple than than most are willing to consider. But to grasp it, people have to accept that our economic existence, our existence in general, is a bit of an illusion. Tough sledding for most.

Spastica Rex's picture

And weather forecasting doesn't predict the futue, it describes the past.

Falconsixone's picture

Only so many uber rich butlers needed.

A Lunatic's picture

Ever considered that maybe the government doesn't give a shit about you finding a job? Joe Blow isn't so hard to "compromise" with when he's hungry...........

narnia's picture

debt financed involuntarily purchases of "schooling" at $18,000+ per kid, the services of the TSA at God knows what per airline passenger & $1B on a bomb to drop on someone who is no threat to us, among the other $6.2 trillion of non-off balance sheet & regulatory federal, state & local spending in 2012, is not real demand.  

SheepDog-One's picture

'Stimulus failed' how exactly? We know the ONLY thing that matters at all is stawks, and at this pace there's only a few moar shopping days left till stawks are ramped back up thru their all time megabubble record highs in a few days!

Pharming's picture

Quiz.  Who said these quotes.  You'll win nothing.

"I've abandoned free-market principles to save the free-market system."

and of course...

"Now, people when I say that look at me and say, 'What are you talking about, Joe?  Your're telling me we have to go spend money to keep from going bankrupt?' The answer is yes, that's what I'm telling you."

and can't go without...

"This is big fuckin deal." as he almost licks his ear...

Pharming's picture

Correct! The man who is just a heartbeat away from ruling the world...

IamtheREALmario's picture

Bush the Dopey. Yes, he along with the same people that claim that we can defeat evil by being evil.

Pharming's picture

Correct!  You win a lifetime of work and no monetary reward.  Congratulations to you and your offspring.  And your offspring's offspring.

ebworthen's picture

The Central Bankers will ignore history; either because "this time is different" or because they are intentionally rewarding Banks and Bankers and punishing individuals.

This won't end until there are a lot of dead people.

Silvertrader's picture

I am afraid it will cost us more than two decades to repair all the damage that has ben done for all these years by our corrupt governments and buisines leaders. I think the only way to survive financially is to allocate your capital wisely. Commodities are good but don't forget trading the forex market. It will see a lot of volatility the coming years and that is good for trading. If you are not a good trader yourself you can always copy the best forex traders in the world. Today there are so many investing possibilities. You can always make money somewhere.