Is stimulus still necessary?

Estimates vary from a multiplier of about two all the way down to zero. A multiplier of two would generate US$480 billion of extra spending, compared with a multiplier of one, which would generate just the initial US$240 billion. If the multiplier is zero, as conservative-minded economists believe, there will be no effect on output, only on prices.

A further source of stimulus is “quantitative easing,” or, more simply, printing money. By buying government securities, the central bank injects cash into the banking system. This is intended to stimulate private spending by bringing down the rate of interest at which banks lend to their customers. Extra hundreds of billions of dollars have been injected into banks worldwide by this means.

But the stimulus effect of quantitative easing is far less certain than even that of fiscal stimulus. While the policy caused credit spreads to narrow and bond market liquidity to improve, many banks have been using the extra money to rebuild their balance sheets (the equivalent of increased household savings) rather than lending it to businesses and individuals.

Several conclusions can be drawn from what admittedly are back of the envelope calculations. The first is that stimulus packages around the world arrested the slide into depression, and may have started a modest recovery. Second, it is too early to scale down the stimulus, as Japan and the US seem ready to do. As one British official said ahead of the G20 summit in Italy in July, “We should start to prepare exit strategies, but we should start implementing them only when [we] are sure [we] have got a recovery that is entrenched and self-sustaining, and I don’t think anyone is saying we are at that point yet.”

Third, existing policy, even if maintained, will not produce self-sustaining recovery. At best, it offers the prospect of several years more of sub-normal activity. A double round of stimulus packages is needed to counteract the real prospect of a double-dip recession.

The time to start worrying about inflation is when the recovery is entrenched. To pay back the debt without strain, we need a booming economy. Talk of government spending cuts is premature. “A boom not a slump is the right time for austerity at the Treasury” said John Maynard Keynes. He was right.

Robert Skidelsky is professor emeritus of political economy at Warwick University

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