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More on Stimulus and Imports December 7, 2008

Posted by A Texan In Grad School in Economic Theories, Federal Debt.
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Apparently BW beat Rodrik et. al. to discussing the difficulties of orchestrating a domestically effective fiscal stimulus.   Business Week claims that,

The financial crisis was caused, in large part, by U.S. consumers borrowing trillions of dollars from the rest of the world to buy imported cars, clothes, and gasoline, even as jobs slipped overseas. As long as the U.S. is running a big trade deficit and borrowing from abroad, a fundamental cause of the crisis remains.

Which is a bit misleading.  While our extremely leveraged consumption played a role in the propagation of the crisis, I personally think that it was not a cause.  Furthermore, our current problem is not so much one of too much existing debt, but the inability to get new debt.

So let’s think about all this.  The problem with a fiscal stimulus is that it sends too much money abroad to other countries that manufacture our goods.  This means fewer jobs created here.  But, one must never forget the relationship between the current account and the capital account.  If our stimulus is spent on goods from abroad, then our current account deficit will increase, but our capital account surplus will also increase.  This is because all the foreigners who have our dollars have to do something with them.  That is, either buy our goods or invest in our economy.  This will increase liquidity.

Now, does this mean that a stimulus is definitely the best policy?  Not necessarily.  Keynesian multipliers and stimulus are not a free lunch.  While foreigners will be investing money in our economy, there will also be an increase in government debt to fund the stimulus.  This will cause crowding-out of private investment.  Also if the government is selling more debt that puts upward pressure on interest rates.  Perhaps what we need is a stimulus funded by federal lands.

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