Fiscal stimulus did not save us

The second, more important, question is whether fiscal stimulus did actually stave off recession on the basis of the narrow and somewhat arbitrary definition favoured by the media: two successive quarters of negative real GDP growth as conventionally measured.

And contrary to common lore, what the data shows is that when the GFC (global financial crisis) most affected real economic activity around the world, it was a dramatic turnaround in Australia’s trade balance that mainly offset falling private investment, including inventory rundowns, not extra government spending, or household consumption assisted by federal cash handouts at the time. Private consumption did increase minimally in the December 2008 and March 2009 quarters, no doubt due in part to cash handouts. But the minor improvement in household consumption is dwarfed by an unusual rise in net exports, and is less than the private investment turnaround in the March quarter. In turn, the private investment improvement was due to a significant reversal of inventory rundown, in part due to increases in farm stocks arising from a breaking of drought.

Fiscal stimulus also involved direct federal government spending initiatives, yet the data shows there was no net contribution from federal spending in the December 2008 and March 2009 quarters, though there was a nugatory contribution from state and local consumption spending. Aggregate public spending has risen in subsequent quarters, but due to administrative delays in implementing new programs, the extra spending arrived after the worst of the GFC had passed.

As modelled more formally in a paper of mine forthcoming in Economic Papers, it was a dramatic loosening of monetary policy and an exchange rate depreciation of nearly 30 per cent on a sustained basis throughout the crisis interval that best explains how Australia avoided a narrowly defined recession. Paul Keating, Bob Hawke, Peter Costello and John Howard can all claim some credit, the first pair for the float of the dollar, and the second for making the Reserve Bank more independent.

Author: Tony Makin (Professor of Economics Griffith University); Opinion piece in The Australian – July 28, 2010.

5a. With the aid of an AD/AS graph describe how the fiscal spending could have led to the avoidance of a recession.

5b. With the aid of an AD/AS graph describe the alternative situation where the floating exchange rate and monetary easing could have led to the avoidance of a recession.

5c. what are the key differences between the two?

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