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Four economists on fiscal stimulus

July 12th, 2010 Posted in Uncategorized by


Sir… many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities. We do not desire to see a renewal of such practices. At best they mortgage the Budgets of the future and they tend to drive up the rate of interest – a process which is surely particularly undesirable at this juncture, when the revival of the supply of capital to private industry is an admittedly urgent necessity. The depression has abundantly shown that the existence of public debt on a large scale imposes frictions and obstacles to readjustment very much greater than the frictions and obstacles imposed by the existence of private debt. Hence we cannot agree… that this is a time for new municipal swimming baths, &c…

“If the Government wish to help revival, the right way for them to proceed is, not to revert to their hold habits of lavish expenditure, but to abolish those restrictions on trade and the free movement of capital… which are at present impending even the beginning of recovery.

We are, Sir, your obedient servants,

T E GREGORY, Cassel Professor of Economics

F A VON HAYEK, Tooke Professor of Economic Science and Statistics

ARNOLD PLANT, Cassel Professor of Commerce

LIONEL ROBBINS, Professor of Economics

University of London, October 18

Okay, it was 1932, but if that was their view during the Great Depression, it must surely apply in today’s recession.

Their original letter, a response to an earlier letter by six economists including Keynes and Pigou, can be downloaded here. Hat tip to Dr Richard Ebeling.


13 Responses to “Four economists on fiscal stimulus”

  1. Jon Says:

    Absolutely – if that was their view in 1932, it would be their view today.

    Would it be correct though? That’s a rather different question. In the US, for instance, it is often said that the plan to balance the books too quickly prolonged the recession and only the stimulus of the Second World War turned things around.

    So there’s an equally strong view that if they were wrong in 1932, they’d be wrong today.

  2. Tom Papworth Says:


    On the first point, Hayek at least was expressing that view until the 1990s. Somewhere else on this site I have an extended quote from him to that effect, based on a radio broadcast he made in the 1970s.

    The debate about what prolonged the recession of the 1930s continues. You are right to say that some claim that it was the withdrawal of the stimulus in the mid-30s that prolonged the recession. Those who make that claim make a similar claim for Japan in the 1990s.

    It is interesting, however, that both these quintessential examples of fiscal stimulus refer to recessions that lasted for over a decade. By comparrison, the recession of 1920-21, which saw a contraction comparable with 1929, was followed by no government intervention at all and a very swift recovery.

    As for the popular old canard that World War II stimulated the economy, all I can say is that it’s the Broken Window fallacy again. How much more stimulating would it have been not to have spent precious resources killing the most productive members of each others’ societies?

  3. Psi Says:

    Tom is spot on. Jon people like you scare me. Suggesting that the deaths of millions along with the destruction of masses of physical capital and diversion of interlectual capital can never be described as positive. If it was so good why did we have the economic problems of the 40s and early 50s?

  4. Dan Says:

    I think Jon’s referring to American before she joined the war, when the Americans were producing and selling a huge amount of military equipment to the British. Obviously this helped their economy somewhat.

  5. Tom Papworth Says:


    It is certainly true that one can stimulate one’s economy if one is swapping unproductive goods for productive ones, which is what arming waring parties represents.

    However, I think Jon is referring to the view – expressed by Nobel Laureate Paul Krugman among others – that the entire war effort lifted America out of depression because it forced it to produce more.

    My original article can be found at, as the above link doesn’t appear to work.

  6. Jon Says:

    Psi, I never said the war was “so good” or even that it is my personal opinion. Get back on your moral high horse and ride off into ignorance someplace else.

    Tom, I’m really only referring to the fact that the duelling economists have been at it for a long time. It should be fairly obvious by now there are no simple explanations. Take the 1920-1 recession which ended without any stimulus at all. Wouldn’t that suggest the Great Depression should have been done with by 1931, years before the New Deal shows up in 1933?

    The Broken Window “fallacy” doesn’t translate well. A replaced window in France is not a new factory churning out new, advanced technology in the US. It’s just a nice little story for Austrian School economists: it sounds good and doesn’t ask them to anything tricky like mathematics.

    I’m coming from industry, rather than finance or academia. In times of crisis, cash flow takes precedence over the paper profitability of long term investments. To me a fiscal stimulus in a liquidity crisis makes a lot of sense, as economies don’t have easy options such as bankruptcy or being acquired. And anyone familiar with project valuation or corporate strategy knows that underfunding a major programme of work can be as bad as just burning the money.

    I appreciate the analogy doesn’t necessarily scale to macroeconomics, so actually I’m fairly agnostic on fiscal stimulus. Even so, it takes rather more than pointing out that Hayek, like David Blaine performing a magic trick, was able to hold his opinion for a very long time. Even Friedman, defender of the free market, considered the Austrian School to be on the fringe.

  7. Tom Papworth Says:


    It certainly is an ongoing debate! However, it is not helped by the myth that the US did not try any stimulus until Rooseveldt’s new deal in 1931. In fact, Hoover – later accused of being laissez faire and allowing the economy to wither – intervened massively from 1921 onwards. The Hoover Dam was a stimulus project, and Mt Rushmore (though started before the Depression) is further evidence of Hoover’s fondness for expensive government-funded schemes. Murray Rothbard refers to “The Hoover New Deal” in his America’s Great Depression, which ends with Rooseveldt’s election.

    On the Broken Window, I think it translates perfectly well: how does breaking windows (or dams, or lives) stimulate the economy? The Austrian critique of econometrics doesn’t derive from a lack of mathematical skill, but from a fundamental rejection of the mechanistic and aggregate economics favoured in Cambridge and Chicago.

    I agree that “it takes rather more than pointing out that Hayek… was able to hold his opinion for a very long time” to make the economic case. That is not what I was doing. Hayek makes the case himself in the quote, and repeatedly thereafter. You are right that Friedman and Hayek did not agree on macroeconomics, but that just goes to show that a monolithic view of “Defenders of the free market” is mistaken.

    Having said that, Friedman was equally scathing of fiscal stimulus as the Austrians. Where they disagreed was on monetary stimulus. Friedman believed that the money supply had to be maintained; Hayek believed that this just stoked the next round of inflation. But both agreed that government spending only displaced, rather than supplemented, private sector spending.

    Coming full circle, war is a great example of this: government diverts money that the private sector would use to make bridges and boats and uses it to make bullets and battleships. I hardly see how the economy or the citizenry gain from that.

  8. Jon Says:

    The problem with the Austrian School isn’t a lack of mathematical skill, it’s the decision not to use it. It makes them preachers, not economists.

    The Hoover Dam didn’t start til ’31. Mt. Rushmore is a distraction, a rounding error. The question stands: why things didn’t recover by ’31?

    I pointed out the Broken Window ignores new capacity and new technology. It is of no surprise you think it is still valid if you ignore counter arguments and rely on trite, emotionally laden questions.

    You talk about the government diverting money the private sector would use, which rather misses the fundamental point that recessions happen when the private sector isn’t using its money. Stimulus shifts the pattern of spending over an economic cycle. At a cost, yes, but timing is important because liquidity issues and deflation. If businesses benefit from improved cash flow, having the cost of the stimulus spread over the full economy could make perfect sense.

    You ignore cash flow. You prefer stories to numbers. Let me guess – you worship but don’t actually work in the private sector and have an arts or social science background?

  9. Tom Papworth Says:


    Your statement that “It makes them preachers, not economists” assumes that economics is a mathematical science. That is a pretty extreme leap of faith, condemning not just the Austrian School but also figures such as Adam Smith, David Ricardo and John Stuart Mill to the status of preachers rather than economists. In fact, the mathematisation of economics is a late phenomenon in a science that for a very long time was built on logic and reason but not on precise calculation.

    For that matter, denying the status of science to any subject that does not rely heavily on mathematics would affect a vast number of disciplines, up to and perhaps including (at least until very recently) chemistry and medicine.

    As regards your question why things did not recover by 1931, I go back to my earlier point that Hoover massively intervened in the economy, retarding any recovery. In his own words: “we met the situation with … the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic… Creating new jobs and giving to the whole system a new breath of life; nothing has ever been devised in our history which has done more…” You may be interested in a summary of Hoover’s interventions.

    On the broken window, I am not ignoring counter arguments. I don’t even see a counter argument. Neither new capacity nor new technology undermine the “broken window” principle or render war economically stimulating. I’m all for creative destruction, but the idea is that one replaces something because the cost of doing so is more than compensated for my the improved productivity. Destruction is not what stimulates progress; it is merely the removeal of things that are standing in the way of progress.

    Recessions don’t happen because the private sector isn’t using its money. They happen because malinvestments manifest themselves, notably over-investment in long-term projects resulting from artifically low interest rates pushed down by governments that want to engineer booms so that they win elections. I have a certain sympathy for the idea in theory of borrowing during the downward cycle and paying it back during the upswing, but governments have a poor record of taking the tough decisions in the good times: why slow growth when one can enjoy a boom and win the next election on the feel-good factor. It worked for the Tories in the mid-80s and for Labour for a decade.

    As for the ad hominem bit at the end, I’m not going to respond. It’s a shame you feel the need to lower the tone of this conversation in such a manner.

  10. Jon Says:


    There was no ad hominem bit. I draw a conclusion on your background from your arguments, not the other way around. I have been blunt, but I would rather lower the tone than reduce the quality of the discussion. It is more of a shame that an elected representative advocates an extreme and simplistic viewpoint. Without a coherent argument, or having such relevant experience as to give their opinion alone some weight, it’s morally dubious I believe. The issue at question is people’s livelihoods, after all.

    Further examples of why your argument lacks coherence:

    I neither stated or made an assumption that economics is a mathematical science. It is, however, one that benefits from its judicious application. As with chemistry, medicine, music and so on. Your stance implies that maths is unnecessary, nought but a recent invention or fad. But as a field evolves, it improves, and therefore there it is likely the recent use of maths in various fields has improved them, not weakened them.

    Hoover was involved in the economy, but what about those numbers? According to your link government spending saw a rather small increase of $13.1 to $13.9 million. That is not a “massive” intervention. It is an interesting approach to use a politician’s hyperbole as evidence.

    The counter argument to the broken window theory is simple: new capacity and new technology represent improved productivity. Anyone who has genuinely considered the broken window fallacy should be aware of this counter argument. To not even see it is rather curious.

    Recessions don’t happen because the private sector isn’t using its money – but recessions happen nonetheless when the private sector is not using its money. Correlation, not causation. Talking of only politicians and elections is wilfully naive – politicians, economists, financiers, central banks, individuals, executives, managers all have poor track records of taking tough decisions in the good times.

    That is the true ad hominem bit. You started with the object of your attack, ascribed them motives, and then pinned the blame on them with selected facts.

  11. Tom Papworth Says:


    Do you really think that you have not presented an ad hominem argument? You have clearly chosen to raise your opponent’s character as subject matter, rather than answering his argument. That is regrettable. Furthermore, it makes your response to Psi, that he should “Get back on [his] moral high horse and ride off into ignorance someplace else” to seem particularly hypocritical.

    As regards my role as an elected representative, I am sorry that you consider my viewpoint “extreme and simplistic”, but unless you can substantiate that with evidence you are saying nothing more substantial than that you disagree with me. That is fairly clear.

    As for inconsistency (you call it “incoherence”), I would draw your attention to:

    Jon 14 July: “a lack of mathematical skill, it’s the decision not to use it. It makes them preachers, not economists”
    Jon 16 July: “I neither stated or made an assumption that economics is a mathematical science”

    I have no problem with allowing maths to inform Economics, but I do not consider Economists to be mere preachers simply because they do not focus on the maths.

    “new capacity and new technology represent improved productivity”

    Indeed, but as I stated in my previous post, there is a massive difference between replacing somthing because it is cost-efficient to do so, and replacing something whether or not it is efficient to do so. Interestingly, your response to Psi (mentioned earlier) was to the effect that “I never said the war was ‘so good’ or even that it is my personal opinion” appears rather incongruous in light of your subsequent statements. Why are you so keen to undermine the “Broken window” argument, which I only cited in reference to warfare-asfiscal stimulus. There is nothing in my comments above that suggest that the “broken window” applied to allfiscal stimulus.

    “Talking of only politicians and elections is wilfully naive – politicians, economists, financiers, central banks, individuals, executives, managers all have poor track records of taking tough decisions in the good times.”

    I agree – and never said otherwise. But I maintain that individuals react more sensibly, and respond less to vested interests, than politicians, or the central bankers they appoint, the financiers/executives/managers who lobby them, and that much of the damage is caused by the fact that policy responds to the desires of interest groups rather than being fair to all people.

    “That is the true ad hominem bit. You started with the object of your attack, ascribed them motives, and then pinned the blame on them with selected facts.”

    I don’t really understand this last statement. “Ad hominem” is focusing one’s attack on one’s interlocutor rather than his/her arguments. I’ve not done that. You have. Please let’s stick to the discussion and not point the finger at one another. All that does is make this look like a pathetic, testosterone-fuelled row instead of an attempt to have a useful and informative conversation.

  12. Tom Papworth Says:

    On the question of Herbert Hoover’s fiscal incontinence, btw, Niall Ferguson’s article in today’s Financial Times notes that “When Franklin Roosevelt became president in 1933, the deficit was already running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. The federal debt burden rose only slightly – from 40 to 45 per cent of GDP…”

    More evidence that Hoover was (almost) as spend-thrift as his near-deified successor.

  13. Jon Says:


    Going by budget deficit, Hoover actually saw a budget surplus from 1921 – 1930, with a mere 0.17% deficit in 1931. By the measure you suggest, he was the very model of fiscal rectitude. I’m still left wondering why the US economy didn’t simply recover of its own accord by ’31.

    (note: in case you missed it, pointing out you are using a single point in time statistic rather than a decades worth of data is the evidence of simplistic thinking you were asking for.)

    I’ll ignore the rest of the hissy fit. I’m starting to think it would be cruel as well as time consuming to pick over all the flaws in the reasoning.