I don’t think advocates of stimulus will buy Tyler Cowen’s argument that the opportunity cost of government borrowing is high. I think they would say the shadow price is reflected in the (low) cost of government borrowing, and that the price is low because the economy has idle savings, labor, and production capacity, which are use-it-or-lose-it resources without silos big enough to store savings—i.e., the economy just shuts down production.
From my perspective, they overlook the fact that government borrowing and spending uses the economy’s finite capacity and willingness to bear risk. In most recessions, this is the binding constraint to growth, and continues to bind today. The shadow cost is high when the economy’s capacity and willingness to underwrite risk, namely its equity, constrain growth. The spread between equity and debt (1/ P-E ratio – 10 year Treasury rate) remains at a high typical of recessions (4.6% the last time I checked). We should expect offsetting private sector dial backs when the government takes risk under these conditions.
Advocates of stimulus spending insist that empirical evidence indicates little, if any, Ricardian equivalence/rational expectations—i.e., that the private sector never dials back to compensate for risks the government takes on behalf of taxpayers, even with evidence to the contrary—as if the private sector were irrational or has an enormous unused capacity to bear risk.
I believe it’s hard to measure compensating private sector dial-backs because they work through redundant channels, and in random path-dependent and circumstantially dependent ways. The economy is a complex self-organizing system, not a clockwork-like system that mechanically optimizes within linear constraints. Empirical studies rarely differentiate critical differences in circumstances e.g., when the economy’s capacity and willingness to take risk does and doesn’t constrain growth; measure the response of more than one channel; or, in the case of micro behavioral studies, measure the responses of different agents, where a handful are far more impactful than the vast majority.
What I see is seven years of subpar employment and productivity growth despite the government’s efforts to stimulate growth via low taxes relative to GDP during the recession; higher spending, deficits, and debt since; a four-fold increase in the monetary base; near-zero interest rates; and regulation intended to mitigate financial risk—just what the hypothesis predicts. That looks consistent with an offsetting dial back to me.
While there is evidence that recoveries are slow after bank-runs, eight years after the financial crisis, any rebound that should have occurred likely would have occurred. That’s becoming an increasingly less convincing excuse for the accumulation of slow growth.
To defend stimulus spending in the face of slow growth, some advocates dismiss the effectiveness of increased government transfer payments to stimulate growth—ironic since Keynesians assert that a lack of consumption slows growth in recessions. Why should government spending or private sector spending on behalf of the government make a significant difference?
Others point to the faster recovery of the U.S. economy relative to Europe’s as evidence stimulus works. But the U.S. economy was growing faster than Europe’s before the financial crisis because it possesses the institutional capabilities needed for faster growth today—e.g., a properly trained and motivate workforce, cutting-edge technology companies, and a relatively large pool of at-risk capital. We should expect the U.S. economy to recover faster too. A more relevant measure compares the U.S. to its own recent history. By that measure, the recovery has been unusually slow.
Some point to the buildup of high-tech cash as evidence that equity doesn’t constrain growth. In fact, advocates of secular stagnation, like Larry Summers, insist that a shortage of investment opportunities constrains growth and leaves cash unused. Ben Bernanke channels Larry’s uncle, Paul Samuelson, to counter that at zero interest rates there should be no shortage of investment opportunities because we could level the Rockies to save gas or increase the developing world’s productivity by deepening its capital per worker, but for the risk of choosing a bad investment and being left to pay back the loan.
While high-tech companies hold cash offshore to avoid taxes, they can and do borrow that cash indirectly to buy back shares. They nevertheless hold cash to maximize their wherewithal to buy successful startups in order to mitigate the risk of technological disruption—Facebook buying Instagram, for example. In the current environment, it’s imprudent for high-tech companies to mitigate disruption risk solely with internal investments—the opposite of a shortage of investment opportunities.