Underutilization of capacity and Ricardian equivalence


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In a recent blog post “Ricardian Confusions”, Paul Krugman commented on my paper “Beyond Keynesianism and the New New Normal” delivered at the Council on Foreign Relations on Feb. 28. He points out that the government’s fiscal stimulus generally is temporary and households will not increase savings by the full amount of the stimulus. As a result, the stimulus is expansionary even if Ricardian equivalence holds. His comment triggered a series of discussions (Antonio Fatas and Ilian Mihov, Mark Thoma, Paul Krugman, Nick Rowe, and Brad Delong).  
I have no disagreement with Paul about the possibility of an expansionary effect of a temporary fiscal stimulus. But if the effect exists and the stimulus does not increase productivity as in his example, there will also be a contractionary effect after the exit of stimulus and the increase of tax to retire the public debts. At the end the issue of underutilization of capacity, which my paper attempts to address, will still be there. 

With the existence of large underutilization of capacity in the industrialized countries’ capital goods sector, I see the need for a Keynesian type of stimulus. However, as elaborated in my paper, the stimulus should be used for projects that are bottleneck-releasing, productivity-enhancing and self liquidating instead of “digging a hole and paving a hole”. Such investments will increase jobs and demand now, and increase the growth and government’s revenue in the future. I am delighted to see that this important part of my argument was picked up by Nick Rowe, who differentiated between useless government expenditure and useful government expenditure.

Related link-  Beyond Keynesianism — The Necessity of a Globally Coordinated Solution | Harvard International Review



Justin Yifu Lin

Former World Bank Chief Economist and Senior Vice President

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