A Better Analogy

October 27th, 2011 at 1:06 pm

Someone was just asking me about some right-wing talking points against stimulus that deserve a response—or at least a better analogy.

Critics like those at Heritage have used the analogy that stimulus spending is like taking water from one end of the swimming pool and putting in the other end.  A dollar that the government spends on stimulus is a dollar someone else won’t be spending, so there’s no net gain.

This is a typical pre-Keynesian mistake which, if adhered to, mires the economy in recession when we should be applying fiscal policy to generate growth–growth that otherwise would be sacrificed by those who don’t understand the dynamics of the moment.  It’s the kind of idea that drives Paul Krugman nuts, because he thought we’d already learned that lesson.

You see, the swimming pool analogy doesn’t work because it’s static—it ignores the dynamics…the actual moving parts in a real economy.  A static economy would be one without cycles—demand would be effectively constant—and you certainly wouldn’t have demand contractions like the Great Recession.

Once you admit such cycles, then the static view disappears.  It’s perfectly easy to imagine dollars sitting on the sidelines not getting spent or invested, and millions suffering unnecessarily because of it.

A better analogy is to think of the economy as a car and fuel as the demand that propels the car forward.  The gas tank is empty, but we’ve got a tank of gas sitting on the lawn next to the car.  If we put the gas in the tank, the car can get started and go somewhere.

Is there any more gasoline in the world?  No.  But we took the gas we had sitting there on the sidelines and used it to get the engine started.*

You can think of gas as the excess savings that won’t otherwise be absorbed because of demand contraction/liquidity trap.  And yes, the government will borrow the gas from idle gas reserves across the globe—monetary policy helps here too, by lowering the cost of borrowing—and pay it back once we’re back on track.

The folks who refuse to understand or accept this dynamic analogy simply assume that savings always instantaneously equals investment, so the gas must already be in car.  They’re like weathermen in a building with no windows, telling everyone that according to their computer model, it’s a beautiful sunny  day, when in fact there’s a hurricane outside.

And it’s not just academic.  It’s a tragic waste of human potential.

*The central bank may reasonably choose to print more “gasoline” at this stage, which also helps.

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21 comments in reply to "A Better Analogy"

  1. Ken says:

    Well said. Although gas sitting on the sidelines kind of implies that you don’t have to give the gas company an IOU. I would say borrow the gas at interest from a cooperative or something to make it a bit more realistic. The last thing you want a right-winger to hear about is anything “appearing out of thin air”.. their negative thoughts about the Fed are built on that statement.

    If deficit spending is deferred taxation (you eventually have to pay for the gas you used on credit), am I correct in saying that it is a good deal for the government in the short term to stimlate to help employ the 9.1% given these interest rates and historic inflation levels? After all, the nominal amount of debt erodes with inflation and current T notes seem to be purchased at lower rates than historic annual inflation expectations, right? Also important to mention, with better employment comes more revenue. Is this too easy of a picture to sell, or is the resistance to this idea just election year sabotage?


    • Jared Bernstein says:

      Exactly right.


      • Ken says:

        Of course, I know any model is more complicated than the short form explanation. That said, a few weeks back you offered a post about Treasury rates (8/22/2011). Now that you have launched a foray into occasional video usage on this blog, I hereby respectfully request that be the next taped lesson. It’s tough to fully understand that subject, and since we (the U.S.A.) seem to be working on that side of the ledger so often, maybe it would be a nice topic for next time. As always, thank you for your insight!


  2. Tom says:

    “It’s a tragic waste of human potential” That is the fundamental point. People who think like the Heritage folks also worry about inflationary effects of printing money, but ignore that printing money won’t be unduly inflationary if it does not cause demand to exceed the ability of the economy to deliver.

    Sometimes I think these people do not view the economy as a collaborative enterprise, but as a game, in which if other people are unemployed, or ‘losing’, they themselves are doing better, at winning the game at least.


  3. Tom in MN says:

    A flowing stream might be better analogy to stick to the water theme and explain why a swimming pool is a poor one. Just as you said, the analogy needs dynamics and not a static (pool) situation in the analogy:

    Flow down stream is purchasing. Workers take water from the bottom (earnings) and move it to the top of the stream (spending). When you are short of workers (unemployment), water accumulates at the bottom and is out of the economic flow. Government spending can replace the missing flow due to lack of employed workers by borrowing water from the bottom and taking it to the top, thereby increasing the flow of economic activity.


    • Auros Harman says:

      Yeah, that’s a good analogy. In fact, it’s so good that the “Circular Flow” model is commonly presented on the first day of undergrad Macro 101.

      http://en.wikipedia.org/wiki/Circular_flow_of_income

      It’s truly shocking to me that a bunch of supposedly-sophisticated economists do not seem to understand even the most basic ideas about money, like the idea that it is possible for capital to be idle. If some rich person decided to take out a billion dollars in cash and stick it under the world’s largest mattress, and then the Fed decided to print a billion dollars and give it to the gov’t to spend, would the freshwater folks insist that this was not helping to generate economic activity that would otherwise have happened anyhow? If they don’t argue with that, then how do they argue that moving dollars out of idle reserves ( http://krugman.blogs.nytimes.com/2009/12/14/followup-on-samuelson-and-monetary-policy/ ), into the circular flow, is any different?

      It must take some real training to un-learn this stuff.


      • Auros Harman says:

        “helping to generate economic activity that would otherwise have happened anyhow”

        Oops, this phrase should’ve been: helping to generate economic activity that would not have otherwise occurred”, or something like that…

        Our language does not express counterfactuals very well. We need an explicit subjunctive mood. (But then, my first degree was in linguistics, even if I am now an MBA specializing in finance…)


      • Tom in MN says:

        Ah Ha!

        It’s been 30 years since I took Econ 101 as my first and last Econ course, but I guess something stuck — even if I can’t remember that’s where I got it from.

        And yes, all the convoluted arguments about second order effects to try and avoid the obvious, like cutting jobs is unlikely to result in higher employment, is certainly baffling.

        P.S. I like my freshwater for sailing.


  4. Michael says:

    According to the anti-stimulus people, a “recession” is physically impossible. Since how could the water level in the pool be lower in the first place?

    That’s where to hit them — how do “recessions” happen, if it’s impossible to change the water level in the pool?


    • Tom says:

      Good point, Michael. And taking Jared’s car analogy one step further, if some people are hoarding gasoline on the sidelines, the government can put it in the car by taxing it.

      If I’m not mistaken, that is exactly what President Obama wants to do with the American Jobs Act.


    • Daniel Ullfig says:

      The great depression lasted the longest in the USA, because the government went into overdrive trying to “fix” the economy. Government can’t fix anything. Government can’t produce anything. People do. Every time government decides to further regulate, it makes it harder for people to produce, not easyer.

      Any regulation or law the government comes up with, requires unproductive time to comply with. Look at the income tax code. it is so massively complicated, an entire industry (tax preparers) exists just to comply with it. Tax preparers produce absolutely nothing. Thousands and thousands of people that make a living from producing nothing. No regulation can ever stimulate the economy. Regulations only get in the way.


  5. Fr33d0m says:

    Wrong analogy. You have to continually go back to the pump for gas, but you don’t have to continually stimulate demand.

    Perhaps if you thought of demand as the battery, ignition switch, or the starter. Either of these need only be activated once in the cycle. Each gets the parts moving until the engine fires, at which point none of these are any longer involved in keeping the car running. And none of these are necessary unless the car stops running.

    Your analogy says that stimulus does no more than temporarily making the economy work. The fuel is more like the natural resources. You need them as well, but they are consumed by the economy and their byproduct is motive power and waste.


  6. Michelle Murrain says:

    You say in this article: “we should be applying fiscal policy to generate growth”. And I agree in general principal with what you are saying here. My question – what do you think about those who argue that growth is basically gone, and we are running up against our resource limits, and we can’t realistically grow much more. For instance, Richard Heinberg, who wrote “The End of Growth.”

    I see that a lot of progressive economists talk about policies that are meant to “get growth going” – and I’d agree with those policies in principle, if I weren’t convinced, like Heinberg, that we’re hitting the ceiling – infinite growth isn’t possible in a world with finite resources.

    Thoughts?


    • SpreadEagle says:

      Recycle. No matter is created or destroyed.


    • Chigliakus says:

      Which resources, specifically, are we talking about here? The only one I can think of that has any potential to limit growth in the next 100 years is oil. If we haven’t yet hit peak oil we almost certainly will in the next decade. This isn’t an immediate barrier to growth, there is lots of oil still in the ground in various forms that is currently considered marginal but will become economically viable to extract when the price of oil reaches some threshold. There have also been some pretty amazing advances in biofuels research recently.

      Obviously there are other issues like global warming, which will certainly be a huge challenge for all of humanity in the coming decades. It will be expensive, but ultimately I don’t think remediating global warming and dealing with the warming and consequences we’ve already “locked in” will put a halt to growth either. I’d also add that as urbanization marches forward in developing nations we’re starting to see the population-growth-slowing effects that city life brings. World population growth should halt and even reverse this century, so if we can continue to grow economies it could result in a higher standard of living for everyone–at least if we can maintain a progressive tax structure and achieve a more equitable distribution of wealth.

      I guess I’m an optimist despite the looming challenges of this century…


  7. smartalek says:

    You see, the swimming pool analogy doesn’t work because it’s static—it ignores the dynamics…the actual moving parts in a real economy.”

    Indeed.
    And isn’t it passing strange that the very same pols (& their media mouthpieces) who castigate the CBO for making “static” projections re: tax-cuts (among other issues)– ie, for not taking into account that changes in taxation will cause changes in behaviors and outcomes — should utterly ignore that self-same sacred principle when it comes to projections of the impacts of gummint spending, esp cuts therein?
    Why, if one didn’t know better, one might suspect such people were engaging in, at best, hypocrisy, and at worst, deliberate deceit!


  8. Fred Donaldson says:

    A snowstorm has just knocked out power to 2.5 million Americans. Perhaps, underground utilities might be an important project, particularly if you want to keep Americans from freezing to death without electricity in freezing weather.

    Instead, government hides its head, and utilities focus on dividends rather than infrastructure.

    Whether raxpayers should assist in burying the grid is the kind of question that deserves national attention – not whether or not Obama smokes or was born in Kenya.


  9. Peter Konitz says:

    I firmly believe that Stimulus spending properly directed will benefit all U.S. citizens. Our infrastructure is crumbling and our efficiency in transporting large segments of society is reaching a breaking point. The indirect costs such as wasted fuel, motor vehicle accidents, lost productivity (can’t get much done in a traffic jam), wear-n-tear on existing roads etc. Our country was not built with transportation efficiency envisioned nor contemplated (fuel would always be plentiful & cheap right). So even with our high deficits having treasury print more dollars might not be such a bad idea. Rebuilding our roads, bridges and highways today in todays dollars just might be cheaper in the long run. Investing in and building High-speed rail to address how we are going to move 300mil+ people efficiently in the future would also be a sound investment. Business large or small cannot survive without employees and the ability to move goods and services. However until the R’s stop their relentless blockade of our government all for the sake of winning elections these will all be pipe dreams.

    Now hopefully I was not to far off topic and I am ready to receive whatever criticism may come my way.


  10. Daniel Ullfig says:

    Your theory is based on a fallacy. You say that there are cycles, and that money may be sitting idle needlesly while people suffer in other sectors of the economy. Sound nice, but here is the fallacy: the federal government is funded almost entirely on income taxes. Money that sits idle produces no income. Any and all taxes that the goverment collects, will be by definition money siphoned away from productive capital, not idle capital. So the stimulus is in fact taking money from one end of the pool, and pouring at the other end.


    • Stephen Beban says:

      Re: Ullfig: You’re forgetting the idle human capital: If a company lays someone off or forgoes hiring due to lack of demand – meaning they lack a secure income to justify said hire – stimulus allows them to hire that worker and the now not-idle worker has money to pursue his preferences, creating demand; this effect, en masse, has enough of an effect that the temporary hires can be sustained due to renewed cumulative demand from the ripple effects of a re-employed work force. I think of it as a tragedy of the commons problem.


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