Stimulus and Inflation in Canada

In an op-ed piece in yesterday's Globe and Mail, economists Richard Lipsey and James Dean make the case that deficit financed stimulus spending is unlikely to produce inflation and simply will not crowd out private investment.

Much of the concern about both, they argue, simply reflects ignorance of economic theory. Thus

Critics often do not point out that these two arguments cannot both be true. If government spending merely replaces private spending dollar for dollar, it does not affect total demand and hence cannot be inflationary.

If “crowding-out” is significantly less than 100 per cent, new spending will employ labour and capital that is now idle and the earnings of workers and investors will reignite both consumer and investment spending. To be sure, stimulus programs should target projects with productive potential. Economies from Canada to China are in dire need of new physical and social infrastructure. But even “unproductive” projects are better than none at all if the alternative is to leave labour and capital unemployed.

And if stimulus spending for infrastructure does come on stream after the end of recession, when real resources and financial markets are re-employed, there are adequate monetary tools to contain such pressures.

Therefore, they reason, stimulus spending, far from impeding recovery, is the road to it. As they conclude

In short, arguments that deficit-financed stimuli will be crowded out are far-fetched in the extreme, even when the deficit is as massive as the Americans'. Yes, “real” crowding-out happens when labour and capital are fully employed. But the essence of our present problem is that the enormous productive capacity of our economies is dangerously underutilized, not the reverse.

And yes, “financial” crowding-out also happens when financial markets are fully utilized. But they are not; the core cause of our present problem is that credit markets are seriously underutilized, and financial markets have melted down. Financing large fiscal deficits by tapping those markets is much more likely to revive them than the reverse.