Gosh...I'm not really sure. Naturally, and like most people, I have some opinions on what sort of policy responses are more likely to work than others. My opinions on this question have evolved over the last 20 years. I interpret this process as learning (or unlearning, in some cases). I've learned a lot of new theories; theories that have opened my eyes to how any given set of observations might interpreted in wildly different, yet plausible, ways. I've also learned something about the history of similar (yet each in their own way, distinct) economic events. Nevertheless, I remain very ignorant; there is still much to learn. I expect that my opinions--or my belief system, if you prefer--will continue to evolve in the light of new theory and evidence.
Recently, I've become interested in the theory of religion. I'm not even sure yet how one might usefully define the term. I have something like the following in mind: "An unshakable belief in some preconceived notion." Formally, one might begin by saying that a person has some prior belief b that A is true; where b is between 0 and 1. This belief may evolve over time according to some learning algorithm, b' = B(b,e), where b' is a posterior belief, updated from a prior belief b, and new information e. I like to think of B(.) as Bayes' rule; but other learning algorithms are possible as well.
I define a person to be religious along dimension A if b=0 or b=1. Now, one interesting thing about Bayes' rule is that b' = b if b = 0 or b = 1. In other words, a Bayesian who begins with an absolute certain prior (one way or the other) will hold on to an unshakable belief (will not learn from any new information). We are all likely religious, in this sense, along at least some dimensions. If we are, then we might do well in recognizing the phenomenon when it occurs and at least be honest enough to own up to it.
On to some macroeconomics. In reply to the question posed above, imagine that someone proposes policy A; where A = a large fiscal stimulus policy is socially desirable in the event of an economic "crisis" as described above.
Now, if you would have asked my opinion on policy A several years ago, I think I might have assigned belief b = 3/4 that A is true. Given what I know today (which is still not very much), I would assign something closer to b = 1/4. In short, I would say that policy A is likely to fail. My good friend, Nick Rowe of Carleton University, expresses an opinion that is closer to b = 3/4. He believes that such a policy is likely to succeed. While we both have very different opinions, we each acknowledge that we really do not know for sure. That is, we are not religious on this matter.
Such differences of opinion are quite natural. The differences can likely be accounted for by the fact that both Nick and I have been exposed to different theories, have read different historical accounts of past crises, and have generally had different personal experiences that, together, have led our beliefs to follow different paths. But because we are not religious, and because we recognize this is so, we find it fruitful to persuade each other (and in the process, ourselves) on the validity of our beliefs. This is, I think, the best we can probably hope for in any science.
This all leads up to the topic of religion in macroeconomics. This field, more than any other it seems, appears to populated by true believers who like to view themselves as priests of some sort. One sure way to identify a priest is in how "exasperated" they become when failing to gain converts on the basis of what they know to be an "obvious" truth. Take Bruce (Father) Wilder for example. He knows that b = 1 when it comes to policy A.
Father Wilder, I have a confession to make.
What is it, son?
I'm not sure that hell exists.
What?! This is blasphemy!
So hell exists?
And how do you know?
Poor, wretched and miserable child!
Um, yeah...OK. But really, how do you know?
It is obvious, you cursed flea-brain; the Bible says so!
Forgive me father, but there appear to be some inconsistencies in the Bible...
You are damned, child...you must endeavor to dismount the fortress of your conceit!
Maybe you can help me, Father...just a little bit of evidence...please?
The flames of Satan himself! Are you blind?
I'm not sure, Father...I have heard that volcanoes might be plausibly explained in some other manner.
How dare you question my authority!?
Sorry! I'm sorry I asked! Yes, I see it now...volcanoes. Got it.
I now direct you to Father Wilder and his volcanoes here.
Can fiscal stimulus spending increase aggregate output and employment? Yes.Um, OK. But this was not the question. Even in the simple static labor-leisure model, output can be made to increase with an increase in G. We know this, you dope. We also know from history that conscripted labor can achieve the same result. But the associated increase in (measured) GDP is not necessarily welfare-improving (although it could be for certain individuals or sectors). What evidence can you bring to bear that a fiscal stimulus actually worked in a time of crisis?
Is there good evidence that this is the case? Yes. What is this good evidence? Well, pretty much the whole history of macroeconomic fluctuations in output and employment is evidence in favor of fiscal stimulus "working" in this positive "mechanical" sense.
If you say so, Father Wilder. Can you show me some evidence...please? Show me, so that I too may be saved from the flames of damnation!
Every year, employment increases with the seasonal rise in Xmas retail sales, and that fluctuation in output and employment is evidence that the economy works in a way that makes fiscal stimulus spending effective in increasing aggregate output and employment (when output is low relative to capacity and unemployment is high).
Volcanoes?! Father, I too am aware that GDP drops by about 90% every night; and there are frequently two consecutive periods (called weekends) in which GDP drops by a similar amount. I am also aware that seasonal fluctuations are huge. Having worked in the construction sector myself for many years, I know what cold weather can do to productivity. I am aware of the boom in expenditure that accompanies seasonal sales. I also know that these fluctuations can all be easily explained by a simple labor-leisure model with time-varying shocks to productivity and preferences. How is this relevant for understanding how fiscal stimulus is likely to mitigate what happens during an economic crisis? I hate repeating myself, but is there any evidence that you might bring to bear on this question?
Every business cycle provides plentiful evidence that rising aggregate spending drives increased output and employment. That kind of aggregate fluctuation kind of defines the business cycle. In the U.S. historical experience, two prime applications of fiscal stimulus as policy, inadvertently in WWII and deliberately during the Kennedy-Johnson Administration, certainly demonstrate increases in aggregate output and reductions in unemployment and chronic poverty. If you want to, you can find plenty of evidence in regional fluctuations as well -- the effect, for example, of the Reagan defense spending increases on Boston's Route 128 were pretty dramatic.
(The man must be hard of reading). Regional fluctuations? I already admitted the case in favor of helping out depressed sectors or regions. I am talking aggregate here. I am not talking about WW2 or the 1960s. I am talking about severe (non-war) economic crises, like the one we're currently experiencing, and like those experienced in history. (And the idea that aggregate spending "drives" the economy is an hypothesis, not a fact. You are confusing correlation with causation).
Let me try to help you out, Father Wilder. One legitimate question that could have been raised is why I think b = 1/4. One piece of data that led me to revise this belief downward was the case of Japan; see, in particular,
This is annual data from the Penn World Tables; and I've talked about it before here. The blue line measures real per capita GDP in Japan relative to that of the U.S. The red line measures the (G/Y) ratio in Japan, relative to that in the U.S. The blue and red lines are virtual mirror images of each other. In particular, note how late in the sample, the relatively expansionary fiscal stimulus in Japan is associated with a relative decline in their GDP.
Now, this is a rather interesting diagram, I think. Doesn't prove a damn thing of course. But it should lead one, I would think, to step back a moment and ponder the validity of b = 1.
Different interpretations are possible. One is that the data is lousy and hence conveys no useful information (so that prior beliefs may remain unchanged). I have some sympathy for this view. Another view is that the large fiscal stimulus in Japan may indeed have worked; in the sense that absent any stimulus, the blue line would have plummeted far more than it did. Yes, this is a possibility; although I wonder how many people might find it persuasive? The other interpretation, of course, is that the fiscal stimulus did not actually work at all; and in fact, likely made things much worse. This may or may not be true, but it certainly does not sound crazy to me. Certainly not crazy enough to deserve the pompous and pretentious sermons of an exasperated preacher trying to convince someone otherwise.
So, I am done asking the same question over and over again to Father Wilder. But I would like to direct this question to others. I am almost certain that one of you can come up with some data over some relevant time period for some crisis episode that might lead me to revise my belief in the other direction. I am very curious to see what the data looks like for the 1930s (a cross-country sample would be desirable).