How To End The Recession

We are in the midst of the worst recession since the Great Depression. It is therefore logical that we should see how that recession was ended for solutions to our current problems. It was solved by  cutting taxes and increasing government spending following the theories of John Maynard Keynes. This was implemented first in America as part of the New Deal, and eventually by the rest of the world as part of the Second World War.

The logic is simple. Let’s say the government hires unemployed workers to build a road. These workers gain, but so does the local businesses as the wages are spent in their shops. The businesses can then start rehiring. These new workers spend their wages, allowing more businesses to hire more people and so on. This virtuous circle continues until the economy recovers. The government benefits as it is no longer paying unemployment benefit to people (so expenditure goes down) and the newly hired people can now pay tax (so revenue goes up)

Note that economy benefited from more than just the initial government spending. This is known as the multiplier and while there is discussion of its size most economists estimate it to be around 2. This means spending 5 billion, increases the size of the economy by 10 billion. Critics point out that this would not work as well in Ireland because of the large amount of imports we buy (meaning the benefits would go overseas). While this is true it ignores the fact that Ireland has a fixed exchange rate which makes a fiscal stimulus more effective. Also this “leakage” would be mitigated if our main trading partners launched their own stimulus’s.

This is a simplified version of the New Deal which greatly reduced American unemployment during the 30’s. However government spending was too small to reduce unemployment enough. It wasn’t until the Second World War with its huge spending on armaments that unemployment was no longer a problem. War spending provided income and jobs to the soldiers and factory workers. The bottom chart shows the drop in unemployment (dotted line is actual unemployment; solid line is unemployment minus those employed by government work schemes).


The next chart shows government taxes and spending. Note the link between the increase in spending and the decrease in unemployment. Also in 1937, spending was cut, taxes raised, the budget balanced . . . and unemployment rose.


Among those calling for a stimulus are Paul Krugman (who won a Nobel Prize in Economics) and Joseph Stiglitz (who also won the Nobel Prize) and in Ireland by Michael Taft and others at the think tank Tasc. Last week 40 economists and social scientists wrote an open letter to the Irish Times calling for a stimulus.

The main question most people have is where would the money come from? There are two main potential sources. 1. A loan. As it stands Ireland is blocked from the bond markets due to our banking debt (which is why any solution has to include a restructuring of bank debt). The IMF-ECD bailout also provides something of a hurdle to climb. 2. Savings. The ESRI estimates we have 50 billion worth of savings put away for a rainy day. Now is as good as time as any to use some (obviously not all or even most) of it to create jobs.

Obviously this plan is not perfect (nothing is). Obviously the debt will have to be paid back in the future, but by then the economy and tax revenues will have recovered so we will be much better able to handle it. This is a rough and simplified idea of how Ireland can get out of the recession. But it’s a start.

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