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Uhh....imports in that period also grew dramatically. So much so that it appears the net effect of international trade on GDP was ~20% of the change in GDP.

Consumption growth was more than twice as big and investment growth was of the same order.

Here is a chart with net exports. The same story holds: in the 1990's net exports took up the slack from govt spending.

I don't disagree that net exports increased GDP. But the single biggest driver was consumption growth, by a long shot. Net exports was a fairly small part of the total story.

Sure. But that's probably cold comfort for the US - it's not clear that they can afford another round of consumption-fueled expansion.

I think you missed the most important point: Canada had interest rates that were comfortably above zero, so monetary policy had complete leeway to offset the fiscal contraction (and would be anticipated to do so).

I imagine that monetary policy is a large part of the reason for the exchange depreciation. But even in a closed economy monetary policy can ordinarily offset a fiscal contraction. The US in the 1990's is an example (not a closed economy, of course, but one where monetary policy operated through other channels). Nobody seems to use that example. Maybe the US fiscal contraction wasn't dramatic enough to make the point. Or maybe supporters of fiscal contraction don't want anyone to be reminded of the obvious contrast between the US in 1992 and the US today.

Also in the 1990s: very low dependency ratios - relatively few 65+s or under 18s. Not true now.

MattM, I would challenge the notion that consumption growth was the major "driver", though it depends on what one means by "driver". I expect that much of the consumption growth was a multiplier effect from export growth, as the growth in private employment suggests. And much of it was induced by the monetary policy response to the fiscal contraction (via rising asset values and cheaper consumer credit). It certainly wasn't something that the US, facing a zero interest rate constraint, and Europe, which avoids that constraint only by adopting a more severe self-imposed constraint, can hope to replicate today.

"I expect that much of the consumption growth was a multiplier effect from export growth"

This sounds like mercantilist thinking.

I think you missed the most important point: Canada had interest rates that were comfortably above zero, so monetary policy had complete leeway to offset the fiscal contraction

I'd interpret that as being related to point 3): since Canada is a small open economy, it gives us an extra degree of freedom - the exchange rate. The US could gain from depreciating against the euro (by how much?) and vice-versa (again, by how much?), but they can't both depreciate against each other.

correct me if I'm wrong, but isn't MattM Ignoring the fact that consumption contributed less to growth in the 90's than it did in the 80s?

I mean, isn't that what the chart shows? Wasn't there slack in consumption, investment and government spending relative to the 80s, with net exports being the only one showing an increase relative to the 80s?

Fiscal austerity? What ARE you talking about?

Federal outlays expanded by ~2 trillion in the past year including the 'off balance-sheet' vehicles (GSEs + other home loan schemes). State outlays have contracted slightly. The president's last budget shows a permanent increase in Federal outlays of 3% of GDP going out into the future.

Everyone believes those numbers are low.

State budget cuts are being muted because future pension payouts are anticipated to be very high, and except for California no one is entertaining a net decrease in expenditure.


Evidence, please.

The Echo Generation, of which I am a part, is moving into its career and child-bearing years.

Baby Boomers may retire but we do have people in the pipe to replace them.

In the 1990's the Echo Generation was still moving through the school system. That's why so many schools sprouted portables.

If you wish to worry about dependency ratios, please provide concrete evidence and cost comparisons. Else I refuse to worry about a problem that doesn't exist.

Determinant, if the dependency ratio is not increasing, why is the CPP planning to build a $250 billion hoard?

"The US could gain from depreciating against the euro (by how much?) and vice-versa (again, by how much?), but they can't both depreciate against each other."

That's why European Austerity will lead to Debt-Deflation, and not a Competitive Advantage against others. That's also why they're touting free trade. Their measures are devaluing the Euro, and any US response will be called Protectionism. Nevertheless, the US will take measures to offset their policies. However, they're already fudging a bit about their austerity plans, so some of this talk is politics.

So do you basically agree with this post?


It appears to me to be consumer debt (mostly lower and middle class) in Canada for consumption growth and consumer debt (mostly lower and middle class) in the USA for exports from Canada.

Good discussion Stephen and others. Very pertinent for ongoing policy debates. Stephen, you write:

"The US could gain from depreciating against the euro (by how much?) and vice-versa (again, by how much?), but they can't both depreciate against each other."

This plus the interest rates zero-lower bound seem to point to significant deflation/persistent recession risks. Fortunately, real interest rates are low, thanks to the fact that generalized and persistent deflation has not arrived yet. Low real-interest rates provide some stimulus. Also, non-conventional monetary policy measures should help, even though their impact is uncertain as was pointed out by Nick and others in previous blogs. In addition, there is the fact that most of the planned fiscal contraction in economies such as Germany and France is to become concrete in coming years, not immdiately.

A significant risk is financial sector weakness. The recent announcement that European governments will publish stress-tests is good news. Especially if this comes with concrete measures to address weaknesses. There will be a fiscal cost to this, however.

Lower net exports from China and a few others would help.

Thanks for the discussion.

"If you're going to count on exports to sustain aggregate demand while your government cuts back, you have to figure out which foreign economy is supposed to absorb all that extra production"

Why is everyone so hell bent on donning their hair shirts and self flagellating? Isn't the major advantage of fiat currency regimes that the CB can just about always sustain aggregate demand with nothing more complex than a printing press? Why the reluctance to break out the helicopters and drop a little free money on households? Is 5%-6% inflation for a few quarters really so much scarier than a decade of 10%+ unemployment (20%+ in parts of Europe). What am I not getting?

PK's take (with a reference to WCI):


You're absolutely correct. Arguing that fiscal tightening will lead to persistent weakness in aggregate demand is tantamount to arguing that central banks are incapable of hitting their inflation targets. If demand is weak due to fiscal tightening, inflation will fall below target and the central bank will leave rates lower for longer than otherwise (or make a conditional commitment or buy government bonds, or stop paying interest on reserves, or charge interest on excess reserves, or target longer maturity treasuries rate or move monetize some of the outstanding stock of debt or do whatever needs to be done).

Currency depreciation is just one mechanism whereby money stimulus affects AD - monetary stimulus also boosts consumption and investment. It’s just that currency deprecation boosting net exports is the easiest channel to see – particularly for those economists who tend to focus on the real (rather than the nominal) shocks that affect the economy.

I'll leave the finer points of the economic arguments to others more knowledgeable. However, what I remember is the conditioning of public opinion in Canada that provided the leeway and room to manoevre for Paul Martin c 1994.

As recall, under Mulroney, Michael Wilson in the mid 80's started making significant efforts to reign in spending/restructure by bringing in Free Trade, GST (a failed attempt to de-index pensions - Remember the senior threatening Mulroney with "Goodbye Charlie Brown"? Then, to much disappointment (mine included) Mulroney reverted to the old traditional pork style political campaign in the 1988 election - which ultimately led to the party's splintering and further emergence of the populist Reform party under Preston Manning (with chief strategist - a young Stephen Harper, formed 1987).

It was their constant messaging of fiscal prudence that eventually brought them to become the official opposition in 1997 (Canadian's took their revenge on Mulroney by reducing his party's seat count to 2 in the 1993 election) and split Chretien's opposition.

At the same time, while Reform was preaching constraint, the CTV's W5 ran a program on New Zealand's "debt crisis" that had ominous signs for Canada unless we reigned in spending. This had a profound impact on public opinion, and set the stage for Paul Martin's budget. One summary here:

There were many who believed that Malling's attitude was too cavalier, that in his quest for edge he could cause real harm to people. His hour-long "New Zealand" documentary for W5 in February 1993 was one such example. Journalist and author Linda McQuaig was infuriated by the program. "It was just full of misinformation," she says. Malling argued that Canada should follow New Zealand in dramatically restructuring its government to reduce debt. In New Zealand's case that meant, among other measures, an end to universal medicare and the sale of state-owned forests. McQuaig says he distorted the situation in New Zealand by presenting what was really a short-term currency crisis as something else: national bankruptcy and the loss of credit. The real issue - an overvalued currency - she says, was never brought up. "I'm talking about confusing the issues," she says, "making people believe things that aren't true because that's the point that he wanted to make. You don't need to come out with a technical lie to do that."

"New Zealand," which drew an audience of 1.6 million, had a huge influence on Canadians. Indeed, politicians used it as justification for slashing social services in the name of debt-reduction. Ralph Klein's Conservative government in Alberta, for example, included transcripts of the program when it sent back rejected grant applications.


I spent much of the period that JVFM is talking about working at the Bank of Canada and I've had the pleasure of visiting the Reserve Bank of New Zealand a couple of times and talking about their "reforms". For what its worth, I agree that the "conditioning" of Canadian public opinion was crucial in providing the political support that made it possible for Paul Martin to largely succeed where Michael Wilson had tried and largely failed.

But another factor that struck me at the time was the role that monetary policy played under Mulroney in making fiscal consolidation harder. From 1988 to 1992, the Bank of Canada was keen to establish its inflation-targeting credentials; that meant quite tight monetary policy until people believed that Crow was really, really serious about fighting inflation. (He was!)

But at the same time, the government was keen to reduce the costs of carrying all that government debt so (as all such governments eventually do) they had increasingly shifted the debt to shorter (and therefore more interest-rate sensitive) maturities, to make the best of the lower interest rates that short rates usually offer.

Think about what that does to the credibility of policy makers. The government maximizes the pain it will suffer from tight monetary policy, just as the central bank is trying to convince them that it will keep rates high for "as long as it takes." That makes it very hard to believe in both fiscal cutbacks and lower inflation at the same time. I think Pierre Fortin pointed out at the time that Canada's sacrifice ratio in that recession looked very by international standards; I always wondered whether that was due to the poor coordination of monetary and fiscal policy.

Ooops....make that "....very high by international standards."

"What am I not getting?"

This is what you're not getting:

See Nick's prior posts on NK models.

Jon: not sure what you're getting at. I could be reading it wrong ... to me that looks graph looks like a symptom of insufficient demand. Wouldn't a helicopter drop to households help with that?

Interestingly, in the States, Republican administrations (ever since Reagan) have run up huge deficits, and the public was silent. As soon as a Democrat comes into office,Republicans suddenly become aware of the deficit again, and demand that the Democratic president fix it!

The only way to restore the country is by reversing Reaganomics. Subject corporations to the free market system that they claim to love (i.e., no more tax breaks and bail-outs). End off-shore tax shelters, and any corp that wants a penny of taxpayer money must be prohibited from exporting jobs for at least 10 years. Invest in the American people -- most specifically, make education and legitimate job skills training available to all qualified Americans, regardless of income. We need to build a modern, qualified workforce and restore responsibilities to businesses. Getting more people into jobs, and ensuring that these jobs pay a family-supporting wage, will significantly increase tax revenues -- and that's the only way we can reduce the deficit. The Republican focus on defunding everything that helps individual Americans, from basic human needs funding to higher education, has been very destructive to the US.

It's time to put the people ahead of corporate powers.

I think the data offered by Stephen fit well the ¿Monetarist? model (or NK, if you prefer: I´v just decided not to see the differences): at the aend, fiscal and monetary policy must be very accurately mixed to reach near full employment without inflation. If the debt is so huge as to demand a fiscal consolidation (in spite of Krugman), the contractive effects MUST be compesated by an expansive monetary policy. The devaluation of the Canadian $ was a wellcome consequence of the policy mix. But not ever the history is so satisfactory, because not ever the rest of the world cooperate so kindly: think of China.


Good point. But you have to consider who benefits/loses from inflation. People with large savings and investments lose big time from inflation. People who are pretty much living from hand to mouth are barely affected by it (assuming that their salaries inflate in a timely manner as well).

In other words, inflation hurts the people who can throw lobbying dollars around, which is why it is absolutely unacceptable.

Keep in mind that the low Canadian dollar at the time was the cause of much wailing and gnashing of teeth, and existential crises. Most Canadians think that the currency is merely a vote on confidence in the country. People were suggesting we adopt the US when the exchange was at 65 cents USD:CAD to prevent any further devaluations. It's really quite amazing how collectively boneheaded the Canadian public was wrt currency at the time.


"Why is everyone so hell bent on donning their hair shirts and self flagellating? Isn't the major advantage of fiat currency regimes that the CB can just about always sustain aggregate demand with nothing more complex than a printing press?"

It is, It is! Unfortunately mainstream economist believe in wrong monetary theory - the exogenous money theory, that states that printing money is highly inflational, due to money multiplier. In the real world, money supply is endogenous and money multiplier does not exist!

This is highly damaging to the world economy and will soon plunge us back to the recession - no make that depression if policies are not changed.

I wonder if anything could be done to raise awareness about endogenous money theory.

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