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Stimulus? What stimulus?!

Hardly a day goes by without another politician, an expert, or a civil servant thoughtfully talking about how they would like to stimulate the economy.

Their near unanimity on desirability of the stimulus is strikingly at odds with the absence of such stimulus. Surreally, this all creates an impression that ‘stimulus’ is some sort of badly needed, but forbidden substance – that there is some kind of ‘stimulus embargo’ imposed by the evil IMF&Co. Watch how politicians gleefully report on how they succeeded in smuggling in some little stimulus to help the economy. What’s going on?

Well, if you give it some thought, there are more things that are at odds with the stimulus. Here are two more. Contradiction #1: ‘Stimulus’ is incompatible with deflation. Those same people tell you that deflation is a necessary evil, don’t they? Deflation is the path to restoring competitiveness of Latvian businesses internationally and domestically, isn’t it? Yet it doesn’t take a PhD in economics to understand that ‘stimulus’ and deflation are two mutually exclusive events. Prices just can’t drop if you’re pouring stimulus into the economy.

Contradiction #2: ‘Stimulus’ is incompatible with reasonable levels of public debt. Stimulus means expansive fiscal policy, as opposed to fiscal consolidation prescribed by the IMF program. That is, the public sector should spend more and, therefore, run larger fiscal deficits. Now, without the fiscal consolidation the budget deficit would probably be around 12% of GDP. So implementing a stimulus would imply deficit levels of 15%, 20% of GDP? More? Even with all the fiscal consolidation (including 1 billion euro cuts over the next two years) the level of external public debt is projected to increase to 60-70% of GDP in the medium term. These already are the levels that are considered to be rather dangerous for developing countries. What levels of public debt we’re talking about with the stimulus? 100% of GDP? 150%? Overtaking Greece?

I could go on and on by pointing more contradictions, but the point should be clear. Fiscal stimulus was never part of the stabilization package that the Latvian government agreed to in November 2008. The government (and the leadership of nearly all the political parties) must be aware of this. The IMF thinks they are aware of this. Quoting from the IMF’s Second Review on Latvia (p.15), “The authorities recognize that the program does not offer any space for expansionary measures (apart from social safety net and EU funds-related spending).” This begs the conclusion that any politician that talks about the stimulus either does not understand what he (or she) signed up for, or is knowingly misleading the public.

Why peddling the ‘stimulus story’ is such a thriving business (for politicians and experts) here in Latvia? I think there are three reasons. First, Keynes couldn’t have put it better when he said that "practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist…" Most people’s (in Latvia) knowledge of economics seems to amount to thinking that if there is a problem with the economy, one needs to add more money (i.e. stimulus). Second, it does seem to conform to what the developed countries are doing, i.e. running huge fiscal stimuli. Of course, the fact that economic crisis in most developed countries has different roots is a subtlety that is lost on your average layman. And finally, “the IMF doesn’t let us stimulate the economy” falls well with most Latvians’ instinctive distrust of and suspicion towards the foreigners. Another manifestation of Soviet after-effects, I guess.

Therefore, expect whining about the stimulus to continue.

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