There are criticisms that some of elements of the stimulus announced by former Prime Minister Mahathir Mohamad do not have immediate impacts, and so it should be replaced with more immediate responses. Responses like bigger cash transfer and bigger spending now. And the new Cabinet seems on course to enlarge the stimulus.

I am here to say, this stimulus needs to address several time horizons. The present as well as the near future. And this is why medium run elements are crucial.

One aspect why it is important is the need to encourage the hoarding of labor in order to minimize job losses. It is about building expectation justifying that hoarding.

I have a simple chart to explain how that is possible:

The chart shows the level of employed labor for 3 types of period. There are two lines signifying a stimulus without medium term expectation setting (blue) and a stimulus with one (red).

A stimulus without medium term expectation setting: companies faced with an negative economic shock will shed labor. This will increase the national unemployment rate. Increased unemployment will affect income negatively and that in turn will adversely affect consumption growth, and inevitably the GDP growth. Companies will shed labor because they do not have a clear view of the medium-term horizon and will optimize their labor size now given current situation.

In constrast, a stimulus with medium term expectation setting will provide these companies with clearer view of the medium-term. It tells them they will need the labor soon, but not now. So, rather than shedding labor, they would try to conserve it and in doing so, not reduce their capacity (by too much). In effect, it will help cushion the unemployment rate from rising as fast as it would under a stimulus without medium term expectation.

So in theory, a stimulus with medium term elements will shed fewer workers than a stimulus without.

Here is the thing: we can do both immediate and medium term elements in a stimulus. There is little reason to decide which one should come in and which one should go out. Both time horizons can be addressed. Both need to be addressed.

There is also another element in play to justify medium term plans: while we are facing both demand and supply disruptions, stimulus is not good at handling the latter. Pumping more money will not solve the supply-side. This gap can be addressed by expectations.

2 Responses to “[2905] Stimulus is about expectation setting too”

  1. […] Point 3 is the ultimate objective. When things become normal, we want the economy to jumpstart and hit its pre-crisis mode as soon as possible. Here, we try to avoid having permanent, or prolonged potential loss. Permanent losses could happen as workers become out of work for too long, and losing their momentum to work or even their skills. So, the relevant policy is labor hoarding and incentives to keep firms in business. Both will need convincing expectation-setting by the government. […]

  2. […] in particular will need the cash, especially if they are to hoard labor and preserve their potential. One of my favorite ideas involving the central bank is for Bank […]

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