“One of the Obama arguments at the time was that the rush in the stimulus program was needed to avoid a Great Depression. This was and is highly doubtful (though, yes, it is widely accepted). The US economic emergency in late 2008 and early 2009 wasn’t really an aggregate demand crisis but a financial crisis. The chaotic failure of Lehman Brothers had led to an intense panic and credit squeeze. The Fed therefore needed to flood the markets with liquidity, which it rightly did, in order to unwind the panic. The Fed’s action was the real difference with 1933 (when the Fed allowed the banks to fail). It was the Fed, not the fiscal stimulus, which prevented a fall into depression.” — Jeffrey Sachs, Responding to Paul Krugman and Crude Keynesianism
Archive for the 'Fiscal Stimulus' Category
The blogosphere reminded me of this future economic bet between Paul Krugman and Greg Mankiw that Mankiw clearly won:
In early 2009, the incoming Obama administration’s Council of Economic Advisers predicted real GDP would rebound strongly from recession levels. In a blog post, Greg Mankiw expressed skepticism. In their blogs, Brad DeLong and Paul Krugman sighed. Of course there would be strong growth, they maintained, because the recovery of employment would mandate it via Okun’s Law. Mankiw challenged Krugman to a bet on the issue, but there was no response. Of course we now have a good idea of the likely outcome, but I posit a hypothetical time series econometrician who, at the time of the blog entries, applies some standard forecasting methods to see whether DeLong and Krugman’s confidence was justified. The econometrician’s conclusion is that Mankiw would likely win the bet and furthermore that a rebound of any significance is unlikely. The econometrician has no idea how DeLong and Krugman could have been so confident in the CEA’s rebound forecast.
Here is the relevant 2009 post where Mankiw challenges Krugman to a bet.
McArdle makes a decent case to be cautious about fiscal stimulus here:
Starts to pick up at the 3 min mark.
Megan McArdle writes:
Hoover did not tighten up on spending. According to the historical tables of the Office of Management and Budget, spending in 1929 was $3.1 billion, up from $2.9 billion the year before. In 1930 it was $3.3 billion. In 1931, Hoover raised spending to $3.6 billion. And in 1932, he opened the taps to $4.7 billion, where it basically stayed into 1933 (most of which was a Hoover budget). As a percentage of GDP, spending rose from 3.4% in 1930 to 8% in 1933–an increase larger than the increase under FDR, though of course thankfully under FDR, the denominator (GDP) had stopped shrinking.
This spending represented a substantial increase over the Coolidge years (outlays had been steady between $2.85 billion and $2.95 billion since 1924). And in real terms they represented a very substantial increase, since both nominal and real GDP were falling.
Hoover did not tighten up on spending. According to the historical tables of the Office of Management and Budget, spending in 1929 was $3.1 billion, up from $2.9 billion the year before. In 1930 it was $3.3 billion. In 1931, Hoover raised spending to $3.6 billion. And in 1932, he opened the taps to $4.7 billion, where it basically stayed into 1933 (most of which was a Hoover budget). As a percentage of GDP, spending rose from 3.4% in 1930 to 8% in 1933–an increase larger than the increase under FDR, though of course thankfully under FDR, the denominator (GDP) had stopped shrinking.This spending represented a substantial increase over the Coolidge years (outlays had been steady between $2.85 billion and $2.95 billion since 1924). And in real terms they represented a very substantial increase, since both nominal and real GDP were falling….
Hoover did not tighten up on spending. According to the historical tables of the Office of Management and Budget, spending in 1929 was $3.1 billion, up from $2.9 billion the year before. In 1930 it was $3.3 billion. In 1931, Hoover raised spending to $3.6 billion. And in 1932, he opened the taps to $4.7 billion, where it basically stayed into 1933 (most of which was a Hoover budget). As a percentage of GDP, spending rose from 3.4% in 1930 to 8% in 1933–an increase larger than the increase under FDR, though of course thankfully under FDR, the denominator (GDP) had stopped shrinking.This spending represented a substantial increase over the Coolidge years (outlays had been steady between $2.85 billion and $2.95 billion since 1924). And in real terms they represented a very substantial increase, since both nominal and real GDP were falling.
“… there is no hard and fast distinction between cyclical and structural unemployment. For instance, if structural unemployment in American has risen closer to European levels, it may be partly due to the decision to extend unemployment insurance from 26 weeks to 99 weeks, and to increase the minimum wage by over 40% right before the recession. Does that mean that demand stimulus cannot lower unemployment? No, because the maximum length of unemployment insurance is itself an endogenous variable. If stimulus were to sharply boost aggregate demand it is quite likely that Congress would return the UI limit to 26 weeks, as it has during previous recoveries. For similar reasons, the real minimum wage would decline with more rapid growth in demand. Aggregate supply and demand are hopelessly entangled, a problem that many economists haven’t fully recognised.” — Scott Sumner, guest blogging on The Economist Blog
“When people like Paul Krugman say that almost $900 billion in stimulus didn’t work because it wasn’t big enough, you have to wonder if an adequate Keynesian stimulus is even possible. Could any government anywhere borrow 15% of GDP or more to spend on temporary measures with the blessing of their citizens? For that matter, would the markets lend the money without ratcheting up interest rates? Can an extra 15% of GDP be spent without showing sharply diminishing returns–meaning that you’d need even more spending to generate the effects you want?” — Megan McArdle
It looks like it’s the union auto industry bailout that was the costliest:
The much-maligned TARP program will cost taxpayers only $25 billion according to the latest estimates from the Congressional Budget Office. That’s substantially less than the $66 billion CBO estimated back in August or the $113 billion that the Office of Management and Budget estimated in October.
The good news, budget-wise, is that the government is on track to make about $22 billion on its assistance to banks.
However, CBO estimates that TARP’s other activities will cost $47 billion. This reflects aid to AIG ($14 billion), the auto industry ($19 billion), mortgage programs ($12), and a few smaller programs ($2 billion).
Donald Marron has more here.
“Wading through the online debates, I note that opinions on stimulus are nearly 100% correlated with the composition of that stimulus, and the opinionator’s prior view of that activity. So when Democrats are in power and stimulus is mostly spending, liberals think that the stimulus is an issue of fierce moral urgency stymied by venal greed and rank idiocy, while conservatives develop deep qualms about budget deficits. When Republicans are in power, and stimulus consists mostly of tax cuts, Democrats get all vaporish about deficits and the income deficit, while Republicans suddenly realize that the normal rules don’t apply in an emergency. When out of power, both sides will grudgingly concede that some small amount of highly temporary stimulus might be all right, but note (correctly) that the other side seems to be trying to make permanent as much of this “stimulus” as possible.” — Megan McArdle
Harvard economist Ed Glaeser gives his recommendation:
But if America does embrace another stimulus round, we should limit the government’s role to being the big borrower rather than the big spender. Cutting payroll taxes for lower-income workers who have just been unemployed is an example of stimulus through borrowing, rather than spending. The government isn’t actually spending money on government services; it’s just borrowing the money and giving it to newly employed workers.
The most orthodox models, derived from the logic of David Ricardo, suggest that this kind of inter-temporal shuffling of taxes has limited downside risk, as long as the government isn’t at risk of default. Consumers can prepare for expected future taxes by saving today’s tax cuts. Moreover, reducing the payroll tax has the added advantage of increasing the incentives to work during a downturn.
The case for more complicated tax tweaks that affect other behavior is weaker….
The case for more government spending on tangible government products is most problematic.
While it is easy to get all misty-eyed about the Tennessee Valley Authority, public spending on roads or high-speed rail can be enormously wasteful. At the extreme, spending a billion dollars on a bridge to nowhere may temporarily increase employment and gross domestic product, but it does so by burning a billion dollars on something no one wants. Infrastructure is serious business, and it is impossible to spend quickly and wisely.
While wading in ignorance, it’s best to avoid the paths near the most dangerous depths.
There is little downside to giving a tax break to previously unemployed low-income workers. Those dollars are being given to people who value them. Building a bunch of unneeded highways, conversely, is a road to waste. The political and economic case for a second stimulus is strongest if that stimulus means a temporary tax reduction and weakest if the package is yet another increase in the size of the public sector.
Full post can be found here.
“Last week, I briefly discussed the geographic distribution of Recovery Act funds. The figure shows the relationship between per capita Recovery Act grants awarded and unemployment across states, which shows that stimulus aid was not particularly well matched with need…On average, for every extra percentage point of the labor force that is unemployed, a state got $25 less per capita.” — Edward L. Glaeser, economics professor at Harvard writing in the New York Times Economics blog
Many Democrats, including Obama, have criticized Republicans for both opposing the Stimulus bill and helping to direct some of that stimulus money to their districts. They claim its hypocrisy. Greg Mankiw argues otherwise:
It seems perfectly reasonable to believe (1) that increasing government spending is not the best way to promote economic growth in a depressed economy, and (2) that if the government is going to spend gobs of money, those on whom it is spent will benefit. In this case, the right thing for a congressman to do is to oppose the spending plans, but once the spending is inevitable, to try to ensure that the constituents he represents get their share. So what exactly is the problem?
Let me offer an analogy. Many Democratic congressmen opposed the Bush tax cuts. That was based, I presume, on an honest assessment of the policy. But once these tax cuts were passed, I bet these congressmen paid lower taxes. I bet they did not offer to hand the Treasury the extra taxes they would have owed at the previous tax rates. Would it make sense for the GOP to suggest that these Democrats were disingenuous or hypocritical? I don’t think so. Many times, we as individuals benefit from policies we opposed. There is nothing wrong about that.
The full post can be found here.
Large changes in fiscal policy: taxes versus spending
We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.
Link via Greg Mankiw here.
“It seems to me that there are two ways of thinking about how monetary policy would react to fiscal stimulus. One approach would be to ask: “What is the optimal Fed response to fiscal stimulus?” And the answer to that question is rather obvious; the Fed should act in such a way as to completely neutralize the impact of fiscal stimulus, i.e. make sure the multiplier is precisely zero. This is because the Fed has some optimal level of expected AD growth in mind, and that level should not change just because fiscal policy changed. So if the Fed is doing its job, which means if it is always targeting expected AD growth at what it sees as the optimal rate, then it will try to completely offset fiscal stimulus and the expected fiscal multiplier will be precisely zero. That’s why fiscal stimulus almost disappeared from graduate textbooks in recent years.” — Scott Sumner, professor of economics at Bentley University, and monetary expert blogging on “The Silly Multiplier “debate”
Even more proof that tax cuts are better at stimulating the economy than fiscal stimulus. Bruce Bartlett describes the recent research by Harvard economist Robert Barro:
Harvard economist Robert Barro is out with a new paper that undoubtedly will get a lot of attention from conservatives. First, he finds that the multiplier effect from government purchases is well less than one; meaning that each dollar of government spending adds less than a dollar to GDP and is, therefore, contractionary rather than expansionary. Second, he finds very powerful effects from cuts in marginal tax rates; a one percent cut raises the growth rate of GDP per capita by 0.6%. Barro also provides a very useful time series of average marginal tax rates, including Social Security and state taxes, from 1912 to 2006.
The full post can be found here. In short, as conservatives argued at the beginning of the fiscal stimulus debate: tax cuts are better at stimulating the economy than fiscal stimulus. This research confirms earlier research that found the fiscal multiplier of Obama’s recent fiscal stimulus to be zero, see here.
According to recent economic data, zero:
Once you allow for a significant role of forward-looking behaviour by households and firms, there is no multiplier. The expectation of future tax increases, or rising government debt and future interest rate increases leads to a reduction in private consumption and investment spending. This holds in particular for the three New Keynesian models developed by economists at the ECB, the IMF and the EU Commission (see Smets and Wouters 2003, Laxton and Pesenti 2003, and Ratto, Roeger and in’t Veld 2009). These models include extensive Keynesian features such as price and wage rigidities, but also employ up-to-date microeconomic foundations. The model of EU Commission researchers is especially interesting because it is recently estimated and one-third of its households do not care about the future and follow a traditional Keynesian consumption function.
Remember the Democrats claim that by empowering a new panel (the Independent Medicare Advisory Council) to recommend future spending reductions we could save several billions of dollars in healthcare costs? If this was before the creation of the CBO (1974, according to Wiki), such claims would be nearly impossible to disprove. Democrats could get away with making the claim and fiscally conservative politicians would have little to say in opposition. The whole debate would break down into a he-said she-said debate, with Republicans pointing to some economist at some University showing the proposal would barely save a few billion dollars and Democrats responding with their own economist and study arguing that it would save multiple billions. How would the average citizen distinguish who is right?
Of course, years after the policy changes had been put into effect, the truth would have come out – which is why in every single healthcare change, including the recent Massachusetts healthcare reforms, the healthcare policies have turned out to cost far more than people assumed – but by then the changes would have already been in affect for atleast a couple of years. New special interest groups would have already been created, and the government program, like any other government program, would become nearly impossible to stop.
But that was before the CBO had so much influence. Today, Democrats have to get their claims past the CBO and are having a very difficult time doing it. The latest is their claim that an Independent Medicare Advisory Council would save several billions of dollars. The CBO argues that that simply is not true, Donald Marron reports:
CBO estimates that the proposed legislation would save a paltry $2 billion over the next ten years, less than 1/500 of the 10-year cost of health reform.
Long gone are the days when Democrats could simply propose some theoretical cost saving legislation and ask the public to take it on good faith. Imagine if the CBO had existed when FDR was around? LBJ?
Although that doesn’t mean the CBO itself doesn’t have serious shortcomings, on the contrary, it too tends to underestimate the costs of policies, as it recently did in predicting the fiscal stimulus recovery (see here and here) but atleast now the Democrats proposals have to pass a higher standard than simply their word.
Keith Hennessey has more here.
Update: The Economist has more.