The Identification Problem

Frequent readers of the blog know that I am a fan of John Taylor. I think that he is an economist who takes the discipline very seriously and tries to understand the world with the tools of an economist. Nonetheless, I was a bit perplexed to see his (fairly) recent analysis of the stimulus package.

In a recent post, Taylor puts up a graph of borrowing by state and local governments and American Recovery and Reinvestment grants issued by the federal government. The former trends down and coincides with the latter trending up. He concludes:

…state and local governments did not increase their purchases of goods and services—including infrastructure—even though they received large grants in aid from the federal government. Instead they used the grants largely to reduce the amount of their borrowing as the following graph dramatically shows.

Now I was not an ardent supporter of the stimulus bill (see this). Nonetheless, I think that this analysis is misleading. There is an identification problem. Did the states stop borrowing because of the grants? Or did the grants provide funding to replace the reduction in borrowing that would have taken place regardless? In other words, we do not know what the path of state and local borrowing would have been in the absence of the grants. In addition, supporters of the stimulus would suggest — and this is not necessarily an endorsement of their argument — that the fact that the stimulus prevented a reduction in borrowing is itself an example of success.

One response to “The Identification Problem

  1. I this is directly related to this post but I watched a discussion on CPAN2 not that long ago where Taylor, Christina Romer, and a few other economists talked about the effects of the stimulus bill. Taylor argued that it virtually had no effect and did not bring the economy into a recovery (i.e. unemployment has not really gone down). Romer kept making all these counterfactual arguments. She seemed to think without the stimulus the economy would have suffered a much deeper recession and unemployment would be higher than 10%.

    With regards to this post I wouldn’t be surprised if someone at each state’s budget office could tell you the answer. My sister had a state accounting job in Ohio a few years back which directly involved working with economists forecasting and planning the state’s budget. Assuming they are willing/ allowed to discuss the state budget they might be able to tell you whether they were planning to reduce borrowing, or were decided to do so after they received the grants. Romer’s counterfactual is probably that state spending would have been lower without the grants.

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