Category Archives: Stimulus

Did GM Pay Back Its Loan? Sort of.

The big news, especially around my neck of the woods:

The new, post-bankruptcy GM made a final $5.8 billion loan payment to the US and Canadian governments on Tuesday.

Two questions, however, emerge. How did they pay it back? What about the $50 billion bridge loan? First, the bridge loan:

The payments however do not include much higher loans made to the company under its former guise, being slowly wound down through the bankruptcy process.

The US government, which provided about $50 billion in emergency loans, holds a 60.8 percent stake in the new company and $2.1 billion in preferred stock. The Canadian government and a retiree health care trust also hold significant stakes.

The expectation seems to be that the government will recoup the $50 billion when the company goes public later this year. However, GM’s market cap has never been $50 billion (let alone 60% of it).

Now to the issue of how the money was repaid via Jamie Dupree of the Atlanta Journal Constitution:

General Motors will make a big splash in the news today by announcing that the automaker will repay several billion dollars loans from the federal government earlier than expected. But it’s not really coming out of the GM wallet.

The issue came up yesterday at a hearing with the special watchdog on the Wall Street Bailout, Neil Barofsky, who was asked several times about the GM repayment by Sen. Tom Carper (D-DE), who was looking for answers on how much money the feds might make from the controversial Wall Street Bailout.

“It’s good news in that they’re reducing their debt,” Barofsky said of the accelerated GM payments, “but they’re doing it by taking other available TARP money.”

In other words, GM is taking money from the Wall Street Bailout – the TARP money – and using that to pay off their loans ahead of schedule.

“It sounds like it’s kind of like taking money out of one pocket and putting in the other,” said Carper, who got a nod of agreement from Barofsky.

“The way that payment is going to be made is by drawing down on an equity facility of other TARP money.”

Translated – they are using bailout funds from the feds to pay off their loans.

This is not quite the good news suggested by the headlines.

UPDATE: I have written a follow-up post with precise details here.

The Failure of Modern Macroeconomics

Since the financial crisis began, I have been one of the most vehement supporters of modern macroeconomics. While I have my own quarrels with the current research, I have found much (not all) of the criticism wanting. Nevertheless, there is one notable and glaring failure in the macro literature that has come to the forefront during this recession. That failure is regarding the zero lower bound on nominal interest rates. Not only do I believe that a consensus is needed on this topic, but I also believe that the zero lower bound is of little practical importance.


The tool of modern macroeconomics is the dynamic, stochastic, general equilibrium (DSGE) model. Monetary models often consist of the baseline New Keynesian model and extensions thereof. This model is characterized by two equations and an interest rate rule. The first equation is the dynamic IS equation, which is expressed in logarithms as follows:

y(t) = E(t)y(t+1) – (1/a)[R(t) – E(t)P(t+1)]

where y(t) is the output gap at time t, E is the mathematical expectation operator, R is the nominal interest rate, P is inflation, and a is a parameter.

The second equation is the New Keynesian Phillips curve:

P(t) = bE(t)P(t+1) + ky(t)

where b and k are parameters.

The system is then closed by a monetary policy rule. This is typically formulated as a Taylor-type rule in which the monetary authority adjusts the nominal interest rate in response to inflation and the output gap. Together with the assumption of sticky prices, the adjustment of the nominal interest rate leads to a corresponding adjustment in the real interest as well.

It is important to note that money is not part of this model. Rather movements in the interest rate pin down the rate of inflation (so long as the policy rule leads to an increase in the real rate of interest when inflation is higher than its target). The purported benefits of these types of models is that they can neglect any reference to money demand and the interest rate captures the complete transmission mechanism through which monetary policy and monetary shocks influence the system. As it turns out, however, this framework contributes to what I believe to be the failure of modern macro in light of this recession. [I also have quarrels with the empirical evidence that justifies this approach, but I will leave that for a separate post.]

The Zero Lower Bound

In the model presented above, monetary policy is conducted by a central bank that adjusts ‘the’ interest rate. The change in the interest rate in turn inversely impacts the output gap through the IS relation. Supposing that we begin from a zero inflation steady state, the increase in the interest rate causes output to fall below the natural rate. As a result, inflation declines in accordance with the New Keynesian Phillips curve.

What this process illustrates is that the interest rate is the sole mechanism through which monetary policy affects the economy. The importance of this point centers on the fact that the nominal interest rate is limited in that it cannot take on a value less than zero. Thus, if we believe this model accurately captures the world in which we live, there exists a precarious position for central banks when the output gap is negative and the nominal interest rate is zero.

The zero bound therefore places a limit on the effects of monetary policy conducted using an interest rate.

Theoretical Foundations

As with all modern theoretical macro models, the New Keynesian model is derived from microeconomic foundations. In other words, the IS equation is derived from utility maximization in which a representative household maximizes utility subject to a budget constraint. In the basic New Keynesian model illustrated above, there is a consumption good and one asset (bonds). The analysis can be extended to include money, but for typical money demand functions, money is essentially a mirror for changes in the interest rate. Nonetheless, the existence of only two assets — money and bonds — is at the heart of the problem.

If monetary policy is ineffective at the zero bound, this is referred to as a liquidity trap. Put differently, if the interest rate on bonds is zero, money and bonds become perfect substitutes. Whereas open market operations would typically be used to increase reserves and thereby lower the federal funds rate, in a liquidity trap agents simply hold the additional cash balances in place of the bonds. Increases in the money supply do not result in real changes, only alterations to the composition of portfolios.

So what is the problem with this analysis?

Well, the problem surrounds the fact that there are only two assets in the model. Monetary policy is impotent because money and bonds are perfect substitutes. Contrary to this model (and others), there are actually substantially more than two assets in the real world. Thus, a natural question to ask is whether these other assets matter for our analysis. In their 1968 paper, Karl Brunner and Allan Meltzer do precisely that. They extend the analysis beyond the two asset world. In such a case, the condition for a liquidity trap is that the marginal rates of substitution for money and all other assets must be equal to zero. As Karl Brunner would have said, we simply know this isn’t true.

This condition, I believe, represents substantial reason for pause in considering the possibility and policy implications of a liquidity trap. In fact, I would argue that it suggests that liquidity traps don’t exist. Put differently, as Scott Sumner has suggested:

Zero rates don’t really make monetary policy more difficult, they make interest rate-oriented monetary policy more difficult.

Indeed, in the absence of a liquidity trap, the zero lower bound is merely a signal that monetary policy needs to employ other methods.

The Evidence . . . Or, Am I alone?

A subsequent question is whether (a) evidence suggests that monetary policy is impotent, and (b) whether I am alone in suggesting that “unconventional” monetary policy — defined as non-interest rate policy — is useful at the zero bound.

Regarding point (a), I will be brief. In a fairly recent paper, Allan Meltzer examines the monetary transmission mechanism by comparing the behavior of the real interest rate and real money balances during periods of deflation. The impetus behind this reasoning is that during periods of deflation, the real interest rate and real balances will increase. If the monetary transmission mechanism is solely captured by the real interest rate as implied by the New Keynesian framework, then one would expect output to decline as the real interest rate rises. In contrast, the monetarist proposition has long been that the monetary transmission mechanism is reflected by the behavior of real money balances as individuals re-allocate their portfolios thereby inducing relative price adjustments on financial assets and subsequently on non-financial, or real, assets. Thus, the mechanism implies that as real balances rise, output should be expected to rise. He finds that in each case the behavior of real money balances is a much better predictor of movements in output than the real interest rate. This not only suggests that there is little reason to fear the zero lower bound, but there is also reason to doubt that the interest rate represents the correct mechanism for analysis of the monetary transmission process.

Regarding point (b), consider some recent papers that examine the zero lower bound. First, Marco Del Negro, Gauti Eggertson, Andrea Ferrero, and Nobuhiro Kiyotaki (HT: David Beckworth):

This paper extends the model in Kiyotaki and Moore (2008) to include nominal wage and price frictions and explicitly incorporates the zero bound on the short-term nominal interest rate. We subject this model to a shock which arguably captures the 2008 US financial crisis. Within this framework we ask: Once interest rate cuts are no longer feasible due to the zero bound, what are the effects of non-standard open market operations in which the government exchanges liquid government liabilities for illiquid private assets? We find that the effect of this non-standard monetary policy can be large at zero nominal interest rates. We show model simulations in which these policy interventions prevented a repeat of the Great Depression in 2008-2009.

Next, Michael Woodford, the founder of the moneyless approach exemplified by the New Keynesian model, and Vasco Curdia:

We extend a standard New Keynesian model both to incorporate heterogeneity in spending opportunities along with two sources of (potentially time-varying) credit spreads and to allow a role for the central bank’s balance sheet in determining equilibrium. We use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions and to consider additional dimensions of central bank policy—variations in the size and composition of the central bank’s balance sheet as well as payment of interest on reserves—alongside the traditional question of the proper operating target for an overnight policy rate. We also study the special problems that arise when the zero lower bound for the policy rate is reached. We show that it is possible to provide criteria for the choice of policy along each of these possible dimensions within a single unified framework, and to achieve policy prescriptions that apply equally well regardless of whether financial markets work efficiently or not and regardless of whether the zero bound on nominal interest rates is reached or not

And finally, Paul Krugman:

Even if the economy is in a liquidity trap in the sense that the nominal interest rate is stuck at zero, the monetary expansion would raise the expected future price level P*, and hence reduce the real interest rate. A permanent as opposed to temporary monetary expansion would, in other words, be effective – because it would cause expectations of inflation.

An astute reader will note that I have chose these authors because they are supporters of or seem content with the interest rate view of monetary policy. Nevertheless, in each case, they find that monetary policy can be effective at the zero lower bound.

Taken together with the evidence by Meltzer above, I think that we have sufficient reason to doubt the existence of liquidity trap.

Brief Conclusion

The zero lower bound represents a key failure of modern macro in that there is little consensus or agreement about the effects of monetary policy in such a circumstance. The issue is of central importance for determining the correct policy prescriptions — both monetary and fiscal. It is my hope that the recent surge in research on the zero lower bound will ultimately reach a consensus. What’s more, I hope that this consensus takes into account that we live in a world with more than two assets and, as a result, that the zero lower bound is nothing more than an intellectual curiosity.

Further Reading: For those interested in the topic, I think that these papers might be of use as well:

Sumner, Scott. 2002. “Some Observations of the Return of the Liquidity Trap.” Cato Journal.

Goodfriend, Marvin. 2000. “Overcoming the Zero Lower Bound on Monetary Policy.” Journal of Money, Credit, and Banking.

Meltzer, Allan. “Monetary Transmission at Low Inflation: Lessons from Japan.” (.doc link here).

Stimulus: Worse Than Imagined

I previously highlighted the paper by Cogan, Cwik, Taylor, and Wieland that outlines the differences in Old Keynesian and New Keynesian multipliers. However, it seems that the differences might be worse than imagined.

Harold Uhlig’s presentation from the Atlanta Fed conference on fiscal policy explains the effects of stimulus when one assumes the presence of distortionary labor taxation. (He also examines the implications if rule-of-thumb consumers and the zero lower bound.) Here is what he finds:

In the context of this model, the impact of a government spending stimulus …

  • … is very sensitive to assumptions about taxes.
  • … on output is rarely larger than the government spending increase
  • … is a comparatively larger output loss later on, due to the increased tax burden.


  • Consumption declines.
  • Rules-of-thumb agents do not change the results much. Consumption may be feebly positive, the increase in output is somewhat larger.
  • Binding zero lower bound: does not change the results much, if temporary, and is extreme and fragile, if longer.

Similar to the paper by Cogan, et. al, the baseline framework that Uhlig uses is the Smets-Wouters model. I cannot find a copy of the paper online. Nevertheless, the link above is to the presentation from the conference and provides substantial information for understanding the framework and assumptions.

More Fiscal Stimulus?

All along I have tried to emphasize the point that I am for fiscal stimulus so long as it is the correct type. Increases in government spending that are (or are perceived to be) permanent are not successful policies. What’s more, not all spending is created equal. When spending is decided by self-interested politicians, I lack the confidence that the right kind of spending will be undertaken.

In contrast, macroeconomic theory has much to offer. Two proposals that I would support are (1) permanent tax cuts, and (2) temporary investment tax credits. The first of which is successful because, as we know from the permanent income hypothesis, individuals consume based on expectations of lifetime income. A permanent income tax cut reduces the future tax burden and leads to increases in consumption. The second policy is a “use it or lose it” policy that encourages businesses to undertake investment now rather than waiting.

Unfortunately, the fiscal policy undertaken has been based on old ideas that modern macro theory suggests are not successful (there is empirical support as well). Along these lines, Greg Mankiw has written an excellent piece in the NYT on what recent research has to say about fiscal policy that, to some extent, expands on the points above. I only wish he had written this months ago.

In Defense of Allan Meltzer

Allan Meltzer is one of the greatest monetary economists to have ever lived (although credit is also due to his long-time collaborator Karl Brunner, who Meltzer would be the first to acknowledge). This is not hyperbole. Meltzer’s work emphasizes the role of imperfect information, uncertainty, and transactions costs in developing an understanding of the role of money in exchange (AER, 1971 with Karl Brunner), the business cycle (with Alex Cukierman and Karl Brunner, JME 1983), evaluating alternate monetary regimes (1986 JME), and the role of monetary and fiscal policy (to be concise, on monetary policy, with Cukierman, Econometrica 1986; Economic Inquiry, 1987; with Mascaro, JME, 1983; with Brunner Carnegie-Rochester Series, 1983; on fiscal policy, with Scott Richard, JPE, 1981; with Brunner, 1993). This is not to mention Meltzer’s work on the history of the Federal Reserve and the monetary transmission mechanism.

For all the talk about economics needing to find a new vision, the work of Allan Meltzer (and his co-authors) represents a strong foundation on which to build.

What’s more, Meltzer has long embraced Keynes’s vision of uncertainty. More importantly, and unlike most others who have done so, he has recognized that uncertainty plagues not only individuals and firms, but also government policy makers.

With that being said, it was particularly disheartening to see Brad DeLong address Meltzer as follows:

Exercise some moral responsibility, Allan.

Shameless partisan hack.

Why would DeLong write such a thing? It seems that he doesn’t much like Meltzer’s critique of quantifying jobs “saved or created” by the stimulus package. Specifically, in a memo to John Boehner, Meltzer writes:

There is no greater recognition of the failure of the stimulus program to create jobs than the efforts to mislead the public into believing the program had saved thousands, or millions, of jobs.

One can search economic textbooks forever without finding a concept called “jobs saved.” It doesn’t exist for good reason: how can anyone know that his or her job has been saved?

The Administration can make up any number it pleases. The number has no meaning.

DeLong argues that this is ridiculous and appeals to authority by citing Milton Friedman arguing that the Depression was worsened by the Fed’s failure to prevent the money stock from declining:

If the concept of “jobs saved” does not exist, how come Milton Friedman says that an extra $1 billion of open market operations in late 1931 would have stopped the Great Depression in its tracks.

He continues:

You can critique models. You can critique parameters. You can critique parameters. You can critique how the calculations are done, but you cannot deny their existence, for the kind of counterfactualcalculations that Milton Friedman does are, of course, the steady diet of what economists and other policy analysts do every day.

Of course, if we expand the earlier quote of Allan Meltzer, we would find that this is precisely what Meltzer is doing in his memo. Here is the full quote:

There is no greater recognition of the failure of the stimulus program to create jobs than the efforts to mislead the public into believing the program had saved thousands, or millions, of jobs.

One can search economic textbooks forever without finding a concept called “jobs saved.” It doesn’t exist for good reason: how can anyone know that his or her job has been saved?

The Administration can make up any number it pleases. The number has no meaning. The Council of Economic Advisers gets a number for jobs saved using the same model that Dr. Christina Romer and Jared Bernstein used when they forecast that the $787 stimulus program would keep the worst unemployment rate in this recession at about eight percent. But as we all know, since that bill became law, our economy has shed some three million jobs and the unemployment rate is nearing double digits.

In other words, Meltzer believes that the model that was used to assess the benefits of the stimulus package is significantly flawed and an impractical guide to assess job creation. In addition, his earlier point is that there is no meaningful basis on which to calculate jobs “saved or created”.

Greg Mankiw has made much the same point:

That is, I do not object to claims such as,

A: “Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus.”

But it is absurd to suggest that you can say,

B: “We have measured how many jobs the stimulus has saved or created, and the number is X.”

Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is,of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials.

Going beyond Mankiw’s description above, statements exemplified by A are dependent on the model that is used. Several questions need to be addressed. How useful is the model? What are the assumptions? How does it compare with other models in the literature?

These questions have been addressed in the paper by John Cogan, Tobias Cwik, John Taylor, and Volker Wieland entitled, “New Keynesian Versus Old Keynesian Government Spending Multipliers”. The model used by Bernstein and Romer is an Old Keynesian model. These authors compare and contrast the Bernstein-Romer model with the Smets-Wouters model that exemplifies the current consensus in macroeconomic thought. Here is their conclusion:

We find that the government spending multipliers from permanent increases in federal government purchases are much less in new Keynesian models than in old Keynesian models. The differences are even larger when one estimates the impacts of the actual path of government purchases in fiscal packages, such as the one enacted in February 2009 in the United States or similar ones discussed in other countries. The multipliers are less than one as consumption and investment are crowded out. The impact in the first year is very small. And as the government purchases decline in the later years of the simulation, the multipliers turn negative.

The estimates reported here of the impact of such packages are in stark contrast to those reported in the paper by Christina Romer and Jared Bernstein. They report impacts on GDP for a broad fiscal package that are six times larger than those implied by government spending multipliers in a typical new Keynesian model and our calculations based on generous assumptions of the impacts of tax rebates and transfers on GDP. They also report job estimates that are six times larger than these alternative models, and the impacts on private sector jobs are likely to be at variance with the alternative models by an even larger amount. At the least, our findings raise serious doubts about the robustness of the models and the approach currently used for practical fiscal policy evaluation.

Allan Meltzer clearly thinks that the model used by Bernstein and Romer is flawed. The work of Cogan, Cwik, Taylor, and Wieland suggests that there is reason to believe that Meltzer is correct to doubt the model.

In addition, Meltzer’s critique of the success of the stimulus package also raises important questions about attributing the recovery to the stimulus package. Specifically, he cites the role of “Cash for Clunkers” and new homebuyer tax credits in contributing to third quarter growth, neither of which was in the stimulus package.

Allan Meltzer is one of the greatest monetary economists to have ever lived. He deserves much better treatment than to be called a “shameless partisan hack”.

UPDATE: Mario Rizzo writes:

As we have been saying here, the claims that the fiscal stimulus has saved or created X number of jobs is not a simple empirical question. It must be an inference from a model that tells us what would have happened in the absence of that stimulus. Collecting reports from various firms or local governments about their job situations will not do. At best these individual reports are based on pop-theories on the part of the reporters about what would have happened.

Assessing the Stimulus

The current administration has unveiled an entirely new metric for measuring the success of stimulus spending. Rather than claim credit for “creating” jobs, they have focused on jobs that were “created or saved” by the stimulus. This, of course, is a preposterous notion. How do we know that a job was saved? The idea of transparent reporting from the government is welcome, but transparent reporting is only part of the problem. What precisely is the definition of a “saved” job? This might seem a bit facetious, but bear with me.

Suppose that a municipality receives money to pave a road. They hire a private firm to do the job. The firm was planning on laying off (we’ll say) 10 workers. However, given the new job, the firm keeps those 10 men on payroll. This seems pretty straightforward. It’s not. These 10 workers might be kept on the payroll until the completion of this job and let go thereafter. Does this still count as a job saved? How long does the person have to remain employed for it to be considered a job “saved”? Near as I can tell, this doesn’t factor in to the decision-making.

Consider another example. Suppose that a state or municipality announces that they are going to lay off teachers or police officers. If stimulus funds keep these individuals employed, this is considered a job that was saved. However, how do we know that state and local governments weren’t, at the very least, exaggerating the number of individuals that were going to lose their jobs in a ploy for more stimulus money?

Of course, all of this ignores the financing. The government doesn’t have money, it must borrow and tax in order to spend money. Thus, any metric of job creation measures gross job creation, but what we are really concerned with is net job creation.

With that being said, the number that has been released regarding the “saved or created” jobs was estimated to be between 640,329 and 1 million jobs. That means that the stimulus has cost between $160,000 and $250,000 per job. (Jared Bernstein calls that “calculator abuse.”)

White House officials have been quick to mention that these numbers do not include jobs that were saved or created through the temporary tax cuts. As I have mentioned numerous times on the blog, temporary tax cuts don’t work. John Taylor has documented this fact for the last two rebate checks. Thus, it would seem that including the cost of these tax cuts would actually inflate the cost per job.

Ultimately, I am not entirely sure what we are to get from the “jobs saved or created” metric. There doesn’t seem to be any true objective way to quantify such a thing. Regardless, based on the data on jobs and growth up to this point, one can hardly conclude that the stimulus has been successful.

UPDATE: John Taylor breaks down the GDP numbers and concludes that the “stimulus did not fuel GDP growth.”

Casey Mulligan writes that he is “still waiting for mistakes that underestimate the potentcy of the stimulus.”

Quote of the Day

“I have been reading [John] Taylor’s various arguments very closely since last fall. I also read a lot about the failure of modern economics, and how modern macroeconomists in particular have been proven completely worthless. But reading Taylor has made me really think twice about those statements.”

Pete Boettke

Yet More Unseen Effects from Cash for Clunkers

Courtesy of Division of Labour:

Mechanics don’t seem to like the program….

…nor do charities.

A Tale of Marginal Analysis

Casey Mulligan has written a post entitled, “The Laws of Economics Have Been Suspended”. Here is the gist:

Professor Krugman is also saying this week that this recession has nothing to do with bad incentives to earn labor income. (Bless him for citing me! When this is all over, I would love to have a monopoly on teaching the “old fashioned” laws of economics.)

I don’t quite understand this obsession with UI-apologetics, because UI (unemployment insurance) is just one of many policies that collectively (and some by themselves) create terrible incentives:

  • mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not
  • minimum wage hike
  • means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic))
  • mean-tested student loan modification
  • unemployment insurance extensions
  • state income tax hikes,
  • IRS means-tested enforcement of prior tax debts
  • marginal federal tax rate hikes on the “rich”!
  • According to Professor Krugman, I am the only one crazy enough to suggest that a list of bad incentives like this might actually show up in the aggregate data!

Not content to let Krugman take all of the credit, one of the anonymous bloggers over at The Economist has written a post entitled, “Lazy workers, enjoying the dole”, in which they argue:

Mr Mulligan seems to be to be using one point, on which he is correct, to make another, on which he is very wrong. Unemployment benefits clearly do provide an incentive to stay out of work longer. Holding other things constant, we would expect an increase in the generosity of unemployment benefits to lead to more joblessness.

But that does not mean that in the absence of unemployment benefits the unemployment rate would be lower, because one cannot hold other things constant while changing benefits.

Of course, this prompted a response from Will Ambrosini: “The Economist doesn’t understand marginal analysis.” Ouch!

Perhaps this is an example why economists have been much maligned recently.

More on Cash for Clunkers

Russ Roberts:

Imagine you’re a member of Congress. You’re a fan of the Cash for Clunkers program. You discover that the $1 billion that Congress budgeted for the program has been spent in FOUR DAYS. The program is now out of money. What do you do?

A. Realize that $4500 per clunker was too big a subsidy and that you can achieve the same effects with a much smaller amount.

B. Worry that maybe there is some fraud in the program and that some of the cash isn’t going to clunkers

C. Increase the budget by $2 billion

HT: Three Sources