Tag Archives: stimulus package

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.”

WSU Blogging

The Wayne State blogging presence is growing (at least for this week) as Robert Rossana is guest blogging this week for the Detroit Free Press on the stimulus package. Here is an excerpt from today’s post:

All governments have a budget constraint stating that, sooner or later, spending must be paid out of tax revenues. Equivalently, deficits today must be balanced by surpluses in the future. Given the deficits that we are now running and are likely to run next year – which are so large that it is unlikely we can “grow” our way out of them – taxpayers must rationally anticipate tax increases in the future.

So is it likely that households will go on a spending spree in response to this additional government spending or will they try to save more, anticipating these future tax increases? Some economists suggest that, because of these implied future tax liabilities, the Keynesian multiplier is actually less than one; as households save in anticipation of future tax liabilities, GDP will rise by less than the increase in government spending.

The Stimulus Will Fail

Recently, I have been receiving a great deal of email that has resulted in responses in which I find myself either defending the stimulus package or defending the proponents of the stimulus package. These defenses, however, have much more to do with the flawed reasoning of fellow stimulus skeptics than with any sort of favorable outlook toward the stimulus package itself. With this in mind, it is perhaps time to clarify my position.

As I have previously noted, there are two questions that seem to be at the center of the debate:

1. Can a stimulus package be designed to give a boost to the economy in the short-run?

2. Can the stimulus package get us out of the recession?

Under the current circumstances, with unemployment approaching 8%, the answer to (1) is undoubtedly “yes.” HOWEVER, this does not imply that (2) can similarly be answered in the affirmative as many stimulus advocates would have you believe. Unfortunately, the debate regarding stimulus has diverged to the point in which those on each side are answering different questions and ultimately giving the impression that there is widespread disagreement as to the effectiveness of fiscal stimulus. Thus, this post is my attempt to explain why the answer to (1) is “yes” and the answer to (2) is “no.”

The traditional Keynesian multiplier analysis suggests that if the government spends money on a particular project it not only increases output by the amount of the increase in government spending, but also by the increase in consumption of those employed to work on the project. Given the idea of the multiplier, government spending can clearly be seen as providing an affirmative answer to both (1) and (2) since $1 of government spending producers more than $1 of additional output.

Unfortunately, this analysis is entirely too simplistic. If fails to take into account the fact that the government must compete for resources (and credit) with private enterprise. The traditional Keynesian response to the criticism is that during times of less than full employment, there are idle resources (e.g. unemployed workers) that can be put to use without competing with private firms. The failure, however, is that to rule out any sort of crowding out effect, all resources utilized by the government must be idle. This is not to say that government spending cannot promote a temporary boost to the economy. Even if there is crowding out, so long as the multiplier is greater than zero, output will increase in response to an increase in government spending. The question as to the value of the multiplier is thus an empirical question.

John Taylor recently presented a paper (non-gated link here) at the AEA meetings on the revival of fiscal policy. In his introduction, Taylor writes:

A decade ago in a paper, “Reassessing Discretionary Fiscal Policy,” published in the Journal of Economic Perspectives, I concluded that “in the current context of the U.S. economy, it seems best to let fiscal policy have its main countercyclical impact through the automatic stabilizers….It would be appropriate in the current circumstances for discretionary fiscal policy to be saved explicitly for longer term issues, requiring less frequent changes.” This was not an unusual conclusion at the time. As Martin Eichenbaum (1997) put it, “there is now widespread agreement that countercyclical discretionary fiscal policy is neither desirable nor politically feasible,” or, according to Martin Feldstein (2002), “There is now widespread agreement in the economics profession that deliberate ‘countercyclical’ discretionary policy has not contributed to economic stability and may have actually been destabilizing in the past.”

Taylor also discusses some of his own empirical work from his 1992 book Macroeconomic Policy in a World Economy on the actual value of the multiplier:

. . . simulations of my (1992) empirically estimated multi-country dynamic model with rational expectations indicates that multiyear changes in government spending phased in at realistic rates have a maximum government spending multiplier less than one because of offsetting reductions in the other components of GDP.

Further, he provides empirical evidence of the utter failure of the tax rebate checks issued in 2008.

Taylor also echoes the point made by Casey Mulligan that there are some types of government spending that can be justified by their intrinsic value, but are unlikely to cause economic stimulus:

To be sure, it may be appropriate to increase government purchases in some areas including for infrastructure as in the 1950s when the interstate highway system was built. But such multiyear programs did not help end, mitigate, or prevent the recessions of the 1950s. In sum, there is little reliable empirical evidence that government spending is a way to end a recession or accelerate a recovery that rationalizes a revival of discretionary countercyclical fiscal policy.

Another issue at hand here is the idea of Ricardian equivalence, which essentially posits the claim that there is no fundamental difference between spending financed by deficits or taxation. Suppose that the government increases spending. It follows that they must either tax current economic agents or issue government bonds to pay for the increased spending. The intuition behind Ricardian equivalence is that when the government increases spending individuals recognize that, even if the spending is financed through government borrowing, the spending creates an increase in their future tax liability.

Consider the incredibly over-simplified example. Suppose the government decides to issue a check for $500 for each taxpayer. They pay for these checks by issuing bonds that will be paid off next period. Under Ricardian equivalence, the individuals recognize that while they will receive $500 this period, but will have their taxes increased to pay for the bonds next period. Thus individuals would simply buy the bonds (save the $500) in order to meet their increased tax liability in the next period.

Critics of Ricardian equivalence have long argued that this is incorrect to the point of being trivial. For example, if individuals have finite lives and the government lives forever, this would seem to refute the idea of Ricardian equivalence — unless, of course, the finite-lived agents view their offspring as mere extensions of their lifetime. This exception, of course, leads to criticism based on the idea of myopic economic agents or the failure of operative bequests to future generations. The list of criticisms far exceed the very small sample above, but they do seem to suggest that Ricardian equivalence fails in simple theoretical applications. Again, however, we must turn to the empirical investigations.

In regards to the validity of Ricardian equivalence, John Seater at N.C. State wrote an excellent survey that appeared in the Journal of Economic Perspectives in 1993 (non-gated link here). Regarding the theoretical issues above, Seater explains:

Finite horizons, nonaltruistic or inoperative bequest motives, childless couples, liquidity constraints, and uncertainty all can lead to failure of Ricardian equivalence, and it seems virtually certain that some of these sources of nonequivalence are operative. It appears likely that the world is not Ricardian. (p. 155 – 156)

Upon examination of the empirical evidence, however, Seater concludes:

Nevertheless, equivalence appears to be a good approximation. Although some of the early empirical literature sent conflicting signals, recent work generally supports Ricardian equivalence. It is true that existing data cannot distinguish the Ricardian model based on altruism, from one of approximate equivalence, based on pure selfishness, but there seems little practical significance to that fact.

[…]

Empirical success and analytical simplicity make Ricardian equivalence an attractive model of government debt’s effects on the economic activity. (p. 184)

Thus, while Ricardian equivalence is seems literally untrue, the idea “holds as a close approximation” (Seater, p. 143) based on empirical evidence.

In short, the fact that Ricardian equivalence serves as a close approximation to actual results and the widespread failure of discretionary fiscal stimulus described by Taylor above, suggest that the stimulus package will be a failure. Further, given the pork-laden nature of the stimulus package, it is unlikely that the spending can even be justified on its intrinsic value, let alone on stimulation.

The stimulus will fail.

An Interview With Robert Barro

Some of you may recall that Paul Krugman referred to Robert Barro’s analysis of the multiplier associated with World War II spending as “boneheaded.” Admittedly, I did agree with Krugman to the extent that the period in question is not ideal for such measurement given the variety of other simultaneous changes (e.g. price controls, rationing, etc.). Nonetheless, I did acknowledge that “Robert Barro essentially wrote the book on government from a macro perspective.” Further, Barro’s analysis was not “boneheaded”, but merely less than ideal.

Now over at The Atlantic, there is an excellent interview with Robert Barro where he discusses the stimulus package, his analysis, and Krugman. First, in response to Krugman:

He said elsewhere that it was good and that it was what got us out of the depression. He just says whatever is convenient for his political argument. He doesn’t behave like an economist. And the guy has never done any work in Keynesian macroeconomics, which I actually did. He has never even done any work on that. His work is in trade stuff. He did excellent work, but it has nothing to do with what he’s writing about.

On stimulus:

This is probably the worst bill that has been put forward since the 1930s. I don’t know what to say. I mean it’s wasting a tremendous amount of money. It has some simplistic theory that I don’t think will work, so I don’t think the expenditure stuff is going to have the intended effect. I don’t think it will expand the economy. And the tax cutting isn’t really geared toward incentives. It’s not really geared to lowering tax rates; it’s more along the lines of throwing money at people. On both sides I think it’s garbage. So in terms of balance between the two it doesn’t really matter that much.

Read the whole thing.

Thoughts on Stimulus, UPDATED

The debate over stimulus is growing quite divergent. First, there is understandable disagreement about the nature of stimulus policies in and of themselves. Second, the is a growing debate as to whether or not the Obama stimulus plan itself will be successful. (I have previously offered my thoughts on stimulus here.)

The first debate is laid out explicitly by Robert Barro, who in today’s WSJ discusses the multiplier associated with government spending:

Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called “multiplier” effect of government spending on economic output is greater than one — Team Obama is reportedly using a number around 1.5.

To think about what this means, first assume that the multiplier was 1.0. In this case, an increase by one unit in government purchases and, thereby, in the aggregate demand for goods would lead to an increase by one unit in real gross domestic product (GDP). Thus, the added public goods are essentially free to society. If the government buys another airplane or bridge, the economy’s total output expands by enough to create the airplane or bridge without requiring a cut in anyone’s consumption or investment.

The explanation for this magic is that idle resources — unemployed labor and capital — are put to work to produce the added goods and services.

If the multiplier is greater than 1.0, as is apparently assumed by Team Obama, the process is even more wonderful. In this case, real GDP rises by more than the increase in government purchases. Thus, in addition to the free airplane or bridge, we also have more goods and services left over to raise private consumption or investment. In this scenario, the added government spending is a good idea even if the bridge goes to nowhere, or if public employees are just filling useless holes. Of course, if this mechanism is genuine, one might ask why the government should stop with only $1 trillion of added purchases.

Barro then uses World War II spending to estimate the multiplier effect of government spending. What he finds is that the multiplier for this period is about 0.8. What this means is that for every $1 that the government spent, GDP increased by $0.80. For times of peace, he finds that the multiplier is statistically insignificantly different from zero (we cannot reject the hypothesis of a complete crowding out of private expenditure, for non-econ nerds). Indeed, this is consistent with Hayek’s critique of Keynesian policies. Hayek pointed out that while Keynes criticized classical economists for assuming full employment, Keynes was implicitly assuming unemployment of resources.

Barro’s peacetime finds warrant further investigation as he does not state whether this measurement is for all periods or times of less than full employment as well as whether he is referring to temporary or permanent government purchases. However, it is clear that his findings regarding World War II fail to satisfy the ceteris paribus assumption needed for such analysis. As Paul Krugman explains:

Consumer goods were rationed; people were urged to restrain their spending to make resources available for the war effort. Oh, and the economy was at full employment — and then some. Rosie the Riveter, anyone? I can’t quite imagine the mindset that leads someone to forget all this, and think that you can use World War II to estimate the multiplier that might prevail in an underemployed, rationing-free economy.

Nonetheless, the debate about the multiplier is perhaps the important question regarding the stimulus package and despite the possible flaw in using World War II data, I think that Barro’s conclusion regarding the multiplier being below 1 is likely correct. After all, I don’t think that we can make the claim that there is no crowd out effect or that the multiplier overwhelms any crowding out.

On this point, Casey Mulligan has offered some interesting thoughts. His main conclusion is as follows:

Government spending will reduce private spending virtually anywhere it may be targeted. The case for government spending should thus be made on its intrinsic, not stimulation, value.

I think that this is perhaps the best way of thinking about stimulus. I agree with Barro and Mulligan in that the multiplier is likely between 0 and 1. I do not buy the argument that it is zero in the current environment. Thus, if it is close to one, there is an argument that can be made for spending based on its intrinsic value. For example, the modernization of government facilities and the rebuilding of infrastructure represent these types of ideas. Ultimately, the multiplier is dependent upon the spending itself. For example, if spending is temporary (as is implied in the examples just given) the multiplier is likely to be larger than if spending is permanent. In the latter case, there is substantial reason to believe that the multiplier is quite small and perhaps near zero.

This brings us to the question as to the likelihood of success of the Obama stimulus package. Mulligan warns of the particular aims of the stimulus:

Despite the recent increase in unemployment rates, I see little reason why the multiplier situation is realistic. For example, President Obama’s economists have explained that about half of the jobs they plan to create (both directly and indirectly) are for women. But the large majority of this recession’s employment reduction has been among men. Thus, the Obama spending plan is not intended to primarily draw on the pool of people unemployed in this recession.

President Obama has a vision to spend more on health care, largely for its intrinsic value. Its stimulation value is minimal because unemployment is low in that sector; health sector employment has actually increased every single month during this recession.

I am not optimistic about stimulus in terms of lifting us out of the recession and, in particular, I am not optimistic about many aspects of the Obama stimulus plan. Further, the assumption of a multiplier of 1.5 is incredibly unlikely. I would much rather see meaningful tax reductions (e.g. lower marginal rates, lower corporate tax rates).

UPDATE: There has been a great deal of discussion in the blogosphere surrounding the nature of the rhetoric, especially with regards to Krugman’s comment that Barro’s analysis was “boneheaded.” In this respect, I think that Tyler Cowen’s comments sufficiently summarize my view:

Either way you cut it, there aren’t any boneheads in the room.

Indeed. After all, Robert Barro essentially wrote the book on government from a macro perspective. The tone of the debate is trending down and I think that we would all do well raise the level of discourse to a respectful tone.

Again, my view (free of name-calling) is that:

1. Stimulus will not get us out of the Depression.

2. The multiplier for government spending is likely between 0 and 1, which means that $1 spent by the government results in less than a $1 increase in real GDP.

3. Given (2), the proponents of the stimulus package must make their proposals based on intrinsic value rather than on promises that are impossible to keep. On this point, Barro is right on, “Back in the 1980s, many commentators ridiculed as voodoo economics the extreme supply-side view that across-the-board cuts in income-tax rates might raise overall tax revenues. Now we have the extreme demand-side view that the so-called ‘multiplier’ effect of government spending on economic output is greater than one — Team Obama is reportedly using a number around 1.5.”