March 1, 2010
Stimulus: Pluses and Minuses
Stimulus: Pluses and Minuses—Posner
Becker is certainly right that it would be a mistake to enact a further stimulus program. With half the existing $787 billion stimulus package (which has grown to $862 billion while no one was looking—and that's the figure I'll use henceforth) that Congress enacted in February of last year still unspent, and given the sluggishness with which our government moves, a new stimulus program would probably not come on line until 2011 or 2012, by which time its principal effect might be to increase our already staggering public debt. Anyway the question of a new stimulus package is thoroughly academic because of the extreme unpopularity of the existing one, which only 6 percent Americans believe has had any positive impact on employment.
I think they're wrong, and that the original stimulus was, on balance, a justified measure. But I can well understand its unpopularity, and I share many of the reservations voiced by critics.
Because it is being financed by federal borrowing rather than by taxes, by the time the stimulus is fully implemented (probably early in 2011) it will have injected $862 billion into the economy: roughly $400 billion in 2009 and the same amount in 2010. Each figure is a little less than 3 percent of GDP. The economic effect of such an increase in GDP depends on what is done with the money. Suppose all the recipients used it to buy Treasury bonds. Then its economic effect would be zero: the government would be lending the money and then borrowing it back from the borrowers.
Obviously some, and probably much, of the money has been spent rather than saved, though no one knows how much. Since the personal savings rate is less than 5 percent and some personal savings finance private business activities, probably almost all of the stimulus money has been or will be spent. This does not mean that it is or will be well spent, in the sense of financing activities that add more to economic welfare than the same amount used for private investment would do. But the stimulus has not reduced private investment, as it might do if the borrowing to finance the stimulus raised interest rates. Interest rates have been kept very low by the Federal Reserve. Despite that, private investment has been anemic; net of depreciation it was negative in 2009. Banks and consumers alike—heavily indebted and pessimistic about profit and income prospects—have trimmed their expenditures. Banks continue to hoard some $1.2 trillion in excess reserves (lendable cash sitting in accounts in federal reserve banks rather than being lent or otherwise invested), and the personal savings rate, which before the current depression was only about 1 percent, has increased dramatically.
In effect, the Treasury has borrowed from Americans money that wasn't being used productively, and from foreigners (but mainly from Americans) money that they preferred to lend than to spend, and has recirculated the money into the American economy. Consumption expenditures rose in 2009 at the same time that incomes were falling and saving was increasing because stimulus money financed consumption that otherwise would not have materialized. An increase in consumption stimulates an increase in production (or at least a more rapid drawdown of inventories, so that production recommences sooner), which in turn increases the demand for labor and so reduces unemployment.
No one knows how many people are employed who wouldn't be were it not for the stimulus money. There are almost 15 million unemployed Americans, and since the unemployment rate is almost 10 percent, this suggests that about 135 million are employed. If the stimulus, which as I said is injecting about $400 billion a year into the economy, has increased the number of employed by 1 percent, that would reduce the number of unemployed by almost 10 percent. Or stated differently, were it not for the stimulus, the unemployment rate might be almost 11 percent rather than almost 10 percent. An unemployment rate of almost 11 percent would cause something akin to panic among businessmen, consumers, and politicians, with very bad consequences for the country. So one can think of the stimulus program as a kind of insurance policy against potential economic and political unrest.
The stimulus has not, not yet anyway, "crowded out" private investment because there is so little demand for such investment at present even though interest rates are extremely low. The Barro-Ricardian Equivalence hypothesis implies that people are reducing their consumption and investment in anticipation of having to pay increased taxes in the future to repay the money borrowed to finance the stimulus. There may be something to this, but probably not much, because no one knows the form and incidence of taxes or other measures (inflation, devaluation, curtailment of government exenditures) that will be necessitated by the borrowing that is financing the stimulus. Probably most people take the view that sufficient unto the day is the evil thereof, rather than curtailing spending in the light of some unknown future prospect of having to pay in some form for their present consumption. The studies by Robert Barro and others that find evidence to support the Barro-Ricardian Equivalence hypothesis are considered unpersuasive by most economists.
The biggest objection to the stimulus is that it adds almost a trillion dollars to our enormous and rapidly growing federal deficit, in a political setting in which measures to reduce the deficit whether by tax increases, spending cuts, inflation, or stimulating more rapid economic growth seem either politically infeasible or economically undesirable, or both. Yet to the extent that the stimulus has increased production, employment, and therefore incomes, it has, by increasing tax revenues, offset some of the increment to the deficit that the borrowing to finance it has added.
The stimulus was poorly designed. A lot of it went to states, and the stimulus supporters brag that it saved hundreds of thousands of state public sector jobs. But without the stimulus the states might have preserved the jobs, or most of them at any rate, by cutting inessential state expenditures. Any such cut would reduce the amount of money in circulation and therefore consumption and therefore production and therefore jobs, but how many and when are entirely unclear.
Moreover, a stimulus that saves public employees' jobs directly and private employees' jobs at best indirectly creates resentment among private employees who have lost or fear losing their jobs. They think the government is in effect paying itself, or taking care of its "own" ahead of the broader public, although many of the public jobs saved (policemen, firemen, teachers) may be essential. Federal financing of state employees' jobs also retards necessary reforms of the swollen public-employee sector.
No effort was made to target the stimulus on industries and areas of the country in which unemployment is greatest; it is those industries and those areas in which the employment effect of the stimulus would have been maximized. Indeed, stimulus moneys spent in areas or industries of low unemployment may not directly reduce unemployment at all, but do so only indirectly through the stimulus that spending imparts to production and hence employment. Becker's argument that the stimulus reflects Democratic Party priorities rather than national priorities is compelling.
The stimulus was also poorly executed, because its direction was placed in the hands of Vice President Biden, who has no management experience, to oversee; and he allotted only 20 percent of his time to the task. The Administration should have hired an experienced manager, as it did to supervise the auto bankruptcies (which went quite quickly and smoothly), to oversee and expedite the stimulus.
And it has been poorly defended. The critical public relations botch was Christina Romer's prediction in January 2009 that, without the stimulus that the new Administration was planning, the unemployment rate would rise from its then rate of 7.2 percent to 8 percent. With the stimulus, of course, the unemployment rate rose to 10 percent, though it has now fallen back to 9.7 percent. It's hard to get people to understand that trying to predict the effect of the stimulus was a chump's game and that without the stimulus the unemployment rate could well be 11 percent.
Although the President is articulate and intelligent, and Romer and the other members of his economic team are competent and in some cases outstanding (Lawrence Summers, for example), none of them seems able to explain the theory behind a stimulus in words that people who are not economists or financiers can understand. It doesn't help that neither the members of the President's team, nor Fed Chairman Bernanke, are gifted communicators, and that Bernanke, Treasury Secretary Geithner, and National Economic Council Director Summers, are implicated (Geithner, and especially Bernanke, deeply) in errors of policy that bear primary responsibility for the economic crisis—complacency, unsound monetary policy, and regulatory laxity. The fact that so few Americans believe that the stimulus saved any jobs suggests a profound failure of communication on the part of the Administration, not to mention financial journalists and public-intellectual economists.
Fiscal Stimulus Packages: What are their Effects? Becker
The over $800 billion American fiscal stimulus package is enormously unpopular in many quarters. Yet for others, including some well-known economists, a second package is needed to make unemployment decline faster. It is very difficult to give a definite answer to the effectiveness of what has been spent so far, but I believe both theory and quite limited empirical evidence suggest that it is likely having a small "multiplier".
According to simple Keynesian models, the rationale for increased government spending during a recession is straightforward. If governments employ underutilized labor and capital when they spend more, that provides an immediate boost to employment and output. A further stimulus comes from the spending by the owners of the unemployed labor and capital who benefit from the government spending. Their spending helps multiply the effects of the government spending still further, and so does spending by the recipients of this second round of spending. The total impact is the sum of all these separate boosts, and its ratio to the initial level of government spending is called the spending multiplier. A study by Dr. Christina Romer, Chair of the Council of Economic Advisers, published shortly before she took office claimed the spending multiplier during the recession at that time would be well over 1.0.
In reality, several major considerations neglected by this Keynesian analysis suggest a rather different multiplier. There is often a long delay between discussions of a fiscal stimulus, enactment of a law providing for the stimulus, and the actual spending. Dr. Romer discussed the broad dimensions of the current stimulus package even before she took her current position, and Congress passed the law providing for about an $800 fiscal stimulus shortly after President Obama took office. Yet it is now more than one year later, and only about a half of the stimulus package has been spent. In the meantime, the economy first hit bottom, and then has begun a strong recovery in GDP, and a modest recovery in unemployment. The long lag between discussion, enactment, and actual spending is an old criticism of fiscal stimulus even by very committed Keynesians.
Nor did the actual stimulus package voted by Congress correspond very closely to the theory behind the multiplier from government spending. Instead of being concentrated mainly on sectors that had suffered large increases in unemployment, such as construction, the stimulus spending was oriented toward many sectors that liberal members of the Democratic controlled Congress wanted to greatly expand. These include healthcare, schools, alternative energy sources, and medical and basic research. Some of this spending may have considerable social value, but it provides little stimulus since sectors like health, education, and wind power development were not hit hard by the recession, and hence have had low levels of unemployment. Government spending in these areas would tend mainly to bid labor away from either the private sector, or other government programs, or raise the earnings of those already employed. As a result, any multiplier from the stimulus package is likely to be less than one, not greater than one.
Even though the theory behind the multiplier has been around for a long time, few studies credibly estimate multipliers from different kinds of government spending. Part of the problem is that many other things are usually also changing when government spending changes, so it is difficult to find "natural" experiments where the effects of government spending are isolated from changes in other important variables. Some of the relevant factors that may be changing are prices, including wage rates and interest rates, consumption, and private investment.
Robert Barro of Harvard University has been estimating both spending and tax multipliers from past episodes, not from the current one. Using historical data obviously has many limitations from the point of view of evaluating the current stimulus, but such an evaluation is difficult because many aspects of the American economy have been changing during this recession along with stimulus spending, such as the monies spent on bank bailouts. Barro's estimated spending multipliers are based mainly on fluctuations in defense spending before, during, and after wars, such as World War II and the Korean War. He reports in a recent Wall Street Journal article (February 23) estimated spending multipliers over a two-year period following changes in defense spending. These multipliers equal about 0.4 following the first year, and 0.6 after two years.
They indicate sizable changes in overall GDP per $100 billion change in defense spending, but they also suggest that government spending significantly crowds out either personal consumption spending, private investment, or exports. Still, if these were the only effects of stimulus packages, multipliers of about 0.6 would indicate that larger government spending, such as the Obama stimulus package, can induce significant growth in GDP, presumably especially when unemployment rates are high.
However, greater spending has to be paid for eventually by higher taxes, including inflation taxes, since governments are subject to long term budget balance requirements, just as are households and businesses. Barro also estimates tax multipliers based on the effects on GDP of changes in average marginal tax rates from federal and state and local income taxes, and social security payroll taxes. These tax multipliers are about -1.1, which means that increases in marginal tax rates that raise tax revenue by say $300 billion would lower GDP by over $300 billion in the following year.
Putting these estimated spending and tax multipliers together, in recognition that government budgets have to be balanced eventually, indicates that the Obama stimulus package on balance would have a small, possibly even negative, overall effect on GDP. To be sure, these results have to be qualified since changes in nondefense spending, as in this stimulus package, may have larger multipliers than those estimated by Barro, although it is not obvious why that should be so. Moreover, if the spending occurs in 2009 and 2010, and raises GDP for a few years during a recession, perhaps that is worth any reductions in GDP that follows in later years when taxes are actually increased to produce the budget balance (although much of that effect might be anticipated earlier).
A few other discussions of the current stimulus package have much rosier conclusions about its effects on employment and GDP. But these estimates have little credibility because of the difficulties in disentangling the stimulus effects from those of Fed and Treasury spending on bailouts, many other factors that have been changing along with the stimulus spending, and the intrinsic strengths of the private sector of the American economy (see, for example, an article by Cogan, Taylor, and Wieland in the Wall Street Journal of September 17, 2009 for a discussion of some of these factors).
My conclusion is that the Obama-Congress stimulus was an attempt at reengineering government's role in the economy that was badly designed and executed relative to the alleged goal of giving a short-term stimulus to the economy. Its design, and the general evidence on the effects of spending fiscal stimulus, should make Americans wary of any attempt to pass a second stimulus package, whatever form it takes.