Economists discuss the impact of the stimulus on our recession
Summary: The US economy continues to slow, albeit the rate of decay has slowed. But the net damage is severe and a recovery soon is imperative — or more “black swans” will appear. This is the third in a series of posts about the effects of basic automatic stabilizers on the economy during this recession.
- Why has the worst recession since the 1930’s had such a mild effect on America?, 14 July 2009
- Update: why has the worst recession since the 1930’s had so little impact on the economy?, 5 October 2009
The stimulus programs were mis-sold to the public, since our ruling elites (”both” parties) are compulsive liars. Government aid cannot end recessions. It serves only to mitigate the downturn and reduce the inevitable suffering. The heavy lifting among these tools results from unemployment aid, Medicaid, and food stamps — focused on those that have suffered loss of income. This post gives some reviews of the performance of these programs during the past few months, in the context of the overall stimulus package.
This is a broad sample of analysis about this important question, not a complete listing.
- Views of economic advisors to Bush and John McCain
- Other economists’ views
- Analysis by the Council of Economic Advisors
- Posts about solutions to this crisis
(1) Views of economic advisors to Bush and John McCain
(a) Excerpt from The Washington Independent, 7 August 2009:
Republicans are pushing back hard against today’s unemployment report, which showed a lowerr-than-expected 247,000 new jobless and the overall unemployment rate falling 0.1 points to 9.4% . Former McCain campaign economic adviser Douglas Holtz-Eakin spoke to reporters on a Republican National Committee-sponsored call to make the wonk’s case against reading too much into the report. “No real earnings growth in this report that would suggest sustained upward growth in this economy,” Holtz-Eakin said. “It cannot be considered good news that people left the labor force. If not for that, the unemployment rate might have creeped up to 9.6%, is my guess.”
Holtz-Eakin challenged Democratic rhetoric about the effect their policies have had in mitigating economic problems, though he allowed that “no one would argue that the stimulus has done nothing.”
The problem: Some Republicans have argued exactly that. In February, Dick Armey, the former House GOP majority leader who now leads FreedomWorks, predicted that the stimulus would actually worsen the economic picture. “Taking money out of the private economy,” Armey wrote, “either through taxes or inflation… and spending it in a way that doesn’t offset the loss of money with real economic gains is worse than doing nothing.” In July, Sen. Jon Kyl (R-Ariz.), the GOP’s whip in the Senate, suggested canceling the rest of the stimulus in a column that ran down the ways it seemed, to him, to be failing and wasting money.
From Wikipedia: Holtz-Eakin is an American economist, professor, former Director of the Congressional Budget Office and former chief economic policy adviser to Senator John McCain’s 2008 presidential campaign.
With a month more evidence, the next two make stronger statements.
(b) Excerpt from “Stimulus Credited for Lifting Economy, But Worries About Unemployment Persist“, Washington Post, 4 September 2009:
While some congressional Republicans and others are dubious about the success of the stimulus plan, economists generally agree that the package has played a significant part in stabilizing the economy. They are less certain about the size of the impact.
“It’s starting to play a role, helping us to have slightly positive rather than slightly negative GDP growth,” said Phillip Swagel, an assistant Treasury secretary in the Bush administration who is now a visiting professor at Georgetown’s McDonough School of Business. “It’s a gigantic amount of fiscal stimulus, and anyone who tells you it has had no impact, you should be skeptical of.”
IHS Global Insight, an economic consulting firm, estimates that the stimulus has increased the 2009 gross domestic product by about 1% over what it otherwise would have been, with the benefit almost entirely in the second half of the year.
The firm also forecasts that the package will, in total, result in about 2 million more jobs than otherwise would have existed at the end of 2010. Moody’s Economy.com estimates that the initiative will increase employment by 2.5 million jobs. Both estimates are below the 3 million to 3.5 million jobs the Obama administration estimated the package would create or save because the firms assumed more modest ripple effects from the stimulus spending than administration economists did.
(c) Excerpt from “US Macro Outlook: Turnign the Corner”, Mark Zandi (a Chief Economist of Moody’s, former McCain economic advisor), 8 September 2009 — Subscription Only:
Unprededented monetary and fiscal support is mainly responsible for the econoy’s upturn. The Federal Reserve’s aggressive actions helped stabilize the system. …
Fiscal policy is also providing significant support. Hard-pressed unemployed workers and fiscally strapped state and local governments would be cutting back much more if not for the federal government’s stimulus measures.
… All this has been costly — the federal budget deficit will approach $1.6 trillion this fiscal year, up frm $450 billion last year — but the cost to the economy and ultimately to taxpayers would have been measurably greater without it. The economy would still be in a deep recession if not for policymaker’s aggressive actions.
Another article by Zandi with the same message: “Boon or Boondoggle“, op-ed in the Philadelphia Inquirer, 11 October 2009 — “Critics are wrong: The stimulus is working. If anything, it wasn’t big enough, as job losses show.”
(2) Other economists’ views
(a) “Fighting Downturns with Fiscal Policy“, Federal Reserve Bank of San Francisco, 19 June 2009 – The best single thing I’ve read about our situation, a rare moment of intellectual honesty. Conclusion:
Earlier this year, Congress passed a $787 billion fiscal stimulus package spread over 10 years. Of that total, $584 billion are spent in 2009 and 2010, with 19% of the funds allocated toward increases in government spending, 33.4% in transfers to the states, and 47.6% toward tax cuts. The findings from the three empirical studies, particularly those of Romer and Romer and Mountford and Uhlig, suggest that the fiscal stimulus package will boost growth substantially over the next two years, partly because it includes sizeable tax cuts that can be implemented quickly and that have significant effects on output.
Nevertheless, the uncertainty regarding those estimates remains high. Several economists remain skeptical that fiscal multipliers–whether from spending or taxes–are very large (see, for instance, Barro 2009). Moreover historical relationships may prove much less reliable during this downturn. Faced with a large decline in wealth and tight credit availability, households may very well respond differently to tax cuts today than they have in the past.
(b) Excerpt from “Stimulus arithmetic (wonkish but important)“, Paul Krugman, blog of the New York Times, 6 January 2009:
How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.
… And that gets us to politics. This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.
I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”
(c) Excerpt from “Social Insurance and the Severity of Recessions“, Mark Thoma (Prof of Economics, U of Oregon), Economist’s View, 1 August 2009:
The question of how bad would economic conditions be right now if there had been no stimulus package and no financial bailout is receiving considerable attention. There’s no way to know for sure, but I believe the economy would have been much worse off without these two policy interventions. But without actually running the alternative scenario – something we can’t do – there’s no way to know for sure.
But one thing I am fairly certain of, and something I don’t think is getting enough attention, is the effect that automatic stabilizers have had in helping to ease the impact of the recession for individual households on and for the overall economy.
What are automatic stabilizers? Automatic stabilizers are taxes and transfers (e.g. unemployment compensation and food stamps) that automatically change with changes in economic conditions in a way that dampens economic cycles. For example, when the economy turns downward, the amount spent on food stamps automatically goes up as more people apply (or eligibility rules are eased), and the extra spending the food stamps helps to soften the downturn for the individuals receiving the help and for the businesses and employees where the money is spent (and then the multiplier process spreads the benefits more widely). Similarly, unemployment compensation, which obviously rises as jobs are eliminated, goes up when conditions deteriorate and that also provides a boost to demand. In addition, income tax as a share of GDP goes down in recessions and that helps to offset the fall in GDP as well.
How much worse would things be now if we had followed the advice of the hardcore rightwing and eliminated the welfare state programs that function so effectively as automatic stabilizers? It still wouldn’t be like the pictures you see of the Great Depression because we are a much wealthier nation than we were then and thus have more private resources to rely upon. But even so, not everyone has wealth to rely upon and the recession would be much more evident, and the amount of human suffering would be much greater, without the social insurance programs we put in place in the years since the Great Depression — programs that we, for the most part, now take for granted. I don’t mean there is no suffering due to the downturn, there is and I don’t want to minimize it – I wish our social insurance programs were even more generous than they are now for that reason – and I don’t mean to say there are no signs at all of economic problems, there are, but we shouldn’t overlook the important role that social insurance plays during recessions.
(d) Update — “A note on Automatic Stabilizers“, Felipe Rezende, Economic Perspectives from Kansas City (faculty of the U of Missouri-KC), 16 Jule 2009 — Excerpt:
What has so far prevented a deep depression in 2009? The answer, as Paul Krugman explained yesterday, are automatic stabilizers. Indeed, as Hyman Minsky emphasized more than 20 years ago in his book Stabilizing an Unstable Economy (1986), this feature of the federal government’s budget – i.e. the fact that it moves counter-cyclically in an automatic fashion – imparts a great stabilizing force to aggregate demand.
(3) Analysis by the Council of Economic Advisors
These have the data and analysis on which other economists rely for their work.
(a) “So, Is It Working? An Assessment of the American Recovery and Reinvestment Act at the Five-Month Mark“. Christina D. Romer (Chairwoman, Council of Economic Advisors), 6 August 2009 — Excerpt:
Even if the Recovery Act is clearly working in the concrete, on-the-ground sense, there is still the question of whether we can see it in the overall performance of the economy.
Here, I can’t resist pointing out the fallacy in a common critique. Throughout the spring, I frequently heard people say: “The unemployment rate is even higher than you all predicted without stimulus. That means the policy isn’t working and may actually be making things worse.” Even leaving aside the fact that we were always very clear that there was tremendous uncertainty about what would happen to the economy, that argument is – to quote a recent New York Times editorial – just plain “silly.”
To understand why, let me give you an analogy. Suppose you go to your doctor for a strep throat and he or she prescribes an antibiotic. Sometime after you get the prescription, and maybe even after you take the first pill, your fever spikes. Do you decide that the medicine is useless? Do you conclude the antibiotic caused the infection to get worse? Surely not. You probably conclude that the illness was more serious than you and the doctor thought, and are very glad you saw the doctor and started taking the medicine when you did.
That was exactly the situation with the economy. It is true that the U.S. and world economies went down much faster last fall and winter than we, and almost all other forecasters, expected. The revised GDP statistics show that the actual decline in GDP growth in the third and fourth quarters of last year was about twice as large as the preliminary estimates we had at the time indicated. And, the rise in the unemployment rate has been exceptionally large, even given the large fall in GDP that we now know occurred. The fact that the economy deteriorated between January when we were doing our forecast and the end of March simply reinforces how crucial it was that we took action when we did. …
Cross-Section Evidence of Macroeconomic Effects
Because the evidence from the path of the economy over time can’t settle the issue of what the effects of the Recovery Act have been, it’s helpful to also look at other types of data. In particular, I want to mention two types of comparative evidence.
Comparisons across Countries.
The first involves comparisons across countries. Countries’ responses to the crisis have varied substantially. One can therefore ask whether countries that have responded more aggressively seem to be recovering more quickly. To get evidence about this, we started with a set of forecasts of growth in the second quarter of this year that were made last November – after the crisis had hit, but before countries had formulated their policy response. We then collected analysts’ recent best guesses for what second-quarter growth will be in those countries.17 This figure shows the relationship between how countries’ second-quarter growth prospects have changed from what was expected back in November, and the countries’ discretionary fiscal stimulus in 2009.
The fact that the observations lie along an upward-sloping line shows that, on average, things have improved more in countries that adopted bigger stimulus packages. And, the relationship is sizable: on average, a country with stimulus that’s larger by 1% of GDP has expected real GDP growth in the second quarter that’s about 2 percentage points higher relative to the November forecast.
This correlation is in some ways surprising, because there’s an obvious element of reverse causation that’s pushing it the other way: countries that got worse news around the turn of the year probably adopted more aggressive stimulus packages. Also, to the extent that analysts back in November could foresee countries’ likely actions and take them into account in making their forecasts, this would cause the relationship to understate the effect of stimulus. But despite these factors tending to bias the estimates down, the relationship is highly statistically significant, large, and robust to changes in the sample and in the measure of forecasted growth. …
What Can We Expect Going Forward?
So much of what I have discussed has focused on the role of the Recovery Act in moderating the GDP decline and saving jobs in the second quarter of 2009. The obvious next question is, what can we expect going forward?
Effects will Increase over Time.
First, the impact of the Recovery Act will almost certainly increase over the next several quarters. We expect the fiscal stimulus to be roughly $100 billion in each of the next five quarters. The impact of this steady stimulus, however, will increase over time because the multiplier effect tends to rise for a substantial period before beginning to wane. Also, the composition of the stimulus will be changing toward components with larger short-run effects. The early stimulus was weighted more heavily toward tax changes and state fiscal relief, whereas going forward there will be more direct government investments. These direct investments have short-run effects roughly 60% larger than tax cuts.
Second, because of the Recovery Act, other rescue measures we have taken, and the economy’s natural resilience, most forecasters are now predicting that GDP growth is likely to turn positive by the end of the year.20 Federal Reserve Chairman Ben Bernanke seconded this opinion in recent Congressional testimony.21 This view is supported by the fact that a number of leading indicators, including initial claims for unemployment insurance, building permits, and consumer confidence, have improved substantially over the past few months. However, as is always the case, especially around a turning point, there is substantial uncertainty to this forecast. There is even greater uncertainty about how strong the recovery is likely to be. The strength will depend on a range of factors, including how fast the economies of our trading partners recover; whether American consumers decide to increase their savings rate even more than they already have; and how quickly financial markets and business confidence return to normal levels.
Continued Job Loss.
Third, it is important to realize that job growth will almost certainly lag the turnaround in real GDP growth. The consensus forecast is for the employment statistics we get tomorrow to show that the U.S. economy continued to lose hundreds of thousands of jobs in July. Given that GDP growth was still negative in the second quarter, this is all but inevitable. And, it is unacceptable. Unfortunately, even once GDP begins to grow, it will likely take still longer for employment to stop falling and begin to rise.
Recovery Will Take Time.
Fourth, and crucially, given how far the economy has declined, recovery will be a long, hard process. Even if GDP growth is relatively robust going forward, it will take a substantial time to restore employment to normal and bring the unemployment rate back down to usual levels. But, the President is committed to job creation, and that is and has been a focal part of our efforts.
The bottom line.
We are no doubt in for more turbulent times. The actions we have taken, particularly the American Recovery and Reinvestment Act, have clearly changed the trajectory we are on. They are doing what the President always said needed to be our top priority – rescuing an economy on the edge of a second Great Depression. And, I firmly believe that when the history of this period is written, the Recovery Act will be seen as the beginning of the end of this terrible economic crisis.
(b) The economic impact of the American Recovery and Reinvestment Act of 2009, First Quarterly Report, Council of Economic Advisors, 10 September 2009 — 48 page PDF. Excerpt from the executive summary:
Evaluating the impact of countercyclical macroeconomic policy is inherently difficult because we do not observe what would have happened to the economy in the absence of policy. And the sooner the evaluation is done after passage, the less data one has about key economic indicators. Any estimates of the impact of the ARRA at this early stage must therefore be regarded as preliminary and understood to be subject to considerable uncertainty. In this regard, it is important to note that there has not yet been any direct reporting by recipients of ARRA funds on job retention and creation. Such direct reporting data will be evaluated and incorporated in future reports.
Because of the inherent difficulties in the analysis, we approach the task of estimating the impact of the Recovery Act from a number of different directions. Our multi-faceted analysis suggests that the ARRA has had a substantial positive impact on the growth of real gross domestic product (GDP) and on employment in the second and third quarters of 2009. That various approaches yield similar estimates increases the confidence one can have in the results.
Among the key finding of the study are:
- As of the end of August, $151.4 billion of the original $787 billion has been outlaid or has gone to American taxpayers and businesses in the form of tax reductions. …
- The areas where stimulus has been largest in the first six months are individual tax cuts, state fiscal relief, and aid to those most directly hurt by the recession. That recovery funds have gone out rapidly certainly increases the probability that the Act has been effective in its first six months.
- Following implementation of the ARRA, the trajectory of the economy changed materially toward moderating output decline and job loss. The decomposition of the GDP and employment change by components or sector suggests that the ARRA has played a key role in this change of trajectory.
- Estimates of the impact of the ARRA made by comparing actual economic performance to the predictions of a plausible, statistical baseline suggest that the Recovery Act added roughly 2.3 percentage points to real GDP growth in the second quarter and is likely to add even more to growth in the third quarter.
- This analysis indicates that the ARRA and other policy actions caused employment in August to be slightly more than 1 million jobs higher than it otherwise would have been. We estimate that the Act has had particularly strong effects in manufacturing, construction, retail trade, and temporary employment services. …
- In addition to the estimates based on statistical projection, we provide estimates of the effects of the ARRA from standard economic models. Both our multiplier analysis and estimates from a wide range of private and public sector forecasters confirm the estimates from the statistical projection analysis. There is broad agreement that the ARRA has added between 2 and 3 percentage points to baseline real GDP growth in the second quarter of 2009 and around 3 percentage points in the third quarter. There is also broad agreement that it has likely added between 600,000 and 1.1 million to employment (again, relative to what would have happened without stimulus) as of the third quarter.
- Fiscal stimulus appears to be effective in mitigating the worldwide recession. Nearly every industrialized country and many emerging economies responded to the severe financial crisis and recession by enacting fiscal stimulus. However, countries differed greatly in the size of their fiscal actions. We find that countries that adopted larger fiscal stimulus packages have outperformed expectations relative to those adopting smaller packages.
- State fiscal relief was one of the ways in which the Recovery Act was able to provide support for the economy most quickly, and it played a critical role in helping states facing large budget shortfalls because of the recession. Our analysis indicates that state fiscal relief increased employment at the state level relative to what would have happened without stimulus. Thus, this analysis both provides evidence of how one particular type of fiscal stimulus impacts the economy and corroborates the more fundamental finding that fiscal stimulus in general is an effective countercyclical tool.
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Posts about solutions:
- A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
- How should we respond to the crisis?, 24 September 2008
- A solution to our financial crisis, 25 September 2008
- The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
- Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
- Dr. Bush, stabilize the economy – stat!, 7 October 2008
- The new President will need new solutions for the economic crisis, 9 October 2008
- New recommendations to solve our financial crisis (and I admit that I was wrong), 23 October 2008
- A look ahead to the end of this financial crisis, 30 October 2008
- Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009
- Bush’s bailout plan is now Obama’s. His quiet eloquence guides the sheep into the pen, 30 March 2009
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