Monday, December 22, 2008
The case against stimulus
I started on this after tweeting Hugh Hewitt about the stimulus package. He asked if it's nuts. Let's start with a chestnut:
One hears arguments for stimulus largely on Keynesian grounds. The argument for fiscal expansion is that private spending is deficient, perhaps because households and private firms are going to save more money to make up for the financial losses incurred. The problem is that a permanent or sustained stimulus -- as opposed to the temporary stimulus packages Larry Summers originally supported -- is found in many cases to lead to a complete offset: Deficits now are seen as likely future tax increases. This was found in the early 1990s by Giavazzi and Pagano, and confirmed in many additional studies (the authors reprise their evidence here.) Small and temporary packages probably work in a more Keynesian sense than do large shocks of raising the full-employment deficit by 1.5% of GDP. (It's highly unlikely that a $750 billion over two year deal as the Obama transition team is proposing does not raise the full-employment deficit by that much.)
You will also hear that those types of estimates of crowding out apply to economies not as bad off as ours, that these are serious times. We need a new New Deal. Price Fishback notes, however,
What benefits do exist from larger deficit spending come more from tax cuts than spending. Ben Bernanke told us this six years ago, and a new paper from NBER supports it, though perhaps more weakly than the WSJ suggests. The authors note that whatever fiscal policy does, there is crowding out, just as Fishback found for the Great Depression. And it has to be a surprise to have that effect.
So the Obama stimulus plan, which appears to have no more than $100 billion in tax cuts while giving away money to state governments and making "investments" in " traditional infrastructure, school construction, energy efficiency, broadband access and health-information technology" should be evaluated as being too sustained, too tilted towards less-effective spending, and perhaps too large in the Giavazzi and Pagano sense.
What would I prefer? The experiment that has not been tried, but has been prepared for by the Fed, is continued monetary easing using quantitative tools rather than the interest rate (since we are now in ZIRP-land.) In their view, effective communication and asset purchases by the Fed are an alternative to fiscal policy. If deflation is the problem, let the Fed do its job of promoting price stability.
The advantages that government officials enjoy in drawing their salaries are what is seen. The benefits that result for their suppliers are also what is seen. They are right under your nose.Bastiat, in What Is Seen and What is Not Seen, begins the case against stimulus. Money spent on things that are worth $100 (we'll skip the sous from now on) for which government extracts $100 are things that we can support. Things that are not worth $100 are not useful; the soil receives less than has evaporated through taxation.
But the disadvantage that the taxpayers try to free themselves from is what is not seen, and the distress that results from it for the merchants who supply them is something further that is not seen, although it should stand out plainly enough to be seen intellectually.
When a government official spends on his own behalf one hundred sous more, this implies that a taxpayer spends on his own behalf one hundred sous the less. But the spending of the government official is seen, because it is done; while that of the taxpayer is not seen, because�alas!�he is prevented from doing it.
You compare the nation to a parched piece of land and the tax to a life-giving rain. So be it. But you should also ask yourself where this rain comes from, and whether it is not precisely the tax that draws the moisture from the soil and dries it up.
You should ask yourself further whether the soil receives more of this precious water from the rain than it loses by the evaporation?
One hears arguments for stimulus largely on Keynesian grounds. The argument for fiscal expansion is that private spending is deficient, perhaps because households and private firms are going to save more money to make up for the financial losses incurred. The problem is that a permanent or sustained stimulus -- as opposed to the temporary stimulus packages Larry Summers originally supported -- is found in many cases to lead to a complete offset: Deficits now are seen as likely future tax increases. This was found in the early 1990s by Giavazzi and Pagano, and confirmed in many additional studies (the authors reprise their evidence here.) Small and temporary packages probably work in a more Keynesian sense than do large shocks of raising the full-employment deficit by 1.5% of GDP. (It's highly unlikely that a $750 billion over two year deal as the Obama transition team is proposing does not raise the full-employment deficit by that much.)
You will also hear that those types of estimates of crowding out apply to economies not as bad off as ours, that these are serious times. We need a new New Deal. Price Fishback notes, however,
Studies that examine [the success of Depression-era stimulus programs] suggest that an additional grant dollar per person distributed to a county for public works and relief during the period of 1933 to 1939 contributed to a rise in in-migration and an increase in income per person in the county of about 80 cents in 1939. We should remember, however, that this was during a period when there were huge numbers of unemployed workers available for work. Even during this period, some studies find evidence of crowding out of private employment. Today, with unemployment rates below 7 percent, it is likely that such public-works spending would crowd out a significant amount of private construction.That is, find out if a $100 of tax revenue taken -- now or later with interest -- generates $100 of benefits. Christina Romer, Obama's new head of the Council of Economic Advisers, wrote in 2003 as an entry in the Encylopedia Brittanica:
My own recommendation would be to evaluate the modern public-works programs more on the basis of the specific productivity of the programs rather than as stimuli to the economy. We know that we have an aging infrastructure of roads, bridges, and dams. The costs and benefits of the replacements would be my focus in evaluating whether to spend the money or not.
Fiscal policy played a relatively small role in stimulating recovery in the United States. ...Franklin Roosevelt�s New Deal, initiated in early 1933, did include aPerhaps Prof. Romer thinks the spending increases were too small -- damn those local and state governments for balancing their budgets! -- but she certainly believes that sustained deficit spending harms economic growth.
number of new federal programs aimed at generating recovery. For example, the Works Progress Administration (WPA) hired the unemployed to work on government building projects, and the Agricultural Adjustment Administration (AAA) gave large payments to farmers. However, the actual increases in government spending and the government budget deficit were small relative
to the size of the economy. This is especially apparent when state government budget deficits are included, because those deficits actually declined at the same time that the federal deficit rose. As a result, the new spending programs initiated by the New Deal had little direct expansionary effect on the economy. Whether they may nevertheless have had positive effects on consumer and business sentiment remains an open question.
What benefits do exist from larger deficit spending come more from tax cuts than spending. Ben Bernanke told us this six years ago, and a new paper from NBER supports it, though perhaps more weakly than the WSJ suggests. The authors note that whatever fiscal policy does, there is crowding out, just as Fishback found for the Great Depression. And it has to be a surprise to have that effect.
So the Obama stimulus plan, which appears to have no more than $100 billion in tax cuts while giving away money to state governments and making "investments" in " traditional infrastructure, school construction, energy efficiency, broadband access and health-information technology" should be evaluated as being too sustained, too tilted towards less-effective spending, and perhaps too large in the Giavazzi and Pagano sense.
What would I prefer? The experiment that has not been tried, but has been prepared for by the Fed, is continued monetary easing using quantitative tools rather than the interest rate (since we are now in ZIRP-land.) In their view, effective communication and asset purchases by the Fed are an alternative to fiscal policy. If deflation is the problem, let the Fed do its job of promoting price stability.
Labels: economics
