Bastiat just rolled over in his grave
By Scott Sumner
The Administration has released a report defending the ARRA program, and it’s every bit as embarrassing as you might expect. Where to begin . . .
1. The report seems to ignore the fact that fiscal stimulus failed to produce the effects the administration claimed it would produce. Now I’m willing to cut them some slack on that point, as ceteris is never paribus. They claimed that the recession turned out to be more severe than they expected, although to be honest it was very clear by early 2009 when Obama took office that the recession was extremely severe. But let’s give them the benefit of the doubt.
2. In 2013 the Federal government switched to a policy of fiscal austerity, which should have slowed growth. Instead growth in 2013 accelerated. This time there was no “the recession of 2009 was deeper than we thought” excuse. The fiscal multiplier model simply failed.
3. Instead of comparing actual to predicted results, they have lots of graphs showing the success of fiscal stimulus based on models of the economy that simply assume the policy was successful. How is that supposed to convince anyone?
4. These models are defended with a very inadequate discussion of the theoretical and empirical research that underpins the multiplier model. Let’s start with by far the biggest problem, monetary offset. They correctly point out that there are new Keynesian models that show a fiscal multiplier can work when monetary policy is constrained by the zero bound. But those models assume the Fed does not engage in unconventional stimulus such as QE and forward guidance. In fact, the Fed does both, which makes those NK models completely inappropriate for evaluating fiscal stimulus in the US. They also ignore international evidence of the failure of fiscal stimulus at the zero bound, such as the Japanese fiscal stimulus of the 1990s and 2000s
5. They cite studies of fiscal stimulus using wartime spending, which is of little applicability to this crisis. These models are based on the notion that people work harder when military spending depresses consumption. Military spending during WWII did boost RGDP, but also depressed consumption and living standards (recall the Great Depression was basically over by early December 1941, before Pearl Harbor.) In contrast, only about 18% of ARRA plus subsequent stimulus was in the form of public investment, it was mostly tax cuts and transfers. Military spending declined. Given monetary offset, there’s no reason to assume that tax cuts had much demand-side effect. And they failed to do the sorts of tax cuts that might have boosted the supply side, such as the employer-side payroll tax cut that Christina Romer recommended
6. If it’s really true (as they claim) that fiscal stimulus was needed in 2009 because monetary policy was constrained by the zero bound, why didn’t Obama appoint some people to the Fed in 2009 who would adopt Paul Krugman-style unconventional stimulus, such as the forward guidance that was eventually adopted in late 2012? After all, the Dems had a filibuster-proof majority in 2009. I think we all know the answer. Larry Summers says he prefers fiscal to monetary stimulus, even where monetary stimulus is possible. Indeed Summers is so pro-fiscal that progressive blogger Matt Yglesias once characterized his views as “socialist.” (Yes, I’m sure Matt was half joking, but there has to be some truth in any joke.) The report suggests fiscal stimulus was needed to save the economy, whereas it was actually adopted for ideological reasons. Obama has not adopted a far left set of public policies. But his actual views (as far as I can tell) are left wing on almost every single economic issue. He’s smart enough to know he rules over one of the most conservative developed economies, and hence is cautious in his policy initiatives. But make no mistake about it, he’ll use any and all opportunities to expand government, and he’ll never try to scale it back in any important way. He’s not a Clinton.
7. The report also discusses cross-sectional studies of the effect of fiscal stimulus, despite the fact that cross sectional studies tell us nothing about the aggregate fiscal multiplier. Even if it were zero at the national level, building a billion dollar air force base in Fargo would boost Fargo’s GDP. Everyone agrees on that. While the report does acknowledge the monetary offset issue at the state level, they go on to discuss data from eurozone countries that seems to ignore the monetary offset issue with cross-sectional studies within a single currency. Mark Sadowski re-estimated the effect for countries with independent monetary policies, and found little impact. The report seems to have been written by people living within the liberal Keynesian echo chamber, who have little knowledge of important criticisms of the fiscal multiplier model.
8. The report brushes aside any concern about the effect of UI insurance on the unemployment rate. Admittedly we don’t have conclusive evidence in this area, but most of the studies I’ve seen (including studies cited by Brad DeLong) point to effects on the order of 1/2%. Not huge, but not trivial either.
9. There are widely implausible estimates of the impact of ARRA on GDP:
Despite the differences in the models, these private-sector forecasters all estimated that the Recovery Act would raise GDP substantially from 2009 to 2011, including a boost to GDP of between 2.0 and 3.4 percent in 2010.
Any private sector forecaster who thinks the Fed would have allowed 2010 GDP to be about 2.7% less than it actually turned out to be needs to have their forecasting license revoked, that estimate is an insult to Ben Bernanke. He was not about to preside over another depression. Bernanke would have instituted price level targeting long before that outcome materialized. People working in this area need to have common sense about plausible outcomes, otherwise nothing they say will be taken seriously. Again, look at some of the absurd NK predictions as to how the 2013 austerity would impact 2013 GDP growth. Here’s what the report says about 2013:
Second, the economy has encountered a long list of additional headwinds in recent years. . . . It includes fiscal austerity at the State and local level that intensified as the Recovery Act began to phase out and has cost hundreds of thousands of additional job losses even during the expansion period. And it includes measures like the sequester which CBO estimated took 0.6 percentage point off growth in 2013, the 16-day government shutdown which the Bureau of Economic Analysis (BEA) estimated directly subtracted 0.3 percentage point from growth in the fourth quarter, and dangerous brinksmanship around the debt limit in 2011 and 2013.
They forgot to mention to big payroll tax increase, or the income tax increases, both occurred at the beginning of 2013. Quite a fiscal drag (the Economist magazine estimated the effect at 1.9% of GDP, even without the shutdown), and yet RGDP growth accelerates from 1.95% in 2012 to 2.7% in 2013. Nor is there a discussion of the fact that fiscal austerity in the U.S. was slightly greater than in the eurozone in recent years. Yet the US economy did far better, solely due to the greater willingness of the Fed to do monetary offset.
10. Elsewhere they suggest that ARRA might have actually reduced the national debt. I guess “voodoo economics” is OK if done by liberals. And note that the standard supply-side model does allow for Laffer-curve type effects, whereas the standard Keynesian model does not. That’s right, even the absurd hydraulic 1960s Keynesian model does not allow for fiscal stimulus to reduce the debt. To get that result you must add on even more absurd assumptions.
I do understand that governments feel a need to defend whatever they have done. Bush still thinks the Iraq War was a success. So I expected a whitewash. But I thought they might at least be able to come up with some plausible arguments to counteract conservative criticism of the program. Unfortunately they’ve failed at even that modest goal. They don’t even engage with their critics.
This is by far the weakest economic recovery in my lifetime.
PS. They even cite Bastiat in defense of the fiscal stimulus. Page 33; read it and weep.
HT Marcus Nunes