The most revealing comments are often those that seem obviously appropriate, but no one ever makes. In this post, I’ll discuss one such example, the economic profession’s strange reluctance to come to grips with the failure of Bush’s 2008 stimulus package. It’s not that people don’t recognize that the stimulus failed, rather that they are unable or unwilling to admit to the reason why it failed.
Readers of the blog know that I have an extremely low opinion of modern macroeconomics. Many conservatives refuse to acknowledge the importance of demand shocks, and many progressives refuse to acknowledge the importance of monetary policy. Today I’ll go after the progressives, but that doesn’t mean I view them as the biggest problem.
Consider fiscal stimulus. It seems obvious to me that President Obama’s 2009 stimulus package failed to stimulate, and the 2013 austerity failed to have the contractionary effect predicted by many progressives. Yet I’m in a tiny minority. One polls suggested that almost all economists believe that the 2009 stimulus was expansionary. That might seem odd, as it was followed by perhaps the weakest recovery in American history, far weaker than the recovery that was predicted even if the stimulus were not adopted. Even worse, the defenders of stimulus often cite cross-sectional empirical studies that have no bearing on the macro effects of demand stimulus in an economy with monetary offset.
In early 2013, a number of progressives argued that the austerity would be a test of market monetarism. When monetary offset was shown to be correct, and Keynesian theory wrong, they quietly dropped the argument that this was a test.
Despite all of the above, I’m willing to cut progressives some slack on these two policy experiments. After all, there are respectable models indicating that monetary policy does not offset fiscal stimulus at the zero bound. I don’t agree with those models, but the world’s very complicated. I concede that fiscal stimulus might work on some occasions, depending on how the central bank reacts.
But here’s the “dog that didn’t bark” problem. There are no respectable arguments against monetary offset of demand-side stimulus when not at the zero bound. (Supply-side is another story). We’ve seen monetary dominance over and over again, in 1968 and 1981 for instance. Bush’s 2008 stimulus ought to be widely discussed as a near perfect example of textbook monetary offset. And yet I don’t recall reading a single article that makes the simple point that, “Of course Bush’s $168 billion boondoggle was a complete waste of money, as monetary offset was operative in 2008.” Perhaps there are a few such essays out there, but I read widely enough to be pretty confident that they are exceedingly rare. And yet this is almost a perfect case study of monetary offset Why the silence?
When you do see explanations of the policy’s failure, they almost entirely miss the mark:
By the time the checks arrived in taxpayers’ hands, it was late summer. It was too late to affect the first half of the year.
It was also too late to prevent the recession. . . .
Even if the checks had arrived sooner, they wouldn’t have made much difference. Tax rebate checks are not an efficient way to stimulate the economy. The biggest impact is made by increases in unemployment benefits. They produce about $1.73 in demand for every dollar spent, according to the Economy.com study.
Perhaps most important, the tax cuts weren’t balanced by a decrease in government spending. As a result, it created a $500 billion budget deficit. By the time Bush left office, the federal debt had doubled to $10 trillion. A large sovereign debt will weaken a country’s currency. Sure enough, the dollar weakened as the debt grew larger. As a result, oil prices rose, creating inflation over the long run.
Actually, most of the checks went out in May and June, and expectations of the tax cut did slightly boost the economy in the spring of 2008, which was the only quarter of positive growth in 2008. The problem was that this growth was taken away later in the year, as the Fed tightened policy to slow inflation, which had risen sharply in early 2008 due to oil and a weak dollar. The Fed was clearly responding to the fiscal stimulus.
The claim that the tax cut “created inflation” may or may not be true, but if it were true it would be evidence that the tax cut was working, not failing. The whole purpose of demand-side stimulus is to boost prices and output, which is obvious from looking at a simple AS/AD diagram.
Nowhere does the article mention monetary offset, which the Fed clearly and explicitly did in order to keep inflation at 2%. It’s odd to see a claim that “late summer” was too late for demand-side stimulus to help the economy, given that as late as mid-September the Fed refused to cut interest rates, explicitly citing the risk of high inflation. (Not to mention that the checks actually went out in the spring.) As late as October, the Fed was instituting interest on reserves to prevent monetary injections from stimulating the economy. How could any sane person have expected Bush’s tax cut to be anything but a fiasco under that sort of monetary regime? What was the point?
And yet the economic profession had little of nothing to say about monetary offset of the 2008 tax cut, a sad situation that remains true to this very day. It’s as if people look at fiscal stimulus as something that impacts “growth” and monetary policy as something that impacts inflation. Of course, both impact demand.
You might say, “At least the money was returned to the public, where the private sector got to spend it.” Yes, that may be better than the government spending the money on expensive but worthless medical procedures, or high-speed rail in California, or fighter aircraft. But keep in mind that the government gets its money from highly distortionary taxes. And even if the debt were never repaid, it would have to be serviced until the end of time. That’s costly. It’s like the government borrowed some ice cream from taxpayers, then a day later returned the (much smaller) portion that hadn’t yet melted. Should we be grateful? It might cost two dollars to raise one dollar through our grotesquely inefficient tax system, in order to raise the money needed to service this $168 billion debt until the end of time.
As Bob Dole once said, “Where’s the outrage?”
PS. There are New Keynesian models where fiscal stimulus in the form of government output do have a stimulative effect, even with monetary offset. But that doesn’t apply to the 2008 Bush stimulus, which took the form of tax cuts.
PPS. Some might argue that the economy was hit by worse shocks than what was expected at the time the tax cut was enacted. But that’s completely irrelevant to the issue, as monetary offset applies regardless of the state of the economy, with the possible exception of the zero interest bound case. But we were not at the zero bound in 2008—so there was no way for the tax rebates to have any stimulative effect, even in the best of circumstances. (Not to mention that the “worse shocks” were basically “tighter than expected money”.)
PPPS. Don’t take this critique of progressives as a defense of conservative economics. At least progressives are talking about the importance of demand shocks—many conservatives are not even a part of the conversation. In much of the conservative world, last Wednesday’s stock market rally on Jay Powell’s comments is a deep mystery.
Update: After I posted this it occurred to me that language like “Bush’s boondoggle” might sound too harsh. It was a boondoggle, but in defense of Bush:
a. Bush was right and the Fed’s experts were wrong on the need for stimulus.
b. A non-economist like Bush should not be expected to know about monetary offset. The scathing criticism in this post is directed against the economics profession, not Bush.
READER COMMENTS
art andreassen
Dec 2 2018 at 4:17pm
Scott: You quote that the rebate checks “produce $1.73 in demand for every dollar”. Previously you say : “The whole purpose of demand side stimulus is to boost prices and output”. My qualm is with the conjoining of output with demand. Consumption is spent on output not on GDP and there is a great deal of leakage to from one to the other.
If I might: from the rebates 5% will be saved and 14% will go for imports leaving 82 cents for purchasing output. Value added is only 50% of output and compensation is only 70% of value added butter the sake of argument let’s assume that 70% of spending goes for compensation giving 57 cents that is available for the spending by induced wages. Take off 5% for savings, 20% for taxes and 14% for imports and you are left with a multiplier of 1.37 at best. My point being that the estimate for the multiplier is very optimistic which is common.
Scott Sumner
Dec 2 2018 at 6:58pm
Art, I think you are confusing “demand” with “consumption” in your first paragraph. They are not the same. The purchase of imports is part of consumption, but not “demand”. I’m not “conjoining” demand and output, I’m saying the point of demand is to raise output.
In my view the multiplier is zero, because of monetary offset. The simple Keynesian model is pretty useless when it comes to multipliers.
Matthew A. Opitz
Dec 2 2018 at 7:16pm
Yes, GWB discovered the “crowding out” effect. On this point, even the Marxist Critique of Crisis Theory blog agrees with you that the 2008 tax rebates were self-defeating given the Federal Reserve’s monetary offset.
Where I think you and him would disagree is, he thinks the Federal Reserve had no choice but to do the monetary offset, whereas I think you would disagree.
In any case, I agree that more credit going to government means either:
Scenario A: less credit going to businesses and consumers—assuming the supply of credit remains the same.
OR
Scenario B: the same amount of credit or more going to businesses and consumers—but at higher interest rates—if the aggregate supply of credit grows but the amount of base money remains the same.
OR
Scenario C: the same amount of credit or more going to businesses and consumers, and interest rates hold steady or even drop—if BOTH the aggregate supply of credit grows AND the amount of base money grows even faster.
However, neither paper dollars nor electronic Federal Funds dollars (convertible on demand into newly-printed paper dollars from the Federal Reserve) actually can function as base money. The real base money in the world economy today remains gold for reasons explained throughout the posts on Critique of Crisis Theory. World gold production must accelerate for Scenario C to happen, and it is precisely on the cusp of crises of generalized overproduction, such as in the 1970s and in 2008, when world gold production lags the most.
Warren Platts
Dec 3 2018 at 10:24am
Interesting article, but the one elephant in the room not mentioned was the huge (and ongoing) trade deficit at the time. That has got to have the effect of reducing the effects of stimulus attempts. Or to put it another way, we could perhaps say that the stimulus actually worked–by helping out the ROW as much or more than it helped out the US of A..
The same problem continues to exist. For example, since 35% of all U.S. equities are now foreign owned (thanks in large part to the current account deficit/capital account surplus), the stimulus imparted by Trump’s corporate tax cut are diluted by 35%. Not exactly chump change!
Marcus Nunes
Dec 3 2018 at 11:08am
…monetarists were not impressed with the 1960s style of macroeconomic policymaking, including the tax cuts (which later would become right-wing orthodoxy as the fuel for economic growth). In a debate with Walter Heller (President Kennedy´s first CEA Chairman) on “Monetary vs. Fiscal Policy” (1969), Milton Friedman argued:
…So far as I know, there has been no empirical demonstration that the tax cut had any effect on the total flow of income in the US. There has been no demonstration that if monetary policy had been maintained unchanged…the tax cut would have been really expansionary on nominal income….
Scott Sumner
Dec 3 2018 at 2:13pm
Warren, It’s a myth that trade deficits reduce aggregate demand. C+I rise by as much as NX falls. I have a number of posts on that topic.
Marcus, Good quote.
Comments are closed.