The dog that isn't barking
By Scott Sumner
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.