Almost two years after the adoption of the stimulus bill, the data shows that the funds didn’t stimulate GDP much, and didn’t stimulate employment either. One reason is that the package failed to prop up government purchases, or consumption purchases in general. For instance, as was the case with previous stimulus bills, it looks like most of the loan, grant, and contract money in the bill went to pay down state and local governments’ debt rather than buy stuff.
So why didn’t White House economists such as Christina Rommer or Moody’s Mark Zandi — two of the biggest stimulus enthusiasts out there — take these facts into considerations when predicting the impact of the stimulus?
Unfortunately, most Keynesian models have been not adjusted to incorporate these facts, so they keep making the same predictions. To cite one example, the multipliers in Mark Zandi’s model as of July 2008 are found here (page 52 of the full document, 5 of the paper) while the multipliers as of December 2010 are found here. They are virtually the same. The model assumes a multiplier from a temporary tax rebate or refund which is greater than one, even though the actual data show it was much less than one in the case of the 2008 and 2009 stimulus packages. Note that the model also assumes a multiplier from a permanent tax cut which is only about 1/3. The relative sizes of permanent and temporary effects are exactly the opposite of what basic economics implies.
Using such results people write stories like this one “Zandi Analyses Show ‘Democratic’ Measures in Tax Cut-UI Deal Boost Economy, ‘Republican’ Measures Add to Deficit Risks” from the Center of Budget and Policy Priorities, supposedly because Democrats favor temporary actions and Republicans favor permanent actions. But the “analyses” are simply old simulations from models which appear to be ignoring the facts. More consistent with the facts and the theory is that the recent tax deal will be more beneficial to the economy than the past stimulus packages because it extends the Bush tax cuts and thus makes them more likely to be permanent. Another example of the problem with the modeling assumptions is the multiplier from “general aid to state governments,” which is assumed to be 1.36 in the Zandi model. Yet the Commerce Department data are very clear that virtually none of this aid to state governments in the 2009 stimulus (ARRA) went into government purchases; most went to reduce borrowing.[...] You cannot get a multiplier of 1.36, or even much greater than zero, when none of the funds went to government purchases and more than half went to reduced borrowing.
Now, the question is whether these economists will revise their models. We will find out soon, I guess.
There is truth in both of those arguments but I think it is useful to add some public choice as well with economists as rent seekers–if you want to be a player, you have to be willing to play. So those economists who argue for the virtues of intervention get a chance to play. Those who oppose intervention remove themselves from any chance of riding the government gravy train.