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Did the Stimulus Work?



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“Yes it has, and yes, it does!” says E. J. Dionne Jr. in the Washington Post. The evidence: Almost all economists agree that it did. That’s him:

[T]he drumbeat of propaganda against government has made it impossible for the plain truth about the stimulus to break through. It was thus salutary that Douglas Elmendorf, the widely respected director of the Congressional Budget Office, told a congressional hearing last week that 80 percent of economic experts surveyed by the University of Chicago’s Booth School of Business agreed that the stimulus got the unemployment rate lower at the end of 2010 than it would have been otherwise. Only 4 percent disagreed.

As it turns out, my colleague Matt Mitchell is a regular and close reader of these surveys and as he shows this is a very narrow reading of the survey. Here is Matt:

On February 15, they put two statements to the panel and asked them to respond. The first statement reads:

Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.

It is true that, of those surveyed, 51 percent agreed and 29 percent strongly agreed with this statement. Some of the comments from those who agreed with this statement are telling. Anil Kashyap of Chicago for example wrote, “But this is an incredibly low bar.” And Darrell Duffie of Stanford wrote, “Subsidizing employment leads employment to go up, other things equal. Adverse impacts through growth incentives might take time.” These statements (and others) suggest that perhaps the question was overly-narrow.

Thankfully, IGM probed further. They asked the economists to weigh in on a second statement:

Taking into account all of the ARRA’s economic consequences — including the economic costs of raising taxes to pay for the spending, its effects on future spending, and any other likely future effects — the benefits of the stimulus will end up exceeding its costs.

This time, when the economists were asked about the longer-run, total effects of stimulus, they were much more equivocal. Less than half agreed or strongly agreed with the statement, 27 percent were uncertain, and the rest either disagreed or had no opinion. A number of respondents noted the uncertainties involved. Nancy Stokey of Chicago summed it up nicely, writing, “How can anyone imagine this question is answerable, given the current state of economic science?” Amen.

So it’s not as straightforward as Dionne claims. Now, the lack of consensus is even more obvious when you look at those economists whose work actually focuses on the effectiveness of stimulus. For instance, a review of the literature shows that there is no academic consensus regarding the size or even the sign of the multiplier (i.e., the value by which the economy grows for each dollar spent by the government). #more#Matt and I wrote recently:

As a recent International Monetary Fund (IMF) working paper puts it, ―Economists have offered an embarrassingly wide range of estimated multipliers. The largest recent estimate is by Northwestern University economists Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo. They estimate that the multiplier may be as large as 3.7, implying that $1.00 in government purchases stimulates another $2.7 in private sector economic activity. On the other end of the spectrum is an estimate by University of Chicago economists Andrew Mountford and Harald Uhlig. They find that the multiplier may be as small as -2.88, implying that $1.00 in government purchases displaces $3.88 in private sector economic activity

So, no consensus. Moreover, a review of these papers also reveals some of the factors that seriously limit the effectiveness of stimulus spending. Here is a short list:

  • High level of debt
  • Flexible exchange rates
  • Balance-sheet recession (when lots of wealth and savings were destroyed)
  • Diminishing returns of stimulus (new stimulus less effective than any previous ones)

For more details go here. Now, you would think that Keynesian economists would have doubts about the ability of stimulus spending to have boosted or to boost the economy, even in the short run, since all these characteristics exist in the United States today and have a for a while.

Second, even by Keynesian standards, the design of the stimulus bill was such that it could not have stimulated much. That’s because the money wasn’t spent to increase government purchases but to close their budget gaps. Also, the spending wasn’t timely and targeted, and is unlikely to be temporary.

This stimulus may not have worked, but could other stimulus spending work? One could say that under the best case scenario, the existence of large multiplier, a perfect implementation, and an absence of massive debt accumulation, there is a chance that stimulus may deliver some results. That level of optimism requires a heavy dose of wishful thinking, however, and should be taken with a grain of salt. Research from Harvard Business School (and others) shows that federal spending in states causes local businesses to cut back rather than to grow. In other words, more government spending causes the private sector to shrink, the exact opposite of the intended result.

Finally, as Reason’s Peter Suderman reminds us if CBO is going to be used as the unbiased arbitrator of this debate, we shouldn’t neglect what Elmendorf writes about the long-term impact of so much government spending:

And the long-term burden of increased debt may ultimately be a net drag on the economy. In fact, that’s exactly what Elmendorf and the CBO have reported is most likely: Last November, Elmendorf told legislators that the stimulus would be a “net negative effect on the growth of GDP over 10 years” and that barring additional action, “it would represent a drag on the economy.”

So there you have it—the CBO, giving us what Dionne calls “the plain truth about the stimulus.” In the long run, borrowing and spending $800 billion in order to temporarily juice the economy will end up dragging the economy down over the next decade.

Update: George Mason University and Cafe Hayek’s Russ Roberts writes a great response to Dionne’s piece here.

No one has a model of the independent impact of these different factors or a way of measuring them accurately and reliably in a way that can be tested and confirmed or rejected. No one. That means everyone, on the left or the right, who claims to have evidence for the impact of one of them or who cherry-picks one of those out of the myriad to choose from and blames that one factor for the lousy pace of the recovery is either fooling himself or fooling you. Don’t be a fool. So when the E.J. Dionnes of the world tell you that government creates jobs, just ask them how they know. Their answer will be that someone with exemplary credentials says so. But there are those with exemplary credentials who say otherwise. Where does that leave us? It should leave us in ignorance and doubt. No certainty. No exclamation points. More humility.



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