Why the Stimulus Didn’t Work as Predicted

by Veronique de Rugy

There has been a lot of debate about the effectiveness of stimulus spending to jump start an economy. For one thing, economics can’t agree on what the value of the multiplier is. Notwithstanding the confidence of stimulus advocates, there is no academic consensus regarding the size or even the sign of the multiplier. As my colleague Matt Mitchell and I explained in a paper that reviewed the multiplier literature last year, the largest recent estimate is can be as high as 3.7 (implying that $1.00 in government purchases stimulates another $2.70 in private sector economic activity) and the smallest one is 2.88, (implying that $1.00 in government purchases displaces $3.88 in private-sector economic activity.) 

We found that this wide range of estimates exists, in part, because there are many different circumstances in which stimulus might be applied. As it happens, many of the circumstances necessary for stimulus spending to trigger large economic growth aren’t present in the U.S. currently.

But perhaps the most important reason to be skeptical about the potency of stimulus spending is that the money must be distributed just as Keynesian theory says they ought to be. That means it must be timely, targeted, and temporary. As it happens, it is more difficult that one may think.

A new paper by the Federal Reserve Bank of New York looks at the whether or not the funding was indeed targeted, meaning whether it was spent in a way that would use idle resources — i.e., unemployed workers — and put them back to work. Not so much, they find. The authors write a good summary of their paper in a blog post:

Our analysis of the distribution of ARRA funds across states shows that the expanded assistance to unemployed workers was indeed highly correlated with state unemployment rates. It turned out, however, that most other state allocations had little association—positive or negative—with state unemployment rates. 

They also explain why that is, and ask great follow-up questions:

In sum, practical considerations in targeting new federal spending under a vast program like the ARRA led to spending that was less linked to state unemployment rates than might be expected. Estimates vary as to the effects of the ARRA, but larger questions remain. Did the particular way that the funds were targeted affect the ultimate impact of the program? Would a given amount of funding distributed in another way have been more effective? Would future anti-recessionary spending programs benefit from pre-planned allocation formulas? Answering those questions would take more than a blog post.

The whole paper is here, and the blog post is here. This paper is consistent with this paper by George Mason University’s Garett Jones and AEI’s Dan Rothschild, which looked at whether stimulus money was used to hire the unemployed.