Five Years of Stimulus

by Veronique de Rugy

“Of course it worked!” That’s the main contention made by this report about the 2009 stimulus package from the Obama administration’s Council of Economic Advisers.

But on the five-year anniversary of the bill’s passage, there are a lot of reasons to take their claim with a grain of salt. For one thing, if it worked, it didn’t work well enough to convince the American people that the labor market is fixed: A new Gallup survey finds that Americans see unemployment as the biggest problem facing the country, with the economy in general listed as their second-biggest concern.

Another way to look at whether the stimulus has worked or not is to measure it against the impact the administration said it would achieve. If you remember, back in 2009, Christina Romer, then the chair of the CEA, made the case to the White House and Democrats in Congress that if the gigantic bill were adopted, it would prevent unemployment from 8 percent. Well, the bill passed, the spending machine was activated, and unemployment swelled all the way to 10 percent, and stayed there for a significant number of months. Five years later, unemployment rates have finally come down, but many economists agree that the drop has a lot to do with people giving up on looking for work. The lucky ones who have actually gone back to work have often settled for part-time jobs and lower pay. Whether this chronic under-employment can be described as “a success” is up for debate especially since its long-term negative consequences can be significant. 

The American people were also promised that the stimulus would jump start the economy and return it to previous levels of growth. We haven’t. Last year, the CBO had to revise downward its estimate of the actual impact of the stimulus, and admitted that government spending didn’t have as big an impact on the economy as they had hoped.

In other words, if we were to measure the effectiveness of the stimulus by the administration promises, we would have to conclude that it failed.

Unfortunately, we can’t quite count on economists to settle this debate. A review of the literature on the effectiveness of government spending as a booster of growth lacks any kind of consensus at all. Some economists predict that the impact of spending on growth could be significant; others predict that it can shrink the economy. As Cafe Hayek’s Russ Robert explained a few years ago, the problem economists have is that we can’t tell you for sure what would have happened without the stimulus:

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.

His whole post is a must-read and is still very relevant today.

So, is there anything we do know about the effects of stimulus? Well, yes. We know that there are factors that that can seriously limit its effectiveness. Here is a short list (for more on these issues, see here):

  • High level of debt
  • Flexible exchange rates
  • A balance-sheet recession (when lots of wealth and savings were destroyed)
  • Diminishing returns of more and repeated stimulus measures

All of these characteristics existed in the U.S. in 2009, and have for a while — meaning anyone committed in principle to the idea that government spending can jump start the economy should at least have had some doubts about the stimulus measures we tried in 2009.

We also know that it matters how a stimulus bill is designed. To get the biggest bang for your buck, the spending needs to be timely, targeted, and temporary. If it isn’t, former Obama adviser Larry Summers warned us, the spending could actually be counterproductive. Unfortunately, in this case, the stimulus had all the wrong design: Much of the money wasn’t spent to increase government purchases, but to close local and state budget gaps, and the spending wasn’t timely and targeted.

Of course, in theory, under the best-case scenario, with a large multiplier, perfect implementation, and no massive debt accumulation, stimulus could deliver some results. But such a scenario requires a heavy dose of wishful thinking. Research from Harvard Business School (and others), for instance, shows that federal spending in states causes local businesses to cut back rather than to grow, meaning that a good portion of the stimulus spending might have caused the private economy to shrink.

We also shouldn’t forget that the CBO has been fairly explicit about the long-term impact of so much government spending: It represents a drag on the economy. Even if short-term borrowing and spending may trigger a small economic boost, we will have to pay the price in the long-term with lower economic growth.

Over at Economics One, John Taylor has a good summary of all this research and posts on the issue over the last five years. ”Keeping a record may help us remember the lessons so we don’t do it again next time,” he hopes.