The Corner

Does Stimulus Spending Work?

Over at U.S. News & World Report’s new Debate Club, I argue the position that the stimulus failed to stimulate economy. Leaving aside the question of failed promises, I make two main points. First, contrary to what stimulus advocates like to claim, there really isn’t a consensus among economists about the impact of spending on economic growth. Some respected economists find every dollar in government spending means more than a dollar of economic growth (a large positive multiplier, in economist speak), but others find every dollar in government spending results in less than a dollar of economic growth (a negative multiplier).

Interestingly, in her latest paper, renowned economist Valery Ramey of the University of California, San Diego, reviews the aggregate empirical evidence for the U.S. about the impact of the stimulus on economic growth as measured by the “multiplier,” and confirms the lack of consensus. In fact, she explains that even if we ignore the impact of future higher taxes collected to pay for government spending and ignore the negative impact an increase in government spending could have on the private sector, the multiplier is probably between 0.8 and 1.5 but we couldn’t rule out a multiplier ranging from 0.2 to 2.

I will conclude that the U.S. aggregate multiplier for a temporary, deficit financed increase in government purchases (that enter separately in the utility function and have no direct effect on private sector production functions) is probably between 0.8and 1.5. Reasonable people can argue, however, that the data do not reject 0.5 or 2.

So, basically, there really isn’t a consensus on the value of the multiplier. And that’s when the stimulus is implemented according to Keynesian standards. Ramey talks about stimulus that actually increases government purchases and is temporary. However, from what we know of the stimulus package passed in 2009, it wasn’t any of that, which is the second point I make in my piece:

During the law’s tenure, economists explained that instead of using the money to increase government purchases, states chose to use the money to close their budget gaps. This choice meant that the money went to keeping school teachers in their jobs and paying public sector workers, rather than to creating jobs in the private sector. Furthermore, the spending wasn’t timely: Three years after the law was adopted, some programs still have managed to spend only 60 percent of the appropriated funds. Not only was the spending poorly timed, it also wasn’t targeted. The data show that stimulus money wasn’t targeted to those areas with the highest rate of unemployment. In fact, a majority of the spending was used to poach workers from existing jobs in firms where they might not be replaced. Finally, a review of historical stimulus efforts shows that temporary stimulus spending tends to linger. Two years after the initial stimulus, 95 percent of the new spending becomes permanent.

Then I ask:

The law 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 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.

The whole debate is here and my piece is here. By the way, you can vote for your favorite piece . . .

You should also check out the piece by e21′s Chris Papagianis on how stimulus spending during a time of major national deficit does more harm than good.