The good thing about a crisis, any crisis, is that academics start writing about it and we get some interesting insights from the Ivory Tower. Take the stimulus. I have reported a fair amount on this blog about the academic literature that looked at whether or not government spending is in fact creating as much economic growth as the president and his team claimed it would before the bill was passed. Here is an update.
Today, the biggest debate is still the value of the spending multiplier (how much economic growth results from one dollar in government spending).
Not surprisingly, government officials assume that the multiplier is high. Christina Romer and Jared Bernstein estimated the impact of the American Recovery and Reinvestment Act of 2009 (ARRA) before the bill passed and assumed a multiplier of 1.5 (that’s at the upper range of estimates). It means that when government spends money, it creates more growth than it spent.
But there is much research that challenges the administration’s wishful thinking. For instance, you may recall the research of Harvard University economist Robert Barro, which shows that historically the multiplier is 0.7 (and negative once we account for the taxes we must pay to finance the government spending). Then there is Stanford University economist John Taylor’s research with John Cogan, Volker Wieland, and Tobias Cwik, which found that the multiplier for ARRA is around 0.7. That’s the same multiplier calculated by the IMF here.
Now, there is a new paper by Ethan Ilzetzki, Enrique Mendoza, and Carlos Vegh on fiscal multipliers that sums it up:
We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.
Okay, the multiplier could be zero, or at best 0.7. That means that in the best-case scenario, the government spends a dollar and we get less than a dollar in growth (and we will have to pay the bill later through our taxes).
But here is the most interesting part, I think. John Taylor, again, has a new working paper with economist John Cogan that shows that, in the end, it doesn’t matter what the value of the multiplier is because the design of the stimulus bill was such that it couldn’t have stimulated anything, even if the multiplier was 5. In the paper, they look at the change in government purchases due to ARRA.
We just finished a reporting the details of our findings, which provide additional evidence that the stimulus has not worked and, just as important, on why it has not worked. Despite the gigantic $862 billion stimulus package, the change in government purchases due to ARRA has been immaterial to the economic recovery: government purchases increased by only 2 percent of the $862 billion package ($18 billion). Infrastructure was even less at $2.4 billion. There has been almost no change in government purchases for the multiplier to multiply. It’s no wonder people don’t think the stimulus worked. And the size of the multiplier is largely irrelevant!
The bottom line: Economists don’t agree or don’t really know what the value of the multiplier is, but one thing is sure: This stimulus bill didn’t work at all.