Yesterday The New Yorker’s Ryan Lizza published a piece detailing President Obama’s decisionmaking on economic policy during his first two years in office. Most of the piece is based on the 57-page memo sent to President-elect Obama by Dr. Larry Summers in December 2008. This article and the memo offer good insights into the level of confidence in economic estimates and the ability of the government to get us out of the recession of the president and his advisers at the beginning of the term.
After an interesting reminder that many believed Obama would be a post-partisan president, Lizza makes the case that, during the stimulus debate, Larry Summers was on the side of a smaller spending bill:
Summers informed Obama that the government was already spending well beyond its means. Yet in the coming months Obama would have to sign, in addition to a stimulus bill, several pieces of legislation left over from the Bush Administration: a hundred-billion-dollar funding bill for the wars in Afghanistan and Iraq; perhaps three hundred and fifty billion dollars more in funds from Bush’s TARP program, to prop up banks; and a four-hundred-and-ten-billion-dollar spending bill that was stuck in Congress. Obama would need resources to save G.M. and Chrysler, which were close to bankruptcy, and to address the collapsing housing market, which he was told would be hit with five million foreclosures during his first two years in office. Summers cautioned Obama, who had run as a fiscal conservative and attacked his Republican opponent for wanting to raise taxes, that he was about to preside over an explosion of government spending: “This could come as a considerable sticker shock to the American public and the American political system, potentially reducing your ability to pass your agenda and undermining economic confidence at a critical time.”
Obama was told that, regardless of his policies, the deficits would likely be blamed on him in the long run.
Jared Bernstein — one of the co-authors of the paper that predicted the stimulus bill would prevent unemployment from reaching 8.8 percent and create millions of jobs – argues that this is not true and that Summers was in fact a proponent of more spending, not less. But in the memo, you find enough to make both cases (Bernstein does mention the old joke about the two-handed economist).
However, over the years, Summers has often explained that while in the short term stimulus spending is an effective tool to jumpstart an economy in the middle of a recession – sticky wages and all – stimulus spending should always be timely, targeted, and temporary. This is effectively the core of neo-Keynesian theory about stimulus spending. During a talk at the Brookings Institution, for instance, he even explains that fiscal stimulus “can be counterproductive if it is not timely, targeted, and temporary.” Unfortunately, there is ample evidence that the stimulus wasn’t timely or targeted and won’t be temporary, making it counter-productive.
The memo clearly shows Summers arguing that a large stimulus bill could spook the markets, a fear that Paul Krugman repeatedly made fun of.
I will leave you with Keith Hennessy’s take on the memo:
Three quotes in the Summers memo describe a tension in the design of the stimulus proposal. Here is the first (p. 7):
“Constructing a package of this size [“considerably larger than $500 to $600 billion”], or even in the $500 billion range, is a major challenge. While the most effective stimulus is government investment, it is difficult to identify feasible spending projects on the scale that is needed to stabilize the macroeconomy. Moreover, there is a tension between the need to spend the money quickly and the desire to spend the money wisely. To get the package to the requisite size, and also to address other problems, we recommend combining it with substantial state fiscal relief and tax cuts for individuals and businesses.”
Here is the second (p. 12):
“Peter Orszag and OMB career staff, together with NEC staff, have worked with the policy teams to identify as much spending and targeted tax cuts as could be undertaken effectively in six priority areas: energy, infrastructure, health, education, protecting the vulnerable, and other critical priorities. The short-run economic imperative was to identify as many campaign promises or high priority items that would spend out quickly and be inherently temporary. The long-run economic imperative, which coincides with the message imperative, is to identify items that would be transformative, making a lasting contribution to the American economy.”
Here is the third (p. 12, emphasis in the original):
“[I]t is important to recognize that we can only generate about $225 billion of actual spending on priority investments over next two years, and this is after making what some might argue are optimistic assumptions about the scale of investments in areas like Health IT that are feasible over this period.”
The advisors selected their core spending priorities by “identify[ing] as many campaign promises or high priority items that would spend out quickly and be inherently temporary.” They started their spending decision process by fulfilling campaign promises.
They could identify $225 B of spending they thought met their criteria. Even that number included optimistic assumptions on how much they could spend quickly for Health IT and other areas.
From a macro standpoint they felt they needed a bigger aggregate number, so they moved to lower priority items. The President chose a (hoped for) big macro effect over a smaller bill that used taxpayer money more efficiently.