This article appeared in the Deseret News yesterday.
Congress passed the American Recovery and
Reinvestment Act in February of 2009. If you will recall, at the time it
was touted by its proponents as an economic treatment for the recession
caused by the housing financial crisis that preceded it.
In trying to determine if the stimulus package worked, we first need to define what "worked" means in this context. What is success for a stimulus package? When
the stimulus was being considered in 2009 the Council of Economic
Advisors (CEA) released a report predicting what would happen to the US
economy if the stimulus were passed and contrasted this with what would
happen if it didn't pass. The
unemployment rate was predicted to peak at just over 9% during 2010 and
run between 8 and 8.5% in early 2011 if the stimulus package did not
pass. With the stimulus, the
unemployment rate was supposed to peak at just under 8% at the end of
2009 and would run between 6.5 and 7% for the first half of 2011.
In reality the unemployment rate peaked at
10.1% in October of 2009 and is currently inching down slowly to its
most recently reported values 8.3%. Clearly by the standards of the CEA report the stimulus did not "work". If
fact, one might argue it worked negatively, since the actual outcome
was worse than what was predicted if congress did not act. The problem with such comparisons is that it is difficult or impossible to establish a counterfactual. What really would have happened if the stimulus had not passed?
Proponents argue that the stimulus helped
because things would have been even worse without it. Unfortunately, the
validity of that argument cannot be tested, since we can't rerun the
economy starting in February 2009 without the stimulus. Over any lengthy span of time a great number of random, unpredictable events will occur that effect the economy. If we could rerun the economy a thousand times we would get a thousand different sets of random outcomes. If
these events really are random and unpredictable before they happen, it
is pointless to argue that something different should have been done. Rather
than ask if a policy was appropriate given what we know now, a more
important question is if the policy was appropriate given what was known
when it was put in place.
The notion of fiscal stimulus is based on
the work of John Maynard Keynes who wrote much of his most influential
work based on his observations of the Great Depression. Keynes
argued for government spending as a way to stimulate the economy
because he observed firms and workers ready and willing to produce goods
and services at the prevailing prices if only they could find someone
willing to buy. If this is really the case, then government spending leads to purchases that would not otherwise occur. Traditional
Keynesian theory argues that a $1 increase in government spending will
lead to a much more that $1 increase in economic activity because the
workers and firms that sell to the government will earn income which
they will, in turn, spend on other goods. This is the notion behind a government spending "multiplier."
Suppose, however, that firms did not stand ready to produce any amount of goods at prevailing prices. Instead suppose that when the government buys goods it increases their demand and causes prices for the goods it buys to rise. In
this case, the higher price will make private consumers and firms cut
back on their purchases and the government ends up "crowding out"
private purchases. In this case the government multiplier may be a number less than one, possibly even close to zero. That is, a $1 increase in government spending increases economic activity by less than $1 or perhaps by nothing at all.
Professor Robert Barro of Harvard
University has estimated that unexpected increases in government
military spending have multipliers of .8 or so. This is in sharp contrast to multipliers of 1.5, 2.0 or even 3.0 that are assumed in some traditional Keynesian models.
So did the 2009 stimulus package work? No, in the sense that it did not work as advertised. The actual performance of the economy has been much worse than the worst-case scenario envisioned in early 2009. On
reason for this failure may be that fiscal stimulus is really not as
effective in our modern economy as it might have been in the 1930's. There are, of course, other methods for stimulating economic activity. These would include reducing taxes on economic activity, particularly on investment in new capital goods.
Does the economy need another stimulus to avoid a "double-dip" recession? Given what I observe from the last stimulus package, I would say no.
