Fiscal Stimulus Packages: What are their Effects? Becker

The over $800 billion American fiscal stimulus package is enormously unpopular in many quarters. Yet for others, including some well-known economists, a second package is needed to make unemployment decline faster. It is very difficult to give a definite answer to the effectiveness of what has been spent so far, but I believe both theory and quite limited empirical evidence suggest that it is likely having a small “multiplier”.

According to simple Keynesian models, the rationale for increased government spending during a recession is straightforward. If governments employ underutilized labor and capital when they spend more, that provides an immediate boost to employment and output. A further stimulus comes from the spending by the owners of the unemployed labor and capital who benefit from the government spending. Their spending helps multiply the effects of the government spending still further, and so does spending by the recipients of this second round of spending. The total impact is the sum of all these separate boosts, and its ratio to the initial level of government spending is called the spending multiplier. A study by Dr. Christina Romer, Chair of the Council of Economic Advisers, published shortly before she took office claimed the spending multiplier during the recession at that time would be well over 1.0.

In reality, several major considerations neglected by this Keynesian analysis suggest a rather different multiplier. There is often a long delay between discussions of a fiscal stimulus, enactment of a law providing for the stimulus, and the actual spending. Dr. Romer discussed the broad dimensions of the current stimulus package even before she took her current position, and Congress passed the law providing for about an $800 fiscal stimulus shortly after President Obama took office. Yet it is now more than one year later, and only about a half of the stimulus package has been spent. In the meantime, the economy first hit bottom, and then has begun a strong recovery in GDP, and a modest recovery in unemployment. The long lag between discussion, enactment, and actual spending is an old criticism of fiscal stimulus even by very committed Keynesians.

Nor did the actual stimulus package voted by Congress correspond very closely to the theory behind the multiplier from government spending. Instead of being concentrated mainly on sectors that had suffered large increases in unemployment, such as construction, the stimulus spending was oriented toward many sectors that liberal members of the Democratic controlled Congress wanted to greatly expand. These include healthcare, schools, alternative energy sources, and medical and basic research. Some of this spending may have considerable social value, but it provides little stimulus since sectors like health, education, and wind power development were not hit hard by the recession, and hence have had low levels of unemployment. Government spending in these areas would tend mainly to bid labor away from either the private sector, or other government programs, or raise the earnings of those already employed. As a result, any multiplier from the stimulus package is likely to be less than one, not greater than one.

Even though the theory behind the multiplier has been around for a long time, few studies credibly estimate multipliers from different kinds of government spending. Part of the problem is that many other things are usually also changing when government spending changes, so it is difficult to find “natural” experiments where the effects of government spending are isolated from changes in other important variables. Some of the relevant factors that may be changing are prices, including wage rates and interest rates, consumption, and private investment.

Robert Barro of Harvard University has been estimating both spending and tax multipliers from past episodes, not from the current one. Using historical data obviously has many limitations from the point of view of evaluating the current stimulus, but such an evaluation is difficult because many aspects of the American economy have been changing during this recession along with stimulus spending, such as the monies spent on bank bailouts. Barro's estimated spending multipliers are based mainly on fluctuations in defense spending before, during, and after wars, such as World War II and the Korean War.  He reports in a recent Wall Street Journal article (February 23) estimated spending multipliers over a two-year period following changes in defense spending. These multipliers equal about 0.4 following the first year, and 0.6 after two years.

They indicate sizable changes in overall GDP per $100 billion change in defense spending, but they also suggest that government spending significantly crowds out either personal consumption spending, private investment, or exports. Still, if these were the only effects of stimulus packages, multipliers of about 0.6 would indicate that larger government spending, such as the Obama stimulus package, can induce significant growth in GDP, presumably especially when unemployment rates are high.

However, greater spending has to be paid for eventually by higher taxes, including inflation taxes, since governments are subject to long term budget balance requirements, just as are households and businesses. Barro also estimates tax multipliers based on the effects on GDP of changes in average marginal tax rates from federal and state and local income taxes, and social security payroll taxes. These tax multipliers are about -1.1, which means that increases in marginal tax rates that raise tax revenue by say $300 billion would lower GDP by over $300 billion in the following year.

Putting these estimated spending and tax multipliers together, in recognition that government budgets have to be balanced eventually, indicates that the Obama stimulus package on balance would have a small, possibly even negative, overall effect on GDP. To be sure, these results have to be qualified since changes in nondefense spending, as in this stimulus package, may have larger multipliers than those estimated by Barro, although it is not obvious why that should be so. Moreover, if the spending occurs in 2009 and 2010, and raises GDP for a few years during a recession, perhaps that is worth any reductions in GDP that follows in later years when taxes are actually increased to produce the budget balance (although much of that effect might be anticipated earlier).

A few other discussions of the current stimulus package have much rosier conclusions about its effects on employment and GDP. But these estimates have little credibility because of the difficulties in disentangling the stimulus effects from those of Fed and Treasury spending on bailouts, many other factors that have been changing along with the stimulus spending, and the intrinsic strengths of the private sector of the American economy  (see, for example, an article by Cogan, Taylor, and Wieland in the Wall Street Journal of September 17, 2009 for a discussion of some of these factors).

My conclusion is that the Obama-Congress stimulus was an attempt at reengineering government’s role in the economy that was badly designed and executed relative to the alleged goal of giving a short-term stimulus to the economy. Its design, and the general evidence on the effects of spending fiscal stimulus, should make Americans wary of any attempt to pass a second stimulus package, whatever form it takes.

 

 

 

Comments

[Meradj Mortezapouraghdam]

Hello to all.

Stimulus packages and the idea of using the printing press now seems an attractive solution to all politicians, however what really puzzles me is that: "are there any other alternatives"?

[Jack]

"Instead of being concentrated mainly on sectors that had suffered large increases in unemployment, such as construction, the stimulus spending was oriented toward many sectors that liberal members of the Democratic controlled Congress wanted to greatly expand."

Both of our Profs seem to have slapped together essays worthy of perhaps a C. For example how and why would one target stimulus to the moribund and overbuilt housing market? (Though truth is there is the first time buyer credit and "starter homes" for young families is going much better than most of the "move up" market) And, much of the money to the states is going toward construction and my guess is that unemployed home building craftsmen are mobile enough to ply their trades on various types of infrastructure maintenance and upgrades.

Posner laments the time lag between the wake up call and stimulus hitting Main Street paychecks despite plenty of evidence this recession is deep and ugly with a long tail. Better late than never.

It would seem they should look at income strata too since we've become such a have and have not society. Saving or creating even SOME jobs means a lot down on Main St. and whether big multiplier or not is likely to help many families muddle through and avoid the foreclosures that are costly to all and disruptive of the families, towns and states. After (if?) this storm begins to subside servicing the debt from the stimulus will fall to those "making a buck" which may have some "chilling effect" but hardly that of the letting the economy spiral down deeper into recession.

Posner: "My conclusion is that the Obama-Congress stimulus was an attempt at reengineering government’s role in the economy that was badly designed and executed relative to the alleged goal of giving a short-term stimulus to the economy."

Subjective I suppose. But the days of 2.5 million housing starts a year are over, and surely it's time to make changes that conserve fossil fuels and embrace viable alternatives and what better time to begin to address a trillion plus of delayed infrastructure maintenance and upgrades than during a nasty recession?

Huge debt? Inflation and squeezing out private investment? I'm no fan of "deficits don't matter" and huge debt, but after the Depression and after WWII we had debt equal to one full GDP, high taxation to pay for it, low interest rates and soon a booming economy. Different times to be sure but do we really think the world is short of investment capital?

[John Brandte]

Jack, I think you are missing part of the argument. If you are trying to immediately stimulate employment as the Obama plan directly stated as the objective, you have to put people back to work in their current occupations; otherwise, the re-employment effect will be delayed due to training, relocation, etc.

What they actually did certainly questions the real intent of their "stimulus" package.

Just my thoughts :)

[Altereggo]

"providing for about an $800 fiscal stimulus"

No wonder it didn't do any good. You could stimulate the economy that much by having a congressional pizza party :D

Good article, but you kind of passed over some important topics; perhaps you just didn't want to get into the endless old ricardian equivalence debate?

[Altereggo]

Jack, I'm sorry, but I stopped reading at "main street paychecks."
You use the phrases "my guess" and "it would seem" far too often for your argument to support any conclusions. Not that I'm not sympathetic to populist outrage, of course.

[Jack]

Alter: Sorry, but I lack the computer models and staff of brilliant PhD's enjoyed by the Admin, Fed, CBO, Sachs and others, and along with quite a number of "Main Streeters" I saw this mess on the horizon 5-7 years ago but remain having to "guess" where chaos combined with panic will take us next. After all is there anyone in the nation who's doing anything more than flying by the seat of their pants?

And Ha! it's at times frustrating that in making a bullish bet on stocks one only has to be right about the direction, while those making a bearish bet by shorting have to be right about the direction and timing.

John: Some of the stimulus did exactly that; aid to schools and states where revenue streams have been walloped with their need to balance their budgets would have faced even more layoffs than they have. Surely you've heard the criticism of "well THAT only keeps useless government employees on the payroll?"

And sure! it would be "great" IF home building crews that scaled up to build 2.5 million homes/year could continue doing what they've done for the last decade, but! problem is we're over-built and household creation is only 1.2 million/year, so the housing industry will be something on the order of 800,000 or less for some time.

And consider: those who used to frame up for poured concrete footings and basements can readily transfer to doing the same on highways, bridges, school buildings etc. And the suppliers of lumber, cement, etc. they're all fairly labor intensive.

As for "intent" I'd question our Profs as to what they think the intent should be. For example IF (as I've thought for 30 years) it's time to lessen our 70% dependency on costly imported oil, and we've legions of unemployed, is there any reason for waiting to catch up with Europe and others on building windmills, installing solar and insulating the substandard 40 million homes recently built, along with the other 100 million old homes that are even worse? In short is a goal of trying to knock down a couple of birds with a single stone suspect?

The problem is daunting for policy makers. Consider, with box stores and other retailing changes (internet etc) we're over-retailed by half, housing that had been one of the last legs of our economy, will be off by 60% from the peak for years, and much of what MUST be done in H/C is that of making it a lot more efficient. For example we use 8 clerical people by contrast to Canada's use of one, but just now those employed in a snowstorm of insurance paperwork are happy to have those jobs be it inefficient or and breaking the backs of premium payers or not.

What is America's future role to be?

[pat toche]

"in recognition that government budgets have to be balanced eventually"

Oh, "balance the budget, cut taxes." Bring back Laffer!

[Brian Davis, Austin, TX]

Stimulus grants to States for "shovel-ready" necessary public works construction projects made sense. It's fine to spread them out over several years so the labor unions and commodities speculators don't bust your budgets. I'd have spent the rest of the "Obama" stimulus on the military. The U.S. will be lucky to salvage anything from the current wars and we won't be ready for the next one. Count on it.

[steve]

Dear Jack,

The first thing I noticed about your comment is that you mixed up Posner and Becker.

Sincerely,
Steve

[Jeff]

I actually saw a math equation that showed the multiplier effect of stimulus would be 0 or even negative. I seem to recall an old Becker post from March of 2009 to that effect.

The stimulus didn't work. Non-Keynesians knew it would not. The other result is more confusion and hesitation from business. Confusion and hesitation means no hiring or expansion.

If we isolate the stimulus-and held all other proposed policy changes constant, the stimulus still would have been a sum of zero. Combined with the proposals from the Obama administration (Health care, cap and trade, cash for clunkers, bail outs, land grabs in the west) the sum effect is a negative integer.

[Jack]

Pat: Laffer is still around. I saw him recently at some televised retro-Reagan gathering. But perhaps he should be cast in faux-bronze atop 13 blocks of crumbling slump-stone in honor of the trillions in debt that has accrued to his theory, or to be more fair, the misuse of his theory once the proponent gets in office and "finds?" that it's far easier to cut taxes than to make cuts in the big chunks, like the military or payments on the debt already accrued.

Brian: I think most economists agree that in terms of GDP growth investments in the military are a negative factor. As you point out the hardware is either taken "over there" and soon destroyed or becomes outmoded. Ike was particularly good at explaining in his warning of the military-i9ndustrial complex speech that he was well aware that every dollar expended on the military was one that might better be spend on school rooms or perhaps his pet; out national highways. The "dividend" of wise military expenditures must be measured in national security.

What are the tools of the "next war?" Perhaps not tanks and carriers, but intelligence, cyber-security, international cooperation against terrorism and diplomacy?

Dear Steve: Thanks! My mistake. But both seem not to stray far from the main (Chicago?) melody of "nothing can or should be done" though we've come to a point in our "capitalism" that will require more changes and protections than after the Depression.

Consider for example "We've little leverage with ..China". Oh? for half a century we've embargoed trade with Cuba on the basis of "commie" fear and civil rights abuses. While there are many advantages of trade with China, instead of waiting for yet more devaluation of the dollar, as suggested, surely we could impose a tariff based on A. purposeful currency manipulation or B. civil rights and working stds violations. I'd argue advantages for both nations; for us a slightly smaller trade deficit and a bit less impact on our labor market along with some much needed Fed revenue. For them a small brake on their helter-skelter 8% growth rate and perhaps benefiting from more goods available for domestic consumption.

BTW, they like to travel and there are already more wealthy Chinese who could afford to travel than there are wealthy Japanese but due to our own travel restrictions we got only 300,000 while the Eurozone enjoyed 17 million visits.

http://www.npr.org/templates/story/story.php?storyId=89953762

Let's see: say ten million spending a bit less than the 6,000 quoted for $50 billion? Not bad! a real "spur" to our ailing tourist industry and ten percent of our trade deficit.

Jeff: I doubt you or they could make an honest case for government spending not having a positive effect unless the expenditures were, say, sillier than AIG throwing a gala as the peasants bailing the thieves and fools out "eat cake". A fair accounting would have to include weighing the cost of job generation against the immediate benefit to mortgage holders and pizza parlors and even the return of revenue to our Treasury from income taxes, and the dividends over the years from repaired and improved infrastructure. You'd also want to consider the inherent costs of unemployment, welfare, housing assistance expended while gaining no future assets and a lot more empty and depreciating housing, commercial and retail stock.

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If we isolate the stimulus-and held all other proposed policy changes constant, the stimulus still would have been a sum of zero. Combined with the proposals from the Obama administration (Health care, cap and trade, cash for clunkers, bail outs, land grabs in the west) the sum effect is a negative integer.

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For example how and why would one target stimulus to the moribund and overbuilt housing market? (Though truth is there is the first time buyer credit and "starter homes" for young families is going much better than most of the "move up" market) And, much of the money to the states is going toward construction and my guess is that unemployed home building craftsmen are mobile enough to ply their trades on various types of infrastructure maintenance and upgrades.