Sep 9 2009, 3:14PM
The Politics and the Economics of Stimulus
My lefty critics don't believe me when I say I support the stimulus. But I do, and I advocated it in my book A Failure of Capitalism, completed before the stimulus was enacted. I am a Keynesian, and I have sharply criticized conservative economists who oppose Keynesian deficit spending. I simply do not believe that it is possible to attribute the improvement in the economy to the actual spending of stimulus money through the end of the second quarter, because I believe the actual spending was small and that the significance of the stimulus program is more psychological than (as yet) economic.
I attribute Christina Romer's August 6 speech, and Vice President Biden's speech of September 3 on the first 200 days of the stimulus program, to the political imperative of shorting up public support for the stimulus. Oddly, the program is unpopular, and not only among Republicans. The reason for its unpopularity I believe is the Administration's health care plan. The unfunded and probably unfundable cost of the plan has riveted public attention on the nation's huge deficits. $787 billion in deficit spending obviously adds a lot to the deficit. The stimulus program probably should have been adopted last fall rather than in February of this year, and expedited more vigorously than it has been. Romer has warned in her academic writing (which incidentally I admire) that Keynesian measures for spurring recovery from an economic downturn tend not to be implemented until the downturn has reached its bottom and thus they risk overheating the economy by adding public demand when private demand is again growing. This should worry Romer, although because of the continuing credit crunch, continued stimulus expenditures may not in fact overheat the economy. In the postwar recessions that she discusses (particularly in a 1994 article with David Romer in the NBER Macroeconomics Annual), fiscal recovery measures came on top of monetary measures, namely reducing interest rates. When a nation's banking system is in bad shape, monetary measures lose much of their efficacy. The Federal Reserve has pushed interest rates way down, without stimulating much lending. The economy may well have considerable slack for months or even years to come, in which event stimulus expenditures will not cause inflation.
My criticisms of Christina Romer's August 6 speech (most recently in my blog posting of August 25) continue to draw criticism, most recently (as far as I know) from the economist Menzie D. Chinn, in an August 27 posting on Econbrowser--an excellent blog. Professor Chinn makes a series of criticisms of my argument, starting with saying I have "given up on accusing Dr. Romer of lying about the $40 billion figure." The reference is to her estimate of the tax benefits authorized by the stimulus bill that were granted by the end of the second quarter of this year (June 30). I never accused her of lying about the figure; I do not even question the figure. My point was the difference between authorizing or disbursing money and spending it. No one seems to know how much of the $40 billion was actually received by taxpayers, as opposed to reducing their future tax payments; and of the amount actually received by them, no one seems to know how much they spent rather than saved. These distinctions have eluded Professor Chinn, though I had emphasized them in my August 25 blog posting--the target of his criticisms. He seems to think that it is possible that all the $40 billion took the form of rebates, but as far as I know none of it did. A rebate would be a check to the taxpayer, as distinct from a tax credit. Bush's spring 2008 stimulus package consisted entirely of tax rebates; the Obama stimulus does not.
Professor Chinn says that even if none of the $40 billion in tax relief was actually spent by recipients of the relief in the second quarter, the remaining $60 billion of Romer's "more than $100 billion" was ample to increase GDP that quarter by two percent. But that assumes that all of the $60 billion was spent, and no one seems to know how much was; Chinn assumes it all was, which is false. A neglected point is brought out in an article by Michael Cooper in the September 5 New York Times. The article points out that federal stimulus spending can be nullified by state cutbacks. For example, a federal grant of stimulus money for mass transit has been nullified by reductions in state expenditures on mass transit. The question then becomes what was the consequence of those reductions? Maybe they enabled a state to rescind a tax increase, in which event state taxpayers would have more money in their pockets. And then the questions would be: how long does this process take, and how much of the additional money do the taxpayers spend rather than save?
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Richard A. Posner
Implicit in this discussion is the notion that if a "stimulus" takes the form of (borrowed) money being directly distributed as cash payments to the general population then such an effort would be ineffective if this cash isn't immediately spent. This is a basic Keynesian "hoarding" concept, and I think it made good sense in the past. I'm not sure it's true this time around for various reasons.
1. Some of the recent drop in demand may have been a panicky overshoot, but my impression is that we have witnessed a readjustment to a "new normal" and that most of the decline in consumption and production will not (and should not) return for some time. The amount of easy-credit-fueled consumption and the reckless behavior of euphoric optimism in 2006 was almost certainly unsustainable. It's different for each sector, of course, but housing and autos provide examples.
Government deficit-spending "stimulus" efforts are justified as preserving the equilibrium level of aggregate production until private sector demand recovers (mostly to preserve employment). If demand falls past equilibrium and there has been an overshoot, then efforts to accomplish an immediate increase in consumer spending seem warranted. But if demand falls to near equilibrium then measures which end the panic, prevent overshoot, and improve the financial health of the overall economy by producing small regular gains over time should be more desirable.
2. Related to this - the most efficient way for a normal consumer to spend extra windfall income is not to save it in a bank account, or even to consume more products immediately, but to de-leverage - to pay off their obligations accruing the highest interest rate. For the vast majority of modern US households that means credit-card debt - of which US consumers owe nearly one trillion dollars (coincidentally, only slightly larger than the stimulus package). If people's economic expectations drop precipitously then it will be hard to get them to make an alternative windfall-expenditure decision no matter how you stimulate.
80% of households have at least one credit card (most have from 5 to 10), and the typical balance for these households is nearly $11,000. The average interest rate is now 15%, and so these households pay an average of $1,650 a year in interest. If a windfall arrives that allows a family to pay off a good portion of these debts, and if they avoid incurring any more, they achieve something like a permanent increase in income. This would actually raise their long-term average level of consumption so long as they avoided credit-based purchasing.
This isn't "spending" (at least not right away), but neither is it "saving" in the hoarding sense. It is more like "investing" in a high-interest bearing, fixed-income asset, and the extra income should act like a permanent stimulus to demand. The catch is that this demand does not appear immediately (as when a consumer uses all of his check to buy goods today), but takes a certain period to arrive. Instead of $1200 extra demand today, it delivers $15 a month extra demand a month from now on. If a drop in aggregate demand is mostly corrective - then this could be a more ideal "stimulus" to end a panic and prevent overshoot.
If stimulus rebate/credit money is mostly used in this way, it resembles a kind of social refinancing. The US borrows money at 4% as a one-time bail-out of its citizens' credit card debts at 15%. At a maximum, this would permanently shift the interest income of around $150 Billion per year from the big banks to consumers.
First Posner says:
"I simply do not believe that it is possible to attribute the improvement in the economy to the actual spending of stimulus money through the end of the second quarter, because I believe the actual spending was small and that the significance of the stimulus program is more psychological than (as yet) economic."
But then he says:
"I attribute Christina Romer's August 6 speech, and Vice President Biden's speech of September on the first 200 days of the stimulus program, to the political imperative of shorting up public support for the stimulus. Oddly, the program is unpopular, and not only among Republicans."
Seemingly oblivious to the inherent contradiction. In short, he's saying the Recovery Act has led to the sudden improvement in the second quarter, not due to any actual spending, but due to its psychological effect, presumably in the form of increased optimism about the economy. But then he goes and points out that the Recovery Act is unpopular. How is it possible for a program to both increase economic optimism and yet generate antipathy?
The simple answer is it's not possible. The Recovery Act is having a positive effect, but it's not through the sheer power of optimism, it's through the tangible effects of net new consumption, investment and government spending.
He writes:
"The stimulus program probably should have been adopted last fall rather than in February of this year, and expedited more vigorously than it has been."
Probably, but so much happened so fast it's hard to remember. The financial crisis erupted in September. The bad economic reports didn't start rolling in until November. It really wasn't apparent until then that the financial crisis had spilled over to the general economy. It was only then that talk of a fiscal stimulus arose. It wasn't until December 1st that the NBER officially declared that we were even in a recession and it wasn't until December 17th that the fed funds rate was dropped all the way to 0%. It was only then that it was clear we had exhausted monetary policy. We were officially in a liquidity trap.
On January 10th the incoming administration revealed a plan for a discretionary fiscal stimulus. On January 28th the House passed a bill. On February 10th the Senate passed a bill. After passing conference the bill was signed into law on February 17th. The first spending occurred the following month. Exactly two months had elapsed from the Federal Reserve dropping the fed funds rate to zero to the president signing the stimulus into law. And that despite the change of government.
He writes:
"Romer has warned in her academic writing (which incidentally I admire) that Keynesian measures for spurring recovery from an economic downturn tend not to be implemented until the downturn has reached its bottom and thus they risk overheating the economy by adding public demand when private demand is again growing. This should worry Romer, although because of the continuing credit crunch, continued stimulus expenditures may not in fact overheat the economy."
The more important consideration is the zero lower bound for the federal funds rate. As long as that's deemed necessary there's no chance that a stimulus is counterproductive. The moment that is no longer the case we might consider curtailing or withdrawing the fiscal stimulus because of the crowding out effect. But given the analysis done by Glenn Rudebusch of the FRBSF there's no chance of that for several years. The bottom line is that a discretionary fiscal stimulus is only necessary and is most effective in a liquidity trap. This is not an ordinary recession.
He writes:
"No one seems to know how much of the $40 billion was actually received by taxpayers, as opposed to reducing their future tax payments; and of the amount actually received by them, no one seems to know how much they spent rather than saved. These distinctions have eluded Professor Chinn, though I had emphasized them in my August 25 blog posting--the target of his criticisms. He seems to think that it is possible that all the $40 billion took the form of rebates, but as far as I know none of it did. A rebate would be a check to the taxpayer, as distinct from a tax credit. Bush's spring 2008 stimulus package consisted entirely of tax rebates; the Obama stimulus does not."
According to the Joint Committee on Taxation there are approximately $121 billion in tax expenditures contained in the FY 2009 portion of the Recovery Act. Not all of these tax expenditures will go out in the form of a rebate or decreased withholding. In fact I estimate that only about 60% of it will. Recovery.gov has recently been releasing those figures. You can find them here:
http://www.recovery.gov/?q=content/estimated-625b-tax-relief-recovery-act
So what are the tax expenditures that are going out immediately week after week?
1) Make Work Pay. As of the end of the second quarter $15 billion had gone out as reduced payroll withholding. If Mr. Posner is not aware of this he hasn't looked at his paycheck stub recently.
2) Other Individual Credits
a) Expanded Tax Break for 2009 First-time Buyers.
This rebate is available immediately as a refundable rebate to taxpayers if you file an amendment to your 2008 Form 1040.
b) Sales Tax Deduction for Vehicle Purchases.
This is available immediately through reduced withholding.
c) Exclude up to $2,400 of unemployment insurance benefits from gross income.
This is available immediately through reduced withholding.
Altogether $8.5 billion in additional individual credits had gone out as a rebate or through decreased withholding by the end of the second quarter.
3) Energy Incentives.
As of the end of the second quarter about $400 million had gone out in the form of tax rebates.
4) Tax Incentives for Business.
The bonus depreciation is available immediately as a rebate and the
carryback of net operating losses is available through decreased withholding. As of the second quarter $14.5 billion had gone out.
5) Cobra.
As of the end of the second quarter $4.9 billion had gone out in the form of decreased withholding.
So in total $43.2 billion had gone out as a rebate or through decreased withholding by the end of the second quarter.
(continued)
Posner writes:
"Professor Chinn says that even if none of the $40 billion in tax relief was actually spent by recipients of the relief in the second quarter, the remaining $60 billion of Romer's "more than $100 billion" was ample to increase GDP that quarter by two percent. But that assumes that all of the $60 billion was spent, and no one seems to know how much was; Chinn assumes it all was, which is false."
Dr. Chinn made no such assumption. His main point was that even if only a small fraction of the money that had gone out by the end of the second quarter had resulted in net new spending this would have resulted in the effect on GDP claimed by Romer and the several private forecasters. But let's suppose that this assumption were true. That means that without last quarter's stimulus GDP would have been approximately $3.49 trillion instead of $3.55 trillion. In other words it was approxiamtely 1.7% larger and at an annual rate that would have added approximately 7.1%.
Now the change between the -6.4% decline in GDP in the first quarter and the -1.0% decline in the second quarter was only 5.4%. So if only 60% of the stimulus spending through the second quarter ended up as net new spending it would have accounted for about 130% of the change.
Posner writes:
"A neglected point is brought out in an article by Michael Cooper in the September 5 New York Times. The article points out that federal stimulus spending can be nullified by state cutbacks. For example, a federal grant of stimulus money for mass transit has been nullified by reductions in state expenditures on mass transit. The question then becomes what was the consequence of those reductions? Maybe they enabled a state to rescind a tax increase, in which event state taxpayers would have more money in their pockets. And then the questions would be: how long does this process take, and how much of the additional money do the taxpayers spend rather than save?"
I'll let Dr. Chinn handle this. He responds:
"he nullification point is an odd assertion. The state cutbacks presumably would have occurred in the absence of the transfers from the Federal government, so in the absence of the stimulus package, state and local spending would have been even lower. In other words, Mr. Posner is asserting a state and local government spending reaction function that implies each dollar of spending transferred from the Federal government induces and equal and offsetting spending reduction. I'm open to this possibility, but I'd appreciate seeing some data (i.e., not anecdotes) to that effect, rather than mere conjecture.
In addition, Mr. Posner sets forth an alternative scenario, where tax increases are rescinded as a consequence of transfers to the states. On this count, CEA has investigated this hypothesis. Figure 7 from The Effects of State Fiscal Relief is illuminating:
http://www.whitehouse.gov/assets/documents/CEA_ARRA_Report_Final.pdf
'Figure 7 compares the size of total funds from these programs that had been transferred to each state through July 3 with the state's maximum reported fiscal 2009 budget gap.22 While these transfers were sizeable in magnitude, in 35 states they are smaller than the reported budget gap. This means that states could have used the funds to increase their rainy day funds only if they reduced expenditures or increased taxes in the same fiscal year. Given that states underwent deep expenditure cuts in 2009 (42 states cutting their fiscal year 2009 budgets by $31.6 billion through June 2009), it seems unlikely that this would have occurred.'
In conclusion, it appears to me that we have several pieces of information, from a variety of sources, that suggest a positive impact on 2009Q2 q/q growth stemming from the ARRA. In addition, if one were to do a meta-analysis of estimated impacts, it would seem to me likely that the mean impact would be in range estimated by CEA."
http://www.econbrowser.com/archives/2009/09/the_arraas_prog.html
Now in conclusion I want to reiterate some of my own points.
After falling considerably, and progressively more deeply in each of the three quarters before the most recent one, the fall in GDP moderated substantially. After declining at an annual rate of 6.4% in the first quarter of 2009, it fell at a rate of 1% in the second quarter. The rise in GDP growth from the first quarter to the second was the largest in almost a decade, and the second largest in the past quarter century.
Econometric analysis performed by Moody's economy.com, Macroeconomic Advisors, Goldman Sachs, J.P. Morgan Chase, IHS/Global Insight and the Council of Economic Advisors (CEA) credit the stimulus with adding 2.8%, 2.1%, 2.2%, 3.0%, 2.3% and 2.3% respectively to GDP growth at an annual rate in the second quarter. The average of these six vector autoregression analyses (VAR) is thus about 2.5%. These same private firms and institutions are predicting that the stimulus will add 3.6%, 1.9%, 3.3%, 4.0%, 2.3% and 2.7% respectively to GDP growth in the third quarter compared to baseline or an average of 3.0%. As a result GDP will be about 1.4% or $200 billion higher at an annual rate in the second quarter thanks to the stimulus. In addition Moody's, Macroeconomic Advisers, IHS and the CEA using VAR analysis project that the stimulus will raise employment by 1,070,000, 620,000, 690,000 and 1,040,000 respectively or an average of 856,000 in the third quarter over baseline.
As of the second quarter $56.2 billion had been spent directly and another $43.5 billion had gone out immediately as tax expenditures for a total of $99.7 billion. As of the end of August approximately $89 billion had been spent directly and $62 billion had gone out immediately as tax expenditures for a total of $151 billion. This is close to 20% of the stimulus. By the end of this quarter this figure will rise to about $180 billion. From now until the end of FY 2010 the stimulus will go out at the rate of about $100 billion. And its effect is proportional to its
flow and not its stock amount.
To have the effect implied by the VAR analyses, GDP merely needed to rise by about 0.6% above baseline in the second quarter (remember we're talking about annual rates). Since GDP in the second quarter was about $3.55 trillion that means only about $22 billion in net new consumption, investment and government spending needed to be attributable to the stimulus or only about 20% of what actually went out.
How small 20% really is is best shown by considering the details of the Recovery Act. As of the second quarter, %15 billion had gone out in the form of Make Work Pay, $28.2 nillion for other individual tax incentives, energy incentives, tax incentives for business and Cobra, $28.3 billion for state fiscal relief, $14.4 billion for unemployment insurance and food stamps and $5.9 billion for government investment outlays.
Let's assume that only 15% of Make Work Pay was spent, and the rest was saved despite the fact it only is being paid out in paycheck increments instead of a large rebate check that's more easily saved. Let's assume that, somehow, the other tax relief was completely fungible and that it generated absolutely no net new spending despite the fact that a fair proportion of it was conditional on investments. Let's assume that only 35% of the state fiscal relief was spent despite the fact that almost all states are in the midst of a severe revenue crisis. Let's assume that only 45% of the unemployment insurance and food stamps was actually spent despite the fact the recipients are probably facing severe liquidity constraints. And let's assume that only 65% of government investment outlays were spent that quarter and that for some mysterious reason the remainder was parked in a bank account.
With all of those assumptions you come up with a figure of about $22 billion in net new spending in the second quarter. Thus GDP was larger by about 0.62% or by 2.5% at an annual rate. Thus you would get exactly what the econometric analysis is implying.
To achieve the impact estimated by the VAR analyses in the third quarter, GDP must rise by about 1.4% relative to baseline. Thus third quarter GDP must be about $50 billion above baseline. In other words the stimulus must generate a total of about $70 in net new consumption, investment and government spending over the two quarters. This will represent less than 40% of the total amount that has gone out by that point. It is perfectly reasonable that it will have that effect.
Addendum:
In my hypothetical discussion of what was actually spent in the second quarter I left out the $13 billion in Economic Recovery Payments that went out as $250 checks to people receiving Social Security etc. Let's assume that none of that was spent as well.
There is a little "typo-like" error in the first period of the -- always insightful -- post by Mr. Posner.
"My lefty critics don't believe me when I say I support the stimulus. But I do, and I advocated it in my book A Failure of Criticism, completed before the stimulus was enacted."
Where we read "A Failure of Criticism", i think it would rather be written "A Failure of Capitalism".
Sincerily
Thiago Maciel Oliveira.