The Impact of the Stimulus and the Issue of Integrity


My two blog entries (August 18 and 19) about Christina Romer's August 6 speech on the stimulus package have drawn an unusual amount of commentary, including criticisms (some by seemingly reputable economists) that are at once obtuse and vitriolic.

Some of the criticisms by economists are downright goofy (I have said before, and will say once again, that business-cycle economics is a very weak field), such as that, in treating output, conventionally enough, as the sum of personal consumption expenditures, investment, and government expenditures, I included "financial assets" in investment.

Output (measured for example by Gross Domestic Product) is a flow concept, not a stock concept. The nation's housing stock, and its other assets, including stocks and bonds, are not part of GDP. What I said, in criticism of economists who deny that a stimulus program can have any beneficial effects, is that while it is true that if a dollar invested by government, say in hiring a road contractor to build a new highway, reduces private investment by a dollar, the government expenditure is unlikely to increase net output, but that I doubted that that would be the effect of the stimulus. If private investment and consumption are down because people and firms are hoarding cash for fear of what the future holds for them, government can in effect put those inert savings to work by deficit spending on public works.

This same economist, Mark Thoma, who like DeLong is notably abusive, resorts to the academic trick of reading a passage literally in order to make the author seem an ignoramus. I had said that one of the events in the second quarter that might have helped reduce the rate of decline in output and employment was increased foreign demand for U.S. goods, relative to the first quarter. Thoma says: "he [Posner] talks about foreign demand for US goods, but doesn't include NX in his definition of output." "NX" means net exports. That is to say that increased foreign demand for U.S. goods is a good thing, since exports increase national income, unless U.S. demand for imported goods grows more. That's true, and if that happened in the second quarter (it didn't) I would not have pointed to the increase in foreign demand as a factor favorable to U.S. output, hence a possible confounding causal factor with the modest stimulus disbursements in the second quarter.

My critics are leftwing economists, and I think they simply can't believe that I really support the stimulus program, that I am a Keynesian, and that I am a critic of conservative macroeonomists and finance theorists, though I do not accuse John Cochrane, a distinguished finance theoriest, as Thomas does, of not knowing freshman economics. 

Well, on to substance.


Romer's speech argues that the disbursements of stimulus funds through the end of the second quarter of this year (that is, through June 30) have had a big effect on economic output and employment. I said this was unlikely as a matter of theory, and that she had no persuasive evidence to back up her claim. And I raised the question of the ethical responsibilities of an academic who takes a government job and then makes a speech that although it deals with a subject that she had studied and written about as an academic is not a responsible academic analysis. My concern is enhanced by the statement of one of my critics that the Council of Economic Advisers, of which Romer is the chairman, has a sterling reputation for political neutrality and analytical rigor. Romer's speech does not bode well for the preservation of that reputation. Another critic argues that since it was just a speech, intended therefore to be heard rather than read, Romer should be permitted to have rounded off her numbers, and thus to have rounded off $89 billion (this critic's estimate of how much stimulus money had been disbursed by the end of the second quarter) to "more than $100 billion" (her language). This overlooks the fact that the speech was posted on the CEA's website, and is replete with footnotes, which I doubt she read aloud.

In fact, while I am on the subject of the amount of stimulus money disbursed so far, $89 billion seems too high. The government's official figure is $60 billion, and a recent estimate by is $58 billion. One of my fiercest critics estimates the figure at "about $60 billion," without however remarking the discrepancy between "about 60 billion" and Romer's "more than $100 billion.

Far more important than the amount of money disbursed is the amount spent. The distinction is essential. When an individual or for that matter a state treasurer (for the entire stimulus disbursements through the end of the second quarter consisted of transfer payments) receives a check, he has a choice between saving it or spending it, or doing some of both; and if he decides to save it, he has to decide whether to hold it in cash, deposit it in a bank account or a money-market account, buy stock, etc. The more of it he decides to save in a safe form, the less the stimulus he received will do to stimulate economic activity. Most economists believe that "transitory" (one-shot) income is mostly saved rather than spent; and the belief is confirmed by most studies of the effect of the $150 billion in tax relief implemented in the spring of 2008 to fight the then-nascent recession.

Romer's speech does not indicate what percentage of the "more than $100 billion" (or is it $58 billion?) had actually been spent rather than squirreled away during the second quarter. Moreover, given the inevitable lag between the disbursement and the expenditure of disbursed funds by the recipient of the disbursement, disbursements made toward the end of the second quarter could not have affected output and employment in that quarter.

Romer's failure to address these points would be understandable if she were not an academic student of stimulus programs; but she is.

When I read her speech the first time, I missed this startling statement: "the fact that consumption fell slightly in the second quarter after rising slightly in the first quarter could be a sign that households are initially using the tax cut mainly to increase their savings and pay off debt" (emphasis added). Well, if that's what they're doing, they aren't doing much to stimulate economic activity. I agree with Keynes that consumption is the motor of the economy (one my critics says that "consumption does not produce," which rather misses the point), and that what government needs to do when personal consumption expenditures drop is to increase government consumption--and that means public works, which employ people, and not transfer payments, which may not translate into proportionately increased consumption, or at least not without a lag. Romer says that public works (she calls them "direct investments," but the meaning is the same) "have short-run effects roughly 60 percent larger than tax cuts." She doesn't indicate where she gets the number, but it is further evidence that she believes that transfer payments are not as efficient in stimulating economic activity as public works are.

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Richard A. Posner

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. More

Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.
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