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Honesty about the Stimulus

On August 6, Christina Romer, the chairman of the President's Council of Economic Advisers, gave a talk entitled "So, Is It Working? An Assessment of the American Recovery and Reinvestment Act at the Five-Month Mark." The reference of course is to the $787 billion stimulus that Congress, at the urging of the Administration, enacted last February.

Romer answers the question in her title: "Absolutely." And despite the reference to "five months" in the subtitle, her focus is on the second quarter of 2009 (April, May, and June) and her claim is that the stimulus had a dramatic effect on output and employment during that quarter. I do not think her analysis is responsible, and I am concerned with the fact that academic economists, when they become either public officials or public intellectuals (like Paul Krugman), leave behind their academic scruples. (This is one of the themes of my book Public Intellectuals: A Study of Decline [2001])--and Krugman was one of my examples of the phenomenon.)


Let me make clear at the outset that I support the stimulus, though I wish it had been better designed. I support it for two reasons. The first is that, given the state of panic of the economy last winter, and the limited efficacy of the measures already taken to arrest the economic plunge--the expansion of the money supply and the bailouts of the banks and the two failing automobile manufacturers (Chrysler and GM)--the government had to make a dramatic commitment to try all means of arresting the plunge. It could not just say, "We've tried everything we think might work; it's not working; so we'll just have to tough it out." That would have been destructive of business and consumer confidence, and would have accelerated the downward spiral that many thought could have brought the economy to the depths it reached in the 1930s depression.

Second, there is a pretty good theoretical case, and some empirical backing, for deficit spending on public works as a means of combating a depression. Output (GDP) is the sum of personal consumption expenditures, investment (including savings), and government expenditures. When personal consumption expenditures and investment decline, so that (if government expenditures are constant or falling) total output declines, which in turn results in layoffs, which further reduce income and therefore output, thus triggering a downward spiral, an increase in government expenditures can arrest or at least slow the downward spiral by replacing some of the decline in private consumption and investment.

Of course it's necessary to consider the impact of those increased expenditures, and the debt burden they impose on the government, on private consumption and investment. The impact on consumption is likely to be positive: if government "buys" new highways and thus employment in construction rises, the resulting increase in total wages will translate into an increase in consumption expenditures, though some of the wages will be saved rather than spent. The impact of the public-works program on investment is more complicated. But suppose, plausibly in a serious economic downturn such as the one that we're in at present (and that was even more serious back when the stimulus bill was enacted), that a great deal of investment is in the form of passive savings, such as demand deposits and Treasury securities, because people and companies are anxious about their economic prospects, and they want safe savings, rather than savings that would be at risk because invested in entrepreneurial projects. (In other words, "liquidity preference" has risen.) These passive savings are economically inert--even bank deposits, when banks are reluctant to lend, as they are, and demand for loans is down, as it is, so that, for both reasons, increased deposits do not translate into significantly increased lending to businessmen. By selling Treasury securities to finance a stimulus program, the government transforms inert private savings into expenditures on projects that result in more jobs and so higher incomes and consumption. It can borrow the passive savings of fearful hoarders because there is no risk of the government's defaulting.

Now unfortunately the stimulus was poorly designed and has been (so far as an outside can judge) lazily implemented. Only about a third of the stimulus funds is for public works. Two-thirds are for tax credits and other benefits (including the popular "cash for clunkers" program) and for state governments. The problem with the two-thirds is that there is no guaranty that transfer payments will be put to productive use; they may be saved, directly or indirectly. Suppose a state uses the money for tax relief; then it is in effect putting money in people's pockets, and the recipients may decide to save, rather than spend, the bulk of what they receive. The personal savings rate has been rising, and additional cash received from the stimulus program may go largely to increase personal savings beyond what they would otherwise be. Or, in the case of the "cash for clunkers" program, the major effect may be that people buy cars a little sooner than they otherwise would, in which event auto sales may be depressed a few months from now; or they buy cars in lieu of other products, and the increase in auto sales is offset by a decrease in other sales.

In contrast, when the government pays a road contractor to build or repair a road, we know that the money is going to be spent to hire workers and buy materials, and so employment will rise.

Conservative economists argue that the effects of the stimulus in increasing output and employment will be undone by the fears of businessmen and consumers concerning the addition to the national debt of $787 billion in deficit spending. Those fears, these economists argue, will cause businessmen and consumers to hoard, knowing that their taxes will have to rise in the future (and their wealth therefore be lower--hence the need for greater savings now, so that they can use their savings to maintain their standard of living when the higher taxes take effect) to pay back the $787 billiion. Most economists, however, believe that it is unrealistic to suppose that people have enough information about the future to adjust their current behavior to expectations of higher taxes, inflation, devaluation, or other possible consequences of an increase in the national debt. There is too much uncertainty.

The point is not that people are irrational, but that they just don't have the information that would enable them to decide what adjustment in savings and consumption they should make today to optimize their economic situation if and when the national debt has to be paid down through higher taxes, inflation, or other measuires.

But Romer actually gives some credence to the unrealistic picture of the far-sighted consumer or businessman by arguing that recipients of tax credits authorized by the stimulus bill will spend rather than save the tax-credit money because they will assume that the credits are permanent. (The significance of this assumption is that people are more likely to spend a tax reduction that they think is permanent than a temporary reduction, because it would be a bother to adjust their spending patterns temporarily only to have to change them back when the surge of money--what economists call "transitory income"--runs out.) They will assume the credits will be permanent, she says, because the Obama Administration is committed to middle-class tax cuts. In fact no one knows whether the tax credits, enacted as part of a temporary measure--the stimulus--will be permanent; and it is extremely doubtful that many people are acting on the expectation that they will be.

Romer argues in her talk that by the end of the second quarter of this year, $100 billion of stimulus money had been spent. That is a suspiciously round number, and it is unclear how it was arrived at; but let us assume it is accurate. She then argues that this small expenditure--about two-thirds of one percent of the Gross Domestic Product--is responsible for the fact that the decline in GDP fell (on an annualized basis) from 6.2 percent in the first quarter of the year to 1 percent in the second quarter (though the latter figure is likely to be readjusted upwards).

This assertion is groundless. No one has the faintest idea what effect the stimulus has had. My guess is that it has had some positive effect, because of its confidence-enhancing character that I mentiioned earlier and because some of the $100 billiion--though no one seems to know how much--has been spent rather than saved. But it is impossible to determine the net impact of the stimulus on GDP or employment because so much else has been happening to stimulate an economic recovery. Some people have had to dissave--turn savings into expenditures--because their income has fallen (maybe because they have become unemployed) below the level necessary to cover their basic expenses. Some people have had to replace durables that wore out. Foreign demand for U.S. products has risen some. (Dissaving, replacing durables, and export growth if the domestic currency loses value are standard nongovernmental spurs to recovery from a depression.) And the government has been doing a lot to stimulate recovery besides the stimulus--has in fact expended or guaranteed trillions of dollars in an effort to increase the amount of lending, which is essential to economic activity.

Disentangling the various factors that are responsible for the reduction in the rate of decline of output in the second quarter is probably impossible, but in any event has not, to my knowledge, been attempted--and certainly not in Romer's talk.

This raises the question of the ethical responsibility of academic economists, such as Romer (and Krugman, and Lawrence Summers, and many others), who write for the media or join the government, either to adhere to academic standards in their nonacademic work or to make clear to the public that they are on holiday from those standards and that what they say in their public-intellectual or governmental careers should not be thought identical to their academic views. As an academic, Christina Romer was a respected student of the business cycle, and actually expressed skepticism, no longer in evidence, about the efficacy of stimulus programs in arresting economic downturns. The statement in her talk that she thinks the allocation of moneys by the stimulus bill is just right is hard to credit as her professional opinion. But as chairman of the Council of Economic Advisers, she is a spokesman for the Administration, and I would guess that her public statements are vetted by the President's political advisers.

(Photos: Flickr Users David Paul Ohmer and borman818)