Taking the Long View of the Stimulus

I'd like to revisit my post on Christina Romer's testimony and the stimulus. Commenter John Thacker keenly notes that a few months ago, I praised the British stimulus and pointed out that the UK was recovering faster than any other country in Western Europe. This was, I think, a bit hasty. I wrote:

Finally, here's a glimpse (via Krugman) at how England's output indices are fairing compared with the rest of Europe. If you can't read the graph, just know that the blue line is England. As of Jan 2009, the horses appear to be running in this order: UK, France, Germany, Italy, Spain.

Well so much for that. In the third quarter of 2009, the UK dipped further into recession than almost any country in the industrialized world. Does that mean fiscal stimulus bills don't work? Not exactly.

In September the Council of Economic Advisers picked up exactly this question and concluded that there was statistically significant evidence that: "All the countries that did very large stimulus (over 2.3 percent of GDP) saw surprisingly strong growth when measured with respect to either private sector forecasts or simple time series forecasts." It should be noted that the US stimulus was, by the CEA's estimate, 2.0 percent of GDP.

The Council offered some graphs to show the relationship between stimulus amounts and GDP recovery in OECD countries. I think this graph is the most telling because it looks at the relationship between each country's stimulus and their economic performance but also it controls for tax share. What does that mean? It means it accounts for countries that, in addition to stimuli, spent extensively through automatic stabilizers like welfare and unemployment insurance, which helps explain the smaller stimulus in France and Norway.
Figure 7: Outperforming expectations and stimulus (controlling for tax share)

What this graph cannot do is to look under the hood of these stimulus programs and figure out what kind of stimulus correlates with higher growth: tax cuts; federal spending; tax credits for companies; etc. The evidence in the report is merely anecdotal. It seems that something like Cash for Clunkers worked well in Germany. Turning inventory in Korea has helped that economy recently. Public investment in construction appears to have helped Japan's economy. But the problem with judging the stimulus plans is that we're comparing 2009's "stimulated" third quarters to past projections of 2009's "unstimulated" third quarters. This is tricky. It's a bit like getting sick and, after two weeks of medicine, comparing your current health to a health projection you made two weeks ago.

What we do know is small and limited. The CEA can spot a slight positive correlation between high stimulus spending and recovery and credits the stimulus with adding about 3 percent to Q2 and Q3 GDP in the United States. Here's what we also know. Unemployment is higher now than the administration projected in its no-stimulus scenario earlier this year, and even the CEA expects it to stay at this level throughout 2010. Whether or not it is fair to judge the success of the stimulus remains a matter of debate, I suppose. But the American people will judge the economy in one year anyway, and if unemployment is as high as the CEA projects, you can bet the last thing Obama will stimulate is the Republican Party.