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Is Government the Solution?

by Matt Mitchell on June 11, 2012

in Stimulus

It was thus salutary that Douglas Elmendorf, the widely respected director of the Congressional Budget Office, told a congressional hearing last week that 80 percent of economic experts surveyed by the University of Chicago’s Booth School of Business agreed that the stimulus got the unemployment rate lower at the end of 2010 than it would have been otherwise.

That’s E.J. Dionne writing in today’s Washington Post. This sort of statement is all too common: “There is consensus on stimulus. All economists agree it is unquestionably beneficial. If anything, the 2009 stimulus was too small. Case closed. Move along.” This is not a fair representation of the scientific view of stimulus.

Let’s start with the Booth School survey. Every week, the Booth School’s Initiative on Global Markets polls an ideologically diverse group of about 40 economists on a particular issue. The surveys are fascinating; I read them every week. On February 15, they put two statements to the panel and asked them to respond. The first statement reads:

Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill.

It is true that, of those surveyed, 51 percent agreed and 29 percent strongly agreed with this statement. Some of the comments from those who agreed with this statement are telling. Anil Kashyap of Chicago for example wrote, “But this is an incredibly low bar.” And Darrell Duffie of Stanford wrote, “Subsidizing employment leads employment to go up, other things equal. Adverse impacts through growth incentives might take time.” These statements (and others) suggest that perhaps the question was overly-narrow.

Thankfully, IGM probed further. They asked the economists to weigh in on a second statement:

Taking into account all of the ARRA’s economic consequences — including the economic costs of raising taxes to pay for the spending, its effects on future spending, and any other likely future effects — the benefits of the stimulus will end up exceeding its costs.

This time, when the economists were asked about the longer-run, total effects of stimulus, they were much more equivocal. Less than half agreed or strongly agreed with the statement, 27 percent were uncertain, and the rest either disagreed or had no opinion. A number of respondents noted the uncertainties involved. Nancy Stokey of Chicago summed it up nicely, writing, “How can anyone imagine this question is answerable, given the current state of economic science?”

Amen. In my testimony last February before the House Education and Workforce Committee, I wrote:

There are many things on which economists agree (e.g., few dispute the merits of free trade or the long-run fiscal problems with our largest entitlement programs). Unfortunately, there is very little consensus among economists on government’s ability to jumpstart a sick economy.

The degree of disagreement over stimulus is evident when you look at the literature on the “government purchases multiplier.” The multiplier measures the amount by which an economy expands when the government increases its purchases of goods and services by $1.00. If the multiplier is larger than 1, it means that government purchases multiply or stimulate private sector economic activity. If it is between 0 and 1, it means that purchases displace or crowd out private sector economic activity. And if it is less than 0, it means that government purchases crowd out enough private sector economic activity to offset any increase in public sector activity.

In my testimony, I showed the following sample of recent estimates. Each bar shows the high and low-end estimate of a particular study.

As I wrote in February:

Note that there is a wide range in the estimates both across and within studies. If the optimistic scenarios are correct, an additional $1.00 in deficit-financed government spending spurs $2.70 in new private sector economic activity. But if the less-optimistic scenarios are correct, then an additional $1.00 in spending destroys $3.80 in private sector activity.

This misses some of the recent data. In a recent paper Valerie Ramey of UCSD, for example, uses: “a variety of identification methods and samples,” and finds that “in most cases private spending falls significantly in response to an increase in government spending.” She finds that while government spending does bring down the unemployment rate, “virtually all of the effect is through an increase in government employment.” Note that this is entirely consistent with the first IGM statement. In other words, one can believe that stimulus harms the private sector and is costly in the long run, but still think that it might have boosted (government) employment for a time. This is hardly a ringing endorsement of stimulus.

For more on this topic, see Garett Jones’s excellent (February) post here or Veronique’s post here.

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Addendum: Vero responds to Dionne’s column, adding links to lots more research on when multipliers might be large or small. And Russ weighs in here, calling for more humility. Read and bookmark both posts.

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