Sunday, March 4, 2012

"Debating Stimulus at Harvard and Stanford"

A follow up to Thursday's "Larry Summers For World Bank: So Much Wrong, So Little Time".
I had a couple friends ask me why I was in favor of Romer's even bigger stimulus. I wasn't and I didn't agree with the thrust of the HuffPo's piece. I wanted it on the blog as another post pointing out Larry Summers' over-inflated sense of self.

A key part of Keynes' argument for stimulatory spending in downturns is the concommitment running of surpluses once the crisis has passed. Since no government, Republican or Democrat, seems to have read that part of The General Theory of Employment, Interest and Money, we're screwed.

We are in a position where the marginal utility of deficit spending is greatly reduced, to the point that the multiplier effect of a dollar of deficit spending is far less than 1.
If you doubt this, check the ten-year forecasts in the President's recently unveiled 2013 budget (hulking huge PDF). Table S-1 on page 205 is a good start.

From Professor Taylor's (he of the rule) Economics One blog:
Larry Summers and I debated “Did Fiscal Stimulus Help the Economy?” at Harvard this week. There was no video streaming or recording, and I will not try to summarize the back and forth (which the overflow crowd seemed to enjoy), but here is a summary of things I said in my opening remarks. There will be a follow-up debate at Stanford on April 4 which will be recorded.

The issue we are debating today is central to economic policy. It’s an issue where there‘s obviously a great deal of disagreement. Students want to know why there’s disagreement, and the point-counterpoint of debate is an important way to learn. So I thank Harvard for sponsoring this debate, and I thank you all for coming.

I have been doing a lot of empirical research on the impact of discretionary Keynesian stimulus packages—the temporary and targeted packages intended to counter recessions and jump-start the economy by increasing government purchases, transfer payments, or tax rebates. I don’t find convincing empirical evidence that they helped the economy, or that they increased economic growth in any significant or sustained way. In fact, by increasing unpredictability about policy and by raising uncertainty about increased deficits and debt, they are likely to have harmed the economy.

Let me start with a few points of clarification:

First, I want to emphasize that I not saying that permanent or long-lasting changes in fiscal policy, such as tax reforms that lower marginal tax rates, cannot help the economy, or that the automatic stabilizers are ineffective. This debate focusses on temporary discretionary fiscal stimulus packages.

Second, I am not objecting to certain features of macroeconomic theory that are sometimes labeled Keynesian, such as that wages and prices are sticky, or that aggregate demand has a role in short run fluctuations, or even that people’s expectations matter, though I would emphasize that expectations have important rational characteristics. For me such complications—which I have been researching for many years—suggest the need for fewer discretionary policy actions and more systematic rule-like ones.

Third, I take a longer perspective than the February 2009 stimulus package and the related cash for clunkers and first time home buyer programs. There were also fiscal stimulus packages in 2008 and 2001, as well as in the 1970s.

The basic idea behind Keynesian stimulus packages is presented in basic college courses: A shift down in aggregate expenditures can be countered by increasing government purchases—augmented by possible multiplier effects—which shift up aggregate expenditures and fill the “gap.” Temporary changes in tax payments and transfers work the same way except that increased consumption is supposed to fill the gap.

Estimated macro models used for policy evaluation—whether old Keynesian or new Keynesian—have this basic mechanism built into them. However, they differ greatly in their predictions of the policy impact because of different assumptions about expectations, the marginal propensity to consume, the speed of price adjustment, and crowding out of other spending. For example, Christina Romer and Jared Bernstein used old Keynesian models to predict the effect of the stimulus package of 2009 before it was implemented. They predicted large effects of the package with multipliers around 1.5. In contrast, in research with John Cogan, Volker Wieland and Tobias Cwik, I used a new Keynesian model to predict the effects of the 2009 stimulus. We predicted a much smaller effect, with multipliers averaging 0.5, even less when you include transfer payments.

The problem with using these existing macro models to answer the question of this debate “Did fiscal stimulus help the economy?” is that they will simply repeat the same prediction story over and over again. You learn virtually nothing if you use the same models to evaluate the impact that you used to predict the impact.

So it is necessary to look at what actually happened, to look at the changes in aggregate consumption or GDP due to the stimulus packages, and that is what I have done. For the parts of the packages which include temporary tax rebates or temporary tax cuts I find no significant consumption effect using regression analysis and controlling for other factors that affect consumption. If you look at a chart of the tax rebates in 2008, for example, the evidence is striking: There was a big increase in personal disposable income at the time of the rebate, but no similar change in consumption. This is exactly what the permanent income or life cycle theories of Milton Friedman and Franco Modigliani tell us. People largely saved the injection of cash. The same thing is true for the 2001 and 2009 stimulus packages....MORE