Does Stimulus Work?
Dylan Matthews has a fascinating post over at the Washington Post Wonkbook. He surveys 15 studies of fiscal stimulus and concludes that 13 of them found a positive effect. Let me begin, as Pete Boettke does, by congratulating Mr. Matthews on his approach. He is reasoned, restrained, and apparently interested in looking at the facts. That is not so common in blog posts about stimulus.
Pete wonders how critics of fiscal stimulus might respond to this. Here is my shot.
I have three broad concerns:
- I believe that Matthews, like many stimulus advocates, continues to overstate the degree of unanimity among economists on the efficacy and wisdom of fiscal stimulus.
- Irrespective of the macroeconomics of stimulus, the public choice of stimulus implementation looks quite bad. Political actors do not behave as Keynesian models suppose they do. So governments do not implement stimulus as Keynesians say they should. And when stimulus is incorrectly applied, it is worse than ineffective. It is counterproductive.
- Matthews’s post ignores the short run / long run tradeoff. Not even the most strident Keynesians believe that permanent stimulus is the path to prosperity. At some point governments have to raise taxes to pay off the debt they have accumulated. That is costly and even if one accepts the possibility of short-term gain, it is irresponsible to ignore the certainty of future costs.
I’ll take each of these points in turn.
Stimulus Advocates Overstate the Degree of Unanimity Among Economists:
In introducing the 15 studies Matthews notes that the Romney campaign “left out” a few studies. I’d note that he, too, left a few out. Among peer-reviewed studies that suggest stimulus mostly crowds-out private sector economic activity, I’d include:
- Valerie A. Ramey, “Government Spending and Private Activity,” (National Bureau of Economic Research [NBER] Working Paper Series no. 17787, Cambridge, MA, 2012);
- Robert Barro and Charles Redlick, “Macroeconomic Effects from Government Purchases and Taxes,” Quarterly Journal of Economics 126, no. 1 and working paper, Mercatus Center at George Mason University, Arlington, VA, 2010;
- John Cogan, Tobias Cwik, John Taylor, and Volker Wieland, “New Keynesian versus Old Keynesian Government Spending Multipliers,” Journal of Economic Dynamics and Control 34, no. 3 (March 2010): 281-95;
- Thorsten Drautzburg and Harold Uhlig, “Fiscal Stimulus and Distortionary Taxation,” (National Bureau of Economic Research [NBER] Working Paper Series no. 17111, Cambridge, MA, 2011);
- Andrew Mountford and Harald Uhlig, “What Are the Effects of Fiscal Policy Shocks?” Journal of Applied Econometrics, 24, no. 6, (2009): 960-992.
- Ethan Ilzetzki, Enrique Mendoza, and Carlos Végh, “How Big (Small?) Are Fiscal Multipliers?” (National Bureau of Economic Research [NBER] Working Paper Series no. 16479, Cambridge, MA, 2010);
- Robert Hall, “By How Much Does GDP Rise If the Government Buys More Output?” (Brookings Panel on Economic Activity, Washington, DC, September 2009);
- Olivier Blanchard and Roberto Perotti, “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output,” The Quarterly Journal of Economics 117, no. 4 (2002): 1329-368;
- Eric Leeper, Todd Walker, and Shu-Chun Yang, “Government Investment and Fiscal Stimulus,” (International Monetary Fund [IMF] Working Paper Series, no. 10/229, Washington, DC, 2010).
In fairness, I’d also include some additional studies which tend to find stimulus stimulates private sector economic activity:
- Charles Freedman, Michael Kumhof, Douglas Michael Laxton, and Dirk Vaughn Muir, “Global Effects of Fiscal Stimulus During the Crisis,” Journal of Monetary Economics 57, no. 5 (July 2010): 506-26;
- Jordi Gali, David Lopez-Salido, Javier Valles, “Understanding the Effects of Government Spending on Consumption,” Journal of the European Economic Association 5, no. 1 (March 2007): 227-70;
- Gauti Eggertsson, “What Fiscal Policy is Effective at Zero Interest Rates?” (Federal Reserve Bank of New York Staff Report no. 402, New York, November 2009);
- Christopher Erceg and Jesper Lindé, “Is There a Fiscal Free Lunch in a Liquidity Trap?” (Board of Governors of the Federal Reserve System International Finance Discussion Paper no. 1003, July 2010);
- Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo, “When is the Government Spending Multiplier Large?” (National Bureau of Economic Research [NBER] Working Paper Series no. 15394, Cambridge, MA, 2009).
Taken together, this does not look like consensus, does it?
Things get even murkier when one digs into the weeds. For example, some of the “big multiplier” studies only find big multipliers in certain circumstances. And there is reason to believe that these circumstances didn’t apply during the recession and are even less likely to apply now that we are in a weak recovery. To wit:
- Multipliers are smaller as stimulus gets larger and we have already undergone massive amounts of discretionary and automatic stimulus.
- Multipliers are smaller in economies that are open to trade.
- Multipliers are smaller in economies with flexible exchange rates.
- Multipliers are smaller in economies that are burdened by high levels of government debt.
- Multipliers may be smaller in a balance sheet recession.
I think the most-recent Nobel Laureate, Thomas Sargent, was right to complain that “President Obama should have been told that there are respectable reasons for doubting that fiscal stimulus packages promote prosperity, and that there are serious economic researchers who remain unconvinced.”
But even this understates the problem. That’s because…
Stimulus Advocates Largely Ignore the Public Choice Problems with Implementing Stimulus:
In the words of stimulus advocate Lawrence Summers, “Fiscal stimulus is critical but could be counterproductive if it is not timely, targeted and temporary.” In my view, the biggest problem with stimulus is that it is very difficult for policy makers to simultaneously satisfy all three criteria.
Untimely: As the President acknowledges, it is very difficult to make stimulus timely, especially when one is dealing with infrastructure projects that involve planning, bidding, contracting, construction, and evaluation. This is why, as late as June 2011, “$45 billion in Department of Transportation infrastructure money had been appropriated, but only 62 percent ($28 billion) had actually been spent.”
Off-Target: It is also very hard to make stimulus targeted. For example, Keynesian theory tells us that to be effective, the money that went to the states needed to have been spent. Instead, 98 percent of it went to decreased borrowing, not increased spending. Worse, of those new hires that were made, many had been previously employed.
Not Temporary: As Paul Krugman has often stressed, stimulus should be temporary to be effective. But as the authors of one of the “large multiplier” studies put it, “it is much easier to start new government programs than to end them.” That’s why, historically, 95 percent of stimulus surges are still there two years after they are begun. It may also explain why the U.S. has spent 90 percent of the last 40 years in a deficit, despite the fact that Keynesian theory would have called for a surplus during most of that time (again, policy makers just don’t behave as Keynesians hope they would).
It’s also why Lord Keynes himself was a skeptic of big stimulus projects near the end of his life, writing:
Organized public works…may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organization (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.
Stimulus Advocates Often Brush Past Long Run / Short Run Distinctions:
I won’t belabor this point since this is already probably my longest post on record. Stimulus is not a permanent path to prosperity. If all goes perfectly well, it can get a nation out of a pinch. But it has long run costs. Stimulus leads to future taxes and/or future debt and we know that both excessive taxation and debt are economically harmful. Stimulus also has a tendency to ratchet-up spending and we know that, excessive government spending is harmful in the long run. Finally, stimulus has a tendency to undermine economic freedom and we know that a lack of economic freedom is harmful in the long run.
In sum, if we have too much stimulus punch today, the economy will get a major headache tomorrow. Though most academic studies acknowledge this, too few policy makers and pundits seem to recognize it.