To stimulate or not to stimulate? That is the question dogging Washington policymakers as evidence mounts that economic growth is slowing or, worse yet, reversing. Last week, the Commerce Department reported that the U.S. economy grew a middling 2.4 percent in the second quarter, down from a revised 3.7 percent in the first quarter and 5 percent in the last quarter of 2009.
Meanwhile, consumer confidence has plunged. The University of Michigan barometer of consumer expectations, considered a harbinger of future growth, declined 10.7 percent in July to 62.3, the lowest level since the stock market hit bottom in March 2009. This week, investors will be focused on the Institute for Supply Management (ISM) report, which measures demand in the manufacturing and services sectors. And it could be ugly. The Goldman Sachs Analyst Index, which shares some of the same data as the ISM report, fell 6.1 points to 55.4 in July. That’s the lowest level since November 2009.
Amid this torrent of unsettling economic news, Washington – and the nation – is deeply divided over what to do. Everyone wants more jobs, but they can’t agree on how to get them. On the one hand, there are the Tea Partiers and other fiscal hawks who decry the earlier stimulus as a massive waste of taxpayer money, and call for steep spending cuts. On the other are economists like Nobel Prize winner Paul Krugman, who argue that more stimulus is needed to avert a double-dip recession.
In between, Fed Chairman Ben Bernanke urges Congress not to pull back fiscal stimulus yet, and says he’s ready to step in with more monetary juice if needed. Republican leaders – and an increasing number of Democrats – are pushing for an extension of the Bush tax cuts. And Democrats are clamoring for passage of the jobs bill, including tax breaks and lending assistance for small business as well as aid for cash-strapped states and the jobless. But as the midterm elections near, politics is trumping common sense, and the jobs bill remains mired in the Senate.
What ended the Great Recession
As the politicians battle it out, a little-noted study of the 2008-2009 stimulus program by two prominent economists – former Fed vice chairman and Princeton professor Alan Blinder and Moody’s Analytics chief economist Mark Zandi – sheds some light on the controversy. Using Moody’s Analytic’s model of the U.S. economy, Blinder and Zandi simulated the macroeconomic impact of the massive fiscal and monetary stimulus programs engineered by the administration, the Fed and the Congress to end the Great Recession.
Their conclusion: The impact on growth, jobs and inflation was “huge,” and “probably averted what could have been called the Great Depression 2.0.” Just 18 months ago, the U.S. economy was shrinking at a 6 percent annual rate, while we were losing close to 750,000 jobs a month. Had policymakers done nothing, the study estimates we would have dropped into a “1930s-like depression” with:
• Real GDP falling a chilling 7.4 percent in 2009 and another 3.7 percent in 2010. Instead the GDP began expanding in the second half of 2009.
• Unemployment peaking at 16.5 percent with 16.6 million jobs lost – about twice as many as were actually lost.
• The federal deficit surging to more than $2 trillion in fiscal year 2010, $2.6 trillion in 2011 and $2.25 in 2012 – versus almost $1.4 billion now.
• Outright deflation in prices and wages, versus today’s low inflation.
Looking closely at both the fiscal and monetary stimulus, Blinder and Zandi conclude that financial-market policies such as the Troubled Asset Relief Program (TARP), the bank stress tests and the Fed’s quantitative easing, were “substantially more powerful” than the fiscal stimulus. That’s not surprising, since this particular downturn began with a collapse of asset prices and a credit crisis. But they found the fiscal policy responses were also substantial, increasing GDP by about 3.4 percent and adding 2.7 million jobs. And the combination was greater than the sum of the financial and fiscal parts taken in isolation. “This is because the policies tend to reinforce each other,” the study noted.
Although controversy still rages over the effectiveness of TARP, the study finds it was extremely cost efficient. While Congress appropriated $700 billion for TARP, only $600 billion was ever committed. As of June 2010, only $261 billion was still outstanding. And the study estimates TARP’s ultimate cost to taxpayers probably will end up close to $100 billion, nearly half of that going to mortgage relief for homeowners, 38 percent to AIG and 25 percent to GM. The TARP program's Capital Purchase Program, designed to recapitalize the banking system, was expected to cost $225 billion, but at its peak in early 2009 was only $205 billion, and is now down to $67 billion as the nation’s largest banks (eager to be rid of federal regs on their compensation among other things) have repaid the funds. Blinder and Zandi conclude that this program “almost certainly will earn a meaningful profit for taxpayers.”
Bang for the Buck
For policymakers considering another round of fiscal stimulus, the study rates key elements of the stimulus plan in terms of “bang for the buck,” that is, the one-year dollar change in GDP for a dollar reduction in federal taxes or a dollar increase in spending. As you can see in the table below, the one-year return on taxpayers’ investment was greatest for spending increases, particularly temporary increases in spending aimed at the states, and the poor and unemployed, including food stamps, unemployment benefits and work-share programs. That’s because this money tends to get spent immediately. Also positive was infrastructure spending, though this money takes longer to work its way into the economy.
| Fiscal Stimulus Bang for the Buck | |
| Tax Cuts | Bang for the Buck |
| Non-refundable Lump-Sum Tax Rebate | $1.01 |
| Refundable Lump-Sum Tax Rebate | 1.22 |
| Temporary Tax Cuts | |
| Payroll Tax Holiday | 1.24 |
| Job Tax Credit | 1.30 |
| Across the Board Tax Cut | 1.02 |
| Accelerated Depreciation | 0.25 |
| Loss Carry back | 0.22 |
| Housing Tax Credit | 0.90 |
| Permanent Tax Cuts | |
| Extend Alternative Minimum Tax Patch | 0.51 |
| Make Bush Income Tax Cuts Permanent | 0.32 |
| Make Dividend and Capital Gains Tax Cuts Permanent | 0.37 |
| Cut in Corporate Tax Rate | 0.32 |
| Spending Increases | Bang for the Buck |
| Extending Unemployment Insurance Benefits | 1.61 |
| Temporary Federal Financing of Work-Share Programs | 1.69 |
| Temporary Increase in Food Stamps | 1.74 |
| General Aid to State Governments | 1.41 |
| Increased Infrastructure Spending | 1.57 |
| Low Income Home Energy Assistance Program (LIHEAP) | 1.13 |
| Source: Moody's Analytics | |
| Note: The bang for the buck is estimated by the one year $ change in GDP for a given $ reduction in federal tax revenue or increase in spending. | |
On the other hand, the impact of tax benefits was muted. Take the 2008 tax rebates. While these payments significantly lifted after-tax income for lower and middle income people who spent a large portion of their rebates, higher income earners, who faced rapidly falling stock and home prices and who did not receive rebates, dramatically pulled back on spending, diluting the impact of the rebates on overall spending.
Still, Blinder and Zandi find that refundable tax rebates are a net positive to growth, as would be a payroll tax holiday and job tax credit. On the other hand, they conclude that many other tax cuts being discussed on Capitol Hill would cost taxpayers more than they generate in growth. Among them: making the Bush income, dividend and capital gains tax cuts permanent, accelerating depreciation for businesses and providing a housing tax credit. Still, they argue that the economy is still too fragile to let the Bush tax cuts expire.
Of course, not everyone agrees with Blinder and Zandi. TFT columnist Bruce Bartlett argues that temporary tax rebates in both 2001 and 2008 failed to stimulate growth. “The problem is that tax cuts really have to be permanent before you get a supply-side effect, which often involves investments that take time to pay off,” he argues.
So what does the Blinder-Zandi study mean for policymakers grappling with whether to engage in another round of stimulus? Stop bashing the 2008-2009 stimulus program. This massive dose of Keynesian stimulus worked! At this stage in the recovery, another round of quantitative easing and fiscal stimulus could also help boost growth, increase jobs and maybe even trim the deficit. But be careful how you do it. Eliminating the Bush tax cuts as the economy is weakening isn’t smart. But longer term, according to this study at least, government spending and targeted tax breaks seem to have more bang for the buck than a permanent across-the-board extension of the Bush tax cuts.