The effectiveness of last year’s $787 billion fiscal stimulus legislation continues to be the subject of analysis, debate and commentary among economists. Many are fearful that fiscal stimulus will be cut back too soon, leading to a double-dip recession. Others assert that fiscal stimulus was ineffective—or at least much less effective than other policies would have been—and are deeply skeptical that more stimulus is justified.
A June 1 New Republic article by former Bill Clinton adviser William Galston looked at the failure of fiscal stimulus in Japan and raised serious questions about its efficacy here, taking issue with Nobel Prize-winning economist Paul Krugman’s view that our deficits need to be bigger to forestall the sort of economic stagnation Japan suffered well before the recent crisis.
● University of California, Berkeley, economist Brad DeLong criticized Galston’s argument in a June 1 blog post.
Also on June 1, Harvard economist Edward Glaeser looked at stimulus spending , by state and changes in state unemployment rates. He sees little relationship, raising questions about the efficacy of stimulus spending.
A May 31 note from the OECD reviews its research on countercyclical policy. Among the conclusions: the nature of business cycles has changed, nations need to be more fiscally prudent during upswings so that they have adequate resources to deal with downturns, both monetary and regulatory policy should be more sensitive to the problem of asset bubbles.
On May 27, University of Oregon economist Mark Thoma announced that he had changed his mind about tax cuts and now says that they may be especially appropriate for “balance sheet” recessions such as that we are presently experiencing.
A May 21 OECD working paper looked at the effect of fiscal stimulus in the euro area and finds a robust short term increase in growth from an increase in public investment, public consumption and a cut in the wage tax. Increases in transfers and a cut in taxes on capital were found to be ineffective.
Also on May 21, Stanford University economist John Taylor cited a new paper utilizing the IMF’s Global Integrated Monetary and Fiscal Model that finds a negative effect on long-term growth from fiscal stimulus spending. From the paper’s summary: “A permanent 10 percentage point increase in the U.S. debt to GDP ratio raises the U.S. tax burden and world real interest rates in the long run, thereby reducing U.S. and rest of the world output by 0.3 to 0.6 percent and 0.2 to 0.3 percent, respectively.”
In the May/June issue of the Cato Policy Report economists Jason Taylor and Richard Vedder look at the fiscal adjustment after World War II. Although Keynesian theory said that the large reduction in government spending after the war should have led to a deep recession, it did not. Taylor and Vedder don’t really explain why this was the case, but simply note that a sharp tightening of fiscal policy doesn’t necessarily lead to an economic downturn.
● A more rigorous analysis of this phenomenon was done in 1990 by economists Francesco Giavazzi and Marco Pagano. They argued that while a cut in government spending reduces aggregate demand, it also changes expectations, leading households to anticipate a permanent increase in their future income due to lower taxes, which increases consumption.
A May report from the CBO found that last year’s stimulus bill raised the level of real GDP by between 1.7% and 4.6%, increased employment by between 1.4 million and 3.7 million, and reduced the unemployment rate by between 0.8% and 1.9%. CBO Director Doug Elmendorf summarizes the results in a May 25 blog post.
● An April 28 Pew Research poll found that only a third of Americans believe that last’s stimulus bill had a positive impact on the economy.
In the Spring issue of the Harvard Journal of Law & Public Policy, Harvard economist Jeffrey Miron presented the case against last year’s fiscal stimulus. He argues that the stimulus package enacted by Congress in February 2009 was less about stimulating the economy than rewarding the Democratic Party’s constituencies. Miron says that elimination of the corporate income tax and reduction of the payroll tax would have provided more stimulus and improved long-term growth as well.
Bruce Bartlett is an American historian and columnist who focuses on the intersection between politics and economics. He has written for Forbes Magazine and Creators Syndicate, and his work is informed by many years in government, including as a senior policy analyst in the Reagan White House. He is the author of seven books including the New York Times best-seller, Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy (Doubleday, 2006)
Previous posts from this week:
The Looming Necessity of Fiscal Consolidation (6/7/2010)