Who Says Keynesian Policy Doesn’t Work?

It’s become fashionable, particularly among Republicans and Conservatives, to claim that Keynesian Policy doesn’t work despite the empirical record. Methinks they don’t know what Keynesian policies are analyses really are. Mark Thoma points out:

Issa: Everyone Knows That the Policies I Called for Don’t Work

Republican House member Darrell Issa has an op-ed in the Financial Times complaining that the stimulus did not stimulate (contrary to research such as this that finds “programs to support low-income households were highly stimulative, as was spending on infrastructure projects”). He says:

The abysmal results came as no surprise to those who knew that the Keynesian doctrine of spending your way to prosperity had been discredited decades ago.

Than it must of surprised him or, as is more likely, he doesn’t actually know what Keynesian economics is. This is what he said around the time when the stimulus package was put in place. His complaint is that the stimulus package doesn’t come online quickly enough, and doesn’t do enough for infrastructure (he also complains that the tax cuts aren’t permanent):

Economic Stimulus: There is bipartisan agreement for emergency spending on infrastructure and tax cuts that will create new jobs and reinvigorate private sector investments. Unfortunately, H.R. 1, the “American Recovery and Reinvestment Act of 2009,” falls short on both fronts. …

To respond to an emergency, you must act quickly. According to the Congressional Budget Office, only 7 percent of the $355 billion in discretionary spending included in the bill would be injected into the economy by the end of fiscal year 2009. By the end of 2010, only 12 percent of the funds set aside for highway construction will be spent.

Stimulus funds must be targeted to be effective. Only 3 percent of the $825 billion will go toward road and highway construction that creates jobs and aids individuals and private businesses alike. …

This bill will grow the government and miss an opportunity to reinvigorate the economy. An effective stimulus can be accomplished through tax cuts and targeted spending…

Targeted spending and tax cuts are effective stimulus, and he supports them, but we’ve known for decades that such Keynesian remedies don’t work? The mystery of the GOP’s credibility on economics continues…

As an note to the readers:  the economic success of Ronald Reagan’s policies in 1983-1988, following the horrible recession of 1982, are actually better explained and better fit a Keynesian analysis than a the predictions of so-called supply-side models and definitely better than New Classical models.  Reagan was really Keynesian, he just didn’t want to admit it and he preferred military spending and tax cuts for the upper income brackets to social spending.

Tax Cuts, Deficits, Debt

The current bill finding it’s way through Congress from Senate to House regarding “tax cuts” will add to the deficit.  How much? $857 billion worth.  That means that this bill, which is in fact a stimulus bill, is actually a bigger stimulus bill than the one Obama and Congress passed in February 2009. The earlier bill was only in the $780 billion range spread over 2.5 years.  This is $857 billion over 2 years.

Tax Bill to add $857 Billion to Debt

by CalculatedRisk on 12/09/2010 11:10:00 PM

From Bloomberg: Senate Tax-Cut Extension Plan Would Add $857 Billion to Debt

The congressional Joint Committee on Taxation, which estimates the revenue effects of tax legislation, said the provisions would cost the government $801.3 billion in forgone revenue over 10 years. Extending unemployment benefits for 13 months, another feature of the package, would cost $56 billion, the Obama administration has said.

It is important to remember the Joint Committee on Taxation assumed all the provisions will end as scheduled; the payroll tax cut after one year, and the other tax cuts after two years. That seems very unlikely, so the actual cost will be much much higher. As an example, if the tax cut for high income earners stays in place for the next decade that will add $700 billion alone to the debt!

Also, the vast majority of the impact is from extending the Bush tax cuts.

The Necessity of Extending Unemployment Benefits

James Hamilton at Econbrowser summarizes my thoughts too:

Extending unemployment benefits

Here I make two quick observations on the policies being discussed.

The first point has been widely noted, but it bears repeating since I keep hearing comments from people who seem to be unaware of it. When you hear that current unemployment benefits can in some cases be collected for up to 99 weeks, and that Congress is discussing an extension of this program, it is perhaps natural to think this means that some people might be eligible for longer than 99 weeks. But this is not the case. Instead what is being discussed is whether the current limits will be kept in place for another two years or whether the limits will be decreased immediately.

The second point to which I’d like to call attention has also been around awhile, but is appropriately still being discussed (e.g., Calculated Risk, Washington Post). The source appears to be these observations made by Wal-Mart CEO Bill Simon in September:

And you need not go further than one of our stores on midnight at the end of the month. And it’s real interesting to watch, about 11 p.m., customers start to come in and shop, fill their grocery basket with basic items, baby formula, milk, bread, eggs, and continue to shop and mill about the store until midnight, when electronic– government electronic benefits cards get activated and then the checkout starts and occurs. And our sales for those first few hours on the first of the month are substantially and significantly higher.

And if you really think about it, the only reason somebody gets out in the middle of the night and buys baby formula is that they need it, and they’ve been waiting for it. Otherwise, we are open 24 hours — come at 5 a.m., come at 7 a.m., come at 10 a.m. But if you are there at midnight, you are there for a reason.

One thing you might take away from such accounts is that the spending multiplier out of compensation for the unemployed is pretty high.

Money spent on unemployment benefits gets into the economy as spending immediately.  Let’s face it, midnight of the day benefits are payable is about as fast it can get.  It’s also evidence that the benefits from last month are totally spent and gone.  That’s economic stimulus.   Tax cuts for millionaires are not high-payback stimulus.  They don’t fully get spent. And they don’t get spent very fast.

Why the Deficit Increased

The deficit increased over the last 2 years, but it wasn’t because of any “surge” or “explosion” in government spending.  It was because the real economy, which generates the tax revenues, collapsed because of a financial crisis, as the following graph shows.  It wasn’t an increase in govt spending. Spending continued to increase at the same rate as it did during the “boom” years of 2005 and 2006.  Instead, when the financial crisis on Wall Street in 2008 spilled over into the real economy it collapsed tax revenues.  Fiscal stimulus to drive recovery really hasn’t been tried yet on a scale commensurate with the problem.

Govt Receipts vs. Govt Expenditures, 2005-10In this graph, the gap between the blue and red line represents the deficit.  Yes, it got bigger in 2008, but it’s because tax receipts dropped.

So how did that $780 billion stimulus bill of the administration that passed in Feb 2009 disappear?  Easy.  First it wasn’t $780 of spending.  It was a little over $400 billion in spending over 2.5 years.  The rest was tax cuts.  Second, it was only Federal government spending.  At the same time, state and local governments and school boards cut spending.  Net: no change.

Government, the Private Sector, and “Make Work”

Maxine Udall, Girl Economist, (love that blog title) has an excellent short rif on the topic of “make work” projects.  Tea Partiers, Conservatives, Republicans, radio talk-show hosts and many right-leaning economists (politically right, not as in “correct”) frequently attack the idea of government stimulus spending as being simply on “make work” projects.  The implication is that money spent on such activities is wasted because nothing “productive” or “constructive” comes of it.

Like most economic arguments, things become much clearer and less susceptible to error if we clarify the assumptions.*  The underlying assumption behind these attacks is that “anything private ownership does is necessarily productive” and “anything government does is necessarily wasteful and useless”. Such an assumption is ludicrous, of course.  Governments can, of course, waste real resources (think war or the TSA, anybody?) But government spending also gives us lots of valuable, productive resources and services that the private sector wouldn’t or couldn’t:  the first demonstration of telegraph, railroads in the West, Interstate highways (heck most highways), airports, fire departments, schools for everybody, sewers, clean running water, healthcare research, the Internet, and on and on.  But just as important is the fact that the private sector can and does waste money and real resources on useless, wasteful projects. And despite the theories of their apologists, the private sector rarely pays the full bill for their errors (that’s left for government!).  BP anyone? the wasteful expanses of never-occupied condos and houses in NV, CA, and FL that government will probably have to tear down?

Maxine says it better than I.  Read her here.

* what I offer here is by no means the only reason why such anti-stimulus arguments are wrong-headed and mis-guided, but alas, scarce resources (time today) and I can’t explain it all.

The Case of the “Disappearing Stimulus” and the “Illusory Inventory”

Worthwhile Canadian Initiative notes that sometimes, a reported slower GDP growth rate is actually better news than another slightly higher reported rate.  As I’ve noted repeatedly on this blog and in class, it’s important to look at the numbers behind the numbers.

When 5.0% GDP growth is better news than 5.9% GDP growth

In 2009Q4, US GDP grew by 5.9% at annual rates; the number was 5.0% in Canada. But our news was much better. Here is a graph of the contributions to GDP growth by expenditure category:

US GDP growth would have been only 2.0% without the contribution of the inventory terms (which was itself a deceleration in the rate at which stocks were being drawn down.) In Canada, the 2009Q4 GDP number would have been 5.8%.

And look at the contribution of government spending. In the US, the contribution was negative: the increase in federal spending was more than compensated by cutbacks at the state level.

It’s easy to see why the Canadian numbers were greeted with more enthusiasm than were those in the US, even though the headline number was smaller. Growth was evenly distributed across all types of expenditures, and we can expect inventories to bounce back as well fairly soon.

Two observations that I’ll emphasize here.  The first I’ve made before. Most of the reported GDP growth the last 2 quarters of 2009 has actually been inventory-driven.  That’s not sustainable, so we need to see Personal Consumption and Investment growing.  Until they do, the “recovery” is in jeopardy of double-dipping.

The other observation here is that the contribution of government spending in the US was negative.  I’m sure some readers will wonder “How can that be? What about the giant $780 some billion stimulus bill?”. Well the data don’t lie in this case.  We really have NOT had much government stimulus in 2009 in the US for 3 reasons.  Yes, there was a stimulus bill, but a very large portion of it was tax cut, not spending increase.  And as we talk about in class, while a tax cut can be stimulating, it is often not as stimulating as an equal amount of spending because people save part of the tax cut and do not spend all of it. The second reason is because the “giant stimulus” bill was spread out over 2.5 years, not all in 2009.  Finally, while the federal government increased spending, this increased spending has been largely offset by cuts in spending at the local and state levels.  Net impact: negative.    Does this mean that the stimulus bill was a bad idea? that it didn’t work?  NO.  It worked – just imagine how bad it would have been (how even larger the negative impact would have been) if states and local govts had cut and not been offset by the feds.

Interesting and Good Stuff from This Week

  • From the Wall Street Journal: Bring Back the Robber Barons I think I’ll pass. I mean why stop with the robber barons? Why not go all the way back to feudalism where most workers are the personal property of some monied rich baron who’s buddy-buddy with the king?
  • From Maxine Udall (girl Economist): Bring Back the Robber Barons? I don’t Think So. You go girl.
  • “The $800 billion federal stimulus bill has boosted employment by 1 million to 2.1 million and helped the economy grow about 1.5% to 3.5% larger than it would have without the stimulus, the nonpartisan Congressional Budget Office said Tuesday.”  Read more as the CBO smacks down the arguments of critics of the stimulus.
  • Rajiv Sethi on Intellectual Property and Guard LaborGreat article including good further links about how wasteful and unproductive copyrights, patents, and other forms of government-granted private monopolies on ideas.  Really such efforts as copyright and patent schemes are really another form of attempted thought-control by a minority at great expense to the rest of us.  [disclaimer: I own a patent myself, but have never attempted to restrict it’s use]
  • Gavin Kennedy at Adam Smith’s Lost Legacy with What Adam Smith Actually Identified as the Appropriate Roles for 18-century Governments responds to one of the latest attempts to claim Adam Smith was an advocate of tiny-government, libertarian policies.  Gavin has a very detailed list of the many functions that Smith specifically said governments should provide (and not outsource to a private profit-making firm). It’s not at all what the Republicans, Libertarians, or Chicago Boys claim.  I really wish people would read the books before they claim some dead author supports them.
  • For the student interested in economic history, particularly macro, the history of Say’s Law is essential.  It defines the difference between Classical theory vs. Keynesianism/Progressive. Brad Delong has an excellent post on this.