Thursday, October 1, 2009

So you can't spend your way back to prosperity?

"Stimulus Spending Doesn't Work," a simply titled piece in the Wall Street Journal by prominent economist Robert J. Barro and Charles J. Redlick, is rightly getting lots of play. If I'm reading the somewhat dense economic-speak correctly, the column says the evidence from past massive government spending -- primarily military expenditures during the world wars, the Korean War and the Vietnam War -- shows that ripping through the federal checkbook actually shrinks the GDP relative to expenditures. Taxpayers can hope for a dollar-for-dollar return on the expenditures only when unemployment rises to double digits.

For annual data that start in 1939 or earlier (and, thereby, include World War II), the defense-spending multiplier that applies at the average unemployment rate of 5.6% is in a range of 0.6-0.7. A multiplier less than one means that, overall, other components of GDP fell when defense spending rose. Empirically, our research shows that most of the fall was in private investment, with personal consumer expenditure changing little.

Our research also shows that greater weakness in the economy raises the estimated multiplier: It increases by around 0.1 for each two percentage points by which the unemployment rate exceeds its long-run median of 5.6%. Thus the estimated multiplier reaches 1.0 when the unemployment rate gets to about 12%.

Barro and Redlick's piece, and the research on which it's based, have powerful implications for the massive "stimulus" bill the federal government passed earlier this year, which was intended to spend our way back to prosperity. If the Journal OpEd is right, the stimulus bill is not just running up deficits and expanding the money supply to the point that it devalues money, it's making the long-term economic situation worse.

Barro doesn't stand alone on this point. The Congressional Budget Office quietly and drily raised similar concerns in March in A Preliminary Analysis of the President's Budget and an Update of CBO's Budget and Economic Outlook. In a section helpfully labeled, "Estimated Macroeconomic Impacts of the American Recovery and Reinvestment Act of 2009, Fourth Quarters of Calendar Years 2009 to 2019," the CBO predicted a bump for the economy through 2012, with the "stimulus" spending shrinking GDP starting in 2015 -- and that was using optimistic assumptions about the multiplier. The CBO explained its reasoning in a separate letter (PDF) to Rep. Charles Grassley, saying:

In contrast to its positive near-term macroeconomic effects, the legislation will reduce output slightly in the long run, CBO estimates. The principal channel for that effect, which would also arise from other proposals to provide short-term economic stimulus by increasing government spending or reducing revenues, is that the law will result in an increase in government debt. To the extent that people hold their wealth as government bonds rather than in a form that can be used to finance private investment, the increased debt will tend to reduce the stock of productive private capital. In economic parlance, the debt will “crowd out” private investment.

So even a Keynesian-style multiplier gets you a brief short-term gain with long-term suffering. If that multiplier is mythical (or negative), as Barro and Redlick suggest, you just get the suffering.

At this point, the last apparent unalloyed enthusiast for stimulus spending appears to be Paul Krugman, who has pretty much been reduced to ad hominem attacks on any economist who disagrees with him, and faith-based veneration for the moldering economic ideas of John Maynard Keynes.

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Anonymous Anonymous said...

Paul Krugman has completely rebuked Barro. And I cannot remember any personal attacks he has made.

October 3, 2009 10:18 AM  
Blogger J.D. Tuccille said...

Krugman's "How Did Economists Get it So Wrong" is full of mischaracterizations of economic theory, as well as attacks on the integrity of the profession. ("economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives.")

John Cochrane of the University of Chicago responds rather strongly here.

And Krugman can "rebuke" Barro all he wants. The evidence seems to support Barro.

October 3, 2009 1:11 PM  

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