The Recovery and Reinvestment Plan

As regular readers know, I have been both for and against Obama’s stimulus plan. This morning the transition team released details of their economic analysis: the Job Impact of the American Recovery and Reinvestment Plan. We are being sold a bill of goods and I don’t like it.

Let me start my analysis with this quote from Obama’s speech last Thursday.

I don’t believe it’s too late to change course, but it will be if we don’t take dramatic action as soon as possible. If nothing is done, this recession could linger for years. The unemployment rate could reach double digits. Our economy could fall $1 trillion short of its full capacity, which translates into more than $12,000 in lost income for a family of four. We could lose a generation of potential and promise, as more young Americans are forced to forgo dreams of college or the chance to train for the jobs of the future. And our nation could lose the competitive edge that has served as a foundation for our strength and standing in the world. [emphasis is my own]

And from a little farther along in the speech

There is no doubt that the cost of this plan will be considerable. It will certainly add to the budget deficit in the short-term. But equally certain are the consequences of doing too little or nothing at all, for that will lead to an even greater deficit of jobs, incomes, and confidence in our economy. It is true that we cannot depend on government alone to create jobs or long-term growth, but at this particular moment, only government can provide the short-term boost necessary to lift us from a recession this deep and severe. Only government can break the vicious cycles that are crippling our economy – where a lack of spending leads to lost jobs which leads to even less spending; where an inability to lend and borrow stops growth and leads to even less credit.

These are scary words. I am one of those who believe that this recession is going to be bad. I assumed when I read this speech that Obama’s economic agreed with my assessment; in fact, I assumed they had a much gloomier outlook than my own. The release today contains details of the team’s economic analysis.

Take a look at Table 1 on page 5. For the moment, just focus on the first line of the table, labeled without stimulus. According to the analysis, real GDP at the end of 2010 will be $11,770 (annual rate, chained 2000 dollars). From the rhetoric in the paragraph above, I expected their estimate of the decline in GDP to be greater than 10 percent. After all, losing the potential and promise of a generation is a Great-Depression-like event. Instead, Obama’s team is actually expecting GDP to rise 0.5 percent over the next two years (real GDP in 2008:Q3 was $11,712. An annual growth rate of 0.25 percent is very weak: it is not catastrophic.

So first, they want to spend almost $1 trillion dollars to save the economy from slow growth. But there is more. Take a look at the next line; it gives the level of GDP at the end of 2010 with the stimulus. They assume that GDP will reach $12,203 billion. That is, the stimulus will increase GDP by 3.7 percent relative to the non-stimulus baseline.

If they spend $775 billion on the stimulus, they will be spending 5.3 percent of GDP today to boost GDP by 3.7 percent over two years, all to save us from an assumed period of slow growth.

We can do the same analysis with their jobs numbers. According to their analysis the stimulus will save or create 3,674,000 jobs. That is a lot of jobs. I am not quite sure why we are going to lose so many jobs if GDP is going to remain more or less constant, but let’s assume these numbers are correct. At a sticker price of $775 billion, these jobs cost $210,941 dollars each. Median household income in 2007 was $50,233. I am not sure this is a good deal. Which would the median household rather have a job today or $210,941 today followed by a four-year unemployment spell.

We can skip the next several sections—do they really expect us to believe they are so good they can predict who is going to get the jobs—and move to the appendix. The appendix is (allegedly) using estimates of fiscal spending multipliers from FRB/US the Federal Reserve’s economic forecasting model. In the first paragraph, the report says “We considered multipliers for the case where the federal funds rate remains constant.” This assumption seems innocuous. The Fed’s interest rate is at essentially zero and is expected to remain there for a long period of time. But this assumption means that the large increase in government spending has zero effect on the interest rates of any maturity or type. Since no prices move, private consumption and private investment (within the model) cannot react to the government spending. They hardwire into their estimates that the private sector is not crowded out: the only effect of government spending comes through increased income. You don’t have to be a hard-line Ricardian to think that spending a trillion dollars might have some impact on private decisions.

Misusing the multipliers is a serious mistake. The economic team is clearly trying to use the stature of the Federal Reserve to boost the credibility of their estimates. They are either intentionally deceiving us as to the likely effectiveness of their plan or (and much worse) they do not realize the severity of their mistake.