Any regular reader of this blog knows my opinion of fiscal stimulus and fiscal multipliers. I have shown evidence (here and here) that fiscal multipliers must be below 1 and are likely closer to zero or even negative. Pushing against this belief is the recent performance of the economy. GDP grew by a very healthy 3.5 percent in the third quarter, boosted by gains ranging from private consumption, to residential investment, to direct government expenditures. According to the Vice President, the increase in GDP is entirely attributable to the stimulus efforts by the administration.
I am inclined to agree.
I believe that in the absence of government stimulus the U.S. economy would have continued to contract in the third quarter. What’s more, I say this without changing my views on the multiplier. How is that possible? Let’s do some math.
The following table shows the GDP growth that would have occurred in the absence of fiscal stimulus under different assumptions for what counts as government stimulus using a multiplier of 1 (my maximum) and a multiplier of 3 (Romer’s base case). Because there is considerable uncertainty over the timing of the stimulus, I show the four-quarter change in GDP through the third quarter. Over this time period, GDP fell by 2.3 percent. The numbers in the table show the four-quarter change without stimulus and should all be viewed relative to the 2.3 percent fall.
The first row of the table assumes that the sum total of fiscal stimulus is the pay out from the ARRA. According to data from Recovery.gov, as of October 29, the government had actually spent $173 billion (this number includes tax relief and spending). This is the most conservative estimate of stimulus spent to date. (Romer would include both actual spending and money allocated ($310 billion). I agree with her but want to use the smallest number to start. My numbers get bigger fast anyway.) Assuming a multiplier of 1 ($173 billion spent adds $173 billion to GDP), counterfactual GDP growth is -3.6 percent. With a multiplier of 3, the counterfactual falls to -6.2 percent.
I find both of these numbers credible.
I actually believe GDP would have fallen more than 6 percent in the absence of the programs. And, if I believed that total stimulus was $173 billion, I would also have to join Romer in the multiplier is greater than 3 world. Fortunately for me (I am not the introspective type), the total amount of stimulus is much greater than $173 billion.
There are lots of ways of accounting for government stimulus, but the most time honored and method (used by the IMF, the OECD, and the Federal Reserve) is to simply examine the change in the government balance. Over the last four quarters, publically held debt rose by $1,732 billion. (Really, we should only count the increase in the growth rate; but over the previous four quarters, debt only increased by $280 billion.) This number is the correct measure of stimulus. It includes all Federal government spending and all implicit reductions in the tax burden. The number is still conservative because it does not include the increase in state borrowing, an additional $50 to $200 billion.
Using this number and a multiplier of 1, yields a counterfactual GDP growth of -15.4 percent. With a multiplier of 3, the number falls to -41.6 percent. These numbers are beyond the pale. GDP never fell by more than 40 percent in the Great Depression. Using this number and my belief of a counterfactual fall in output of 10 percent, the current multiplier is negative.
But, there is also the issue of the Fed’s balance sheet. The Fed has pumped almost $1,000 billion into the economy over the same period. This is measured by the expansion of the Fed’s balance sheet. There is no difference between receiving a tax break for $1 trillion dollars and receiving a $1 trillion dollars in cash from the Fed. We can argue about effectiveness but that is the exercise here.
Adding the Fed’s balance sheet expansion to the calculation, yields a counterfactual GDP growth of -22.4 percent. With a multiplier of 3, we have the absurd number of -62.5 percent. I believe that latter number would be a modern-era record. I suspect we would have to go back to the plague years in Europe to find an equivalent fall. I would love to see Summers or Romer stand up and make the case for this counterfactual.
So like many Banana Republics before us, we have managed to spend enough to turn GDP growth positive. But, the cost of achieving this number has been phenomenal. To achieve a paltry $212 billion increase in real GDP, we spent about $2 trillion dollars. This gives us a net return of 20 cents on the dollar.
Yes, GDP would have fallen without the spending. The probability that this recession would have scored as a depression in the absence of stimulus is high.
Was it worth it?
Using this number and a multiplier of 1, yields a counterfactual GDP growth of -15.4 percent. With a multiplier of 3, the number falls to -41.6 percent. These numbers are beyond the pale. GDP never fell by more than 40 percent in the Great Depression. Using this number and my belief of a counterfactual fall in output of 10 percent, the current multiplier is negative.
But, there is also the issue of the Fed’s balance sheet. The Fed has pumped almost $1,000 billion into the economy over the same period. This is measured by the expansion of the Fed’s balance sheet. There is no difference between receiving a tax break for $1 trillion dollars and receiving a $1 trillion dollars in cash from the Fed. We can argue about effectiveness but that is the exercise here.
Adding the Fed’s balance sheet expansion to the calculation, yields a counterfactual GDP growth of -22.4 percent. With a multiplier of 3, we have the absurd number of -62.5 percent. I believe that latter number would be a modern-era record. I suspect we would have to go back to the plague years in Europe to find an equivalent fall. I would love to see Summers or Romer stand up and make the case for this counterfactual.
So like many Banana Republics before us, we have managed to spend enough to turn GDP growth positive. But, the cost of achieving this number has been phenomenal. To achieve a paltry $212 billion increase in real GDP, we spent about $2 trillion dollars. This gives us a net return of 20 cents on the dollar.
Yes, GDP would have fallen without the spending. The probability that this recession would have scored as a depression in the absence of stimulus is high.
Was it worth it?
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4 comments:
Gold is at 1085. Isn't that a benefit?
I forgot the inflation. All benefit, all the time.
SE
There is some serious double counting going on here. A susbtantial portion of that increase in debt (which is normally a fine measure of money add to tehe conomy) was taken up by the Fed..and then ended up in Fed reserves. it was effectively 'sterilized'.
Furthermore, if you start counting Fed credit creation (balance sheet expansion) then you ahve to comapre that to the significant balance sheet / credit contraction in the commercial sector (i.e., there is a, partial, substitution effect but no net add).
There is likely some double counting but not much. Yes, the Fed bought a bunch of debt, mostly GSE but also treasury. But this debt is not double counted.
My source for the increase in debt is publicly held debt not total debt. Debt purchased by the Fed or by the Social Security fund is not included in publicly held debt.
In 2007, 56 percent of the total treasuries outstanding were held by the public. Since, the ratio has increased to 63 percent. Not only has the total amount of debt increased but the percent held by the public has increased.
Over the last 18 months, the total number of treasuries increased by 27 percent. The total number of treasuries held by the public has increased by 43 percent.
By the way, the Fed has not increased its holdings of Treasuries relative to its holdings in September 2007 (just before the crisis began). The recent increase in the Fed's holdings offset a huge decrease between September 2007 and September 2008. The Fed held $779 billion in Sept 2007 and held $774 billion in Oct 2009 (Table H.4.1). The same can't be said for their total balance sheet, $876 billion in Sept 07 and $2.1 trillion in Oct 09. There has been no sterilization.
SE
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