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.

New (Good) Details: Obama’s Economic Stimulus

President-Elect Obama must read this blog (or he has good economists advising him). Yesterday, the Wall Street Journal (article) reported that Obama is planning to spend about $300 billion dollars on tax cuts in his stimulus plan. According to the WSJ,

“The largest piece of tax relief in the new plan would involve cuts for people
who pay income taxes or who claim the earned-income credit, a refund designed to
lessen the impact of payroll taxes on low- and moderate-income workers.”

This plan is probably as close as we can get politically to my proposal (see this post) to lift the FICA tax. Because the plan changes the withholding tax, it increases incentives to work at the same time the plan is moving cash into a large number of pockets. And, since the plan is aimed at low- to-moderate income groups, the money will appear in the pockets of those who are most likely to be liquidity constrained at the moment.

How much will the plan boost output? I expect the proposal to boost consumption directly by about $85 billion, or almost 1 percent of consumption. This increase is exceptionally large, but so is the stimulus.

But, there is also a sizable indirect effect to the plan. At the moment, banks in the United States seem to need a capital injection. The $215 billion not spent will be saved and the savings will be held in ordinary bank accounts.

As a result, the tax cut will act simultaneously to stimulate consumption and to recapitalize the banks. And, this recapitalization plan is controlled by U.S. households. Banks will have to compete for the money (they have to compensate households for the injection) and any bank that households deem unworthy will not get the injection.

This plan will not end the recession. We are only talking about a 1 to 1.5 percentage point boost to GDP growth at most. Nevertheless, it is the best stimulus idea Obama (or Bush) has put forward. I think this plan already has support on the Hill, but let me add my two cents: pass this part of the stimulus now!

Obama's Economic Stimulus

Welcome! This is the place to talk about the economy.

Let's get started. In his radio address today, Obama announced the key components of his economic stimulus plan. I am shocked. During the campaign, Obama and his team put together a sound economic plan. Take a look at the campaign web page. Many of these ideas could easily be turned into components of a real, workable, and immediate economic stimulus plan. He has good ideas. Yet, not one element in the details released today will provide any near-term economic relief. Here are his five key elements and my thoughts on each.

1.) Launch a massive effort to make public buildings more energy-efficient. Energy efficiency is an important goal. Changing the light bulbs in federal buildings won't save the economy. Replacing old heating systems might, but it takes years to plan and implement. It's seems like this was more important before the collapse of energy prices. Still, if the President Elect wants to promote energy efficiency and stimulate the economy, a federal tax credit on energy efficient home heating systems might work. By the way, this plan was first announced in August (see the bottom of page 7) as a small piece of the New Energy for America Plan.

2.) The single largest new investment in our national infrastructure since the creation of the federal highway system in the 1950s. I have to back off a little. This is real government spending and there is no question about the need to renovate our transportation infrastructure. And, some of this spending can be done quite quickly. Many states have projects on the books ready to go but "the single largest new investment ... since the federal highway system" will take time (years) to implement. How long does Obama think the recession is going to last? If the spending hits when the economy is trying to recover, it is much more likely to "crowd out" private investment than it is to boost the economy. If we rush the roads projects, they are much more likely to end up being roads to nowhere and we will end up crowding out good private investment with useless bridges. This plan is contained in the campaign web page (search for infrastructure). I liked the scale of the earlier plan better.

3.) The most sweeping effort to modernize and upgrade school buildings that this country has ever seen. Again, this is a good idea. Public schools across the country are falling apart. New schools need to be built and old schools need to be modernized. This is not a medium-term stimulus plan. Every issue with roads construction is doubled with school construction.

4.) We’ll also renew our information superhighway. I am not even going to comment. Connecting every library in the country to the Internet tomorrow is not going to create enough jobs to ever be noticed. I like the vision: It's not stimulus.

5.) Help modernize our health care system. This was one of the pet projects of the current administration. They failed. In the very long run, making the health care system more efficient is a great idea if it can be done. It will boost the economy and make every American better off -- in the very long run.

I don't think much of the details released so far. I hope the rest of the economic plan has a bit more substance to it. I don't mind spending federal tax dollars if there is at least a hope they might do some good. Spending money for the sake of doing something is a waste of time. And, using the economic crisis to push forward a favorite parts of an existing agenda may do some good (I like the policies) but it won't solve the crisis.