Why the Stimulus Failed
John Taylor writes about why the stimulus failed on his blog:
Paul Krugman writes (citing Noah Smith) that he agrees with the empirical findings in my critique of the revival of Keynesian activism in the 2000s (the stimulus packages of 2001, 2008 and 2009). In particular, he writes that “it’s far from clear that the ARRA actually led to much of a rise in government spending, while the tax cuts that made up much of the stimulus were probably largely saved.”
Basically, local and state governments offset federal spending by paying off debt (he writes about this elsewhere on his blog--that's why aggregate government spending didn't go up; after all, the feds were picking up the tab for highway infrastructure, education, Medicaid, food stamps. . .why not use the opportunity to pay off debt?). By the way, kudos to Professor Taylor for getting Krugman to admit he was wrong. Can we get him (Taylor, not Krugman) on Ricochet?
The IMF also has a fascinating paper written circa 2009, on the (as yet to be performed then) global coordinated fiscal stimulus. The IMF economists lay out the conditions necessary for such an old-style Keynesian strategy to succeed.
Basically, the IMF's view is that credibility is key. As page 12 (13 in PDF readers) explains, the long-run effects of non-credible global fiscal stimulus is that:
all countries experiencing a roughly 1.4 percentcontraction in investment and a 0.6 percent permanent contraction in GDP. When all countries increase the ratio of their debt to GDP by 10 percentage points, the effect on world real interest rates is almost three times as large at 39 basis points, with GDP permanently contracting by 1.3 percent worldwide. This carries extremely high costs because the contractions are not only large but also permanent.
There are other, more short-term problems with non-credible stimulus in the paper, such as the crowding-out effect of businesses and consumers paying down debt in anticipation of lower future savings, higher future real interest rates, etc.
Both sources paint a similar story, though the details differ: a badly constructed stimulus will be offset by local governments, or market forces, or foreigns investors, or someone. I can only conclude that a well-constructed stimulus package requires far to much perfection and credibility for the United States federal government to handle.
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Comments :
Re: Why the Stimulus Failed
How odd. Who could have predicted this? Oh, yes, didn't that Hayek fellow have something to say about this?
Well, I'm not going to get exercised about it. After all, in the long run we're all dead. Mind you, this is all awfully unpleasant in the short run.
Jun '10
Re: Why the Stimulus Failed
Alas, debt, as with elections, has consequences. The surprise is that it is reported as only 39 basis points. I would have thought it would have been more, but that might depend on the overall sizes of the borrowing relative to the measures such as GDP. Thanks for posting the link to the IMF paper, looked at the TofC and will try and read it later today.
Sep '10
Re: Why the Stimulus Failed
The only unpredicatable element of this is Krugman admitting he was wrong. It is also not surprising that these people who all have huge vested interests in promoting activist goverment spending find way after way of rationalizing the failure of keyensian economics.
Re: Why the Stimulus Failed
I think we've had John Taylor on the site -- he's a spectacular thinker, and maybe the next Fed Chairman, if other things align...
May '10
Re: Why the Stimulus Failed
I don't think that the offset problem conclusively discredits Keynesian fiscal policy. Increasing aggregate spending is a Keynesian prescription; if it does not occur, then Keynesians can simply argue that the failure of the economy to recover is a result of the absence of such spending. The Austrian theory of the business cycle, the crowding-out effect - these discredit Keynesianism.