Bittlingmayer and Hazlett on the Stimulus

Bittlingmayer has written frequently on antitrust activity, and Hazlett, on cable television and other telecommunication issues. Both are keen observers of the interaction of the relationship between stock markets and economic and political events, and they have frequently collaborated to the benefit of their readers. Their latest collaboration, "The Market Is Shorting Obama's 'Stimulus'," examines investors' reaction through the DJI to the Obama stimulus bill as it passed through Congress. By increasing government spending through deficit spending, the administration hopes to boost economic activity by more than the spending itself through a multiplier effect. Bittlingmayer and Hazlett emphasize that investors aren't buying the economic theory; at least they are not buying its political manifestation.

Government deficits are nonetheless being sold as doctor’s orders, an elixir that – while it looks ugly and tastes bitter – will propel us back to economic health. Yet the best forecast currently on the table is the one made by investors risking their own money. They are shorting the “stimulus.”

The skepticism is huge.

[K]ey political victories for the Team Obama spending plan have not been viewed as buying opportunities on Wall Street. A string of negative market reactions began with the December 18 announcement of a stimulus bill of $700 billion (Dow down 2.5%), continued with the January 7 announcement that the actual plan would be “on the high side” (-2.7%) and continued with last week’s 61-36 Senate vote supporting the Administration’s fiscal plan. The White House victory and the new bank bail-out plan announced the following day by Treasury Secretary Geithner were met with a 5% wipe-out in the DJI, and a decline in Treasury bond yields, indicating a “flight to quality.”

Are investors truly the best forecasters? Economists place a great deal of value in betting and prediction markets. They have been more accurate in predicting the outcome of elections and sporting events than experts, presumably because investors have money in the game and their earnings are dependent on correctly predicting outcomes. Experts are paid for expressing their opinions whether they are correct or not.

A skeptic will note that investors did not do well in predicting the value of housing and stock market in the recent past, but neither did our elected representatives and government regulators, who created perverse incentives in the housing and banking industry.

Bittlingmayer and Hazlett suggest a reason for investors' doubt.

How do economists know that, while a deficit amounting to 6% of GDP budget was sufficient to spur the economy back to health in 1983, it will take more than twice that federal borrowing to do the same now? They don’t. Economic models are all over the place in their projections. Indeed, Prof. Barro’s cutting edge analysis of fiscal policy finds no historical stimulus from peacetime deficits. Of course, we’ve never seen so massive a deficit – one that would bar the U.S. from membership in the European Union, on grounds that our government finances are a mess -- and so we lack empirical evidence to inform the precise experiment we’re running today.

We do, however, know the accounting trends: our government faces massive new spending increases as Baby Boomers retire and their Social Security and Medicare bills come due. Market investors are wary of new spending, guaranteeing either future tax increases or inflation, as a run-up to the demographically guaranteed spending spiral. The quest for “shovel-ready” projects makes one think, Where’s Senator Ted Stevens when we need him? In any event, this fiscal bridge to nowhere is not spurring markets.