Cogan, Taylor and Wieland on the Stimulus

Economists have been busy measuring the impact of fiscal stimulus on the economy.  In September, John Cogan, John Taylor, and Volker Wieland summarize empirical research in a Wall Street Journal article “The Stimulus Didn't Work.”  They examine two aspects of the American Recovery and Reinvestment Act of 2009, transfer payments and tax cuts, and government spending; they find that neither provided much stimulus. 

The transfer payments and tax cuts fail to cause a sustained increase in consumption.  They write

This is exactly what one would expect from "permanent income" or "life-cycle" theories of consumption, which argue that temporary changes in income have little effect on consumption. These theories were developed by Milton Friedman and Franco Modigliani 50 years ago, and have been empirically tested many times. They are much more accurate than simple Keynesian theories of consumption, so the lack of an impact should not be surprising.

The authors also observe that the Bush administration’s Economic Stimulus Act of 2008 failed for the same reason.

Indeed, one need not have looked any further than the Bush administration's Economic Stimulus Act of 2008 to find plenty of evidence that temporary payments of this kind would not jump-start consumption. That package made one-time payments and rebates to people in the spring of 2008, but, as the chart shows, failed to stimulate consumption as had been hoped. Some argued that other factors such as high oil and gasoline prices caused consumption to fall during this period and that consumption would have been even lower without the stimulus, but no significant impact of these rebates is found even after controlling for oil prices.

They say less about government expenditures because, at the time they wrote, those expenditures were small.

Direct evidence of an impact by government spending can be found in 1.8 of the 5.4 percentage-point improvement from the first to second quarter of this year. However, more than half of this contribution was due to defense spending that was not part of the stimulus package. Of the entire $787 billion stimulus package, only $4.5 billion went to federal purchases and $17.7 billion to state and local purchases in the second quarter. The growth improvement in the second quarter must have been largely due to factors other than the stimulus package.

In a second article by Cogan and Taylor, “The Obama Stimulus Impact? Zero,” also published in the Wall Street Journal but with fifteen months more data, examines federal spending and transfers to state and local governments.  They conclude that government expenditures have done little to stimulate economic activity.  They provide an explanation for the program’s lack of efficacy.

Recently released Commerce Department data show that of the $862 billion stimulus package, the change in government purchases at the federal level has, thus far, been extremely small. From the first quarter of 2009 through the third quarter of 2010, government purchases have increased by only 3% of the $862 billion ($24 billion). Infrastructure spending increased by an even smaller amount: $4 billion. In a $14 trillion economy, these amounts are immaterial.

Of the effectiveness of transfers to states and local governments they write

The bottom-line is the federal government borrowed funds from the public, transferred these funds to state and local governments, who then used the funds mainly to reduce borrowing from the public. The net impact on aggregate economic activity is zero, regardless of the magnitude of the government purchases multiplier.

This behavior is a replay of the failed stimulus attempts of the 1970s. As Gramlich found in his work on the antirecession grants to state and local governments: "A large share of the [grant] money seems likely to pad the surpluses of state and local governments, in which case there are no obvious macrostabilization benefits."

The implication of our empirical research and Gramlich's is not that the stimulus of 2009 was too small, but rather that such countercyclical programs are inherently limited. The lesson is to beware of politicians proposing public works and other government purchases as a means to stimulate the economy. They did not work then and they are not working now.

Those economists supporting the stimulus will find evidence of its success, but I do not believe that it will counterbalance evidence showing its limitations.  The bulk of economic research long ago concluded that fiscal stimulus was ineffective in recessions of average length and depth.  It looks as if new research will find that fiscal stimulus is also ineffective in longer deeper recessions, but the price is real.  The deficit is wider and more difficult to close and the debt is mounting.