Wednesday, March 17, 2010

Is the stimulus worth its cost? Guest Stolen post of the day. 

I don't have much time to blog these days, but fortunately there's plenty of material on other blogs that's better than anything I could write to borrow steal and post here.

For instance, how's the stimulus working out?

Has it really saved a lot of jobs? Been a bust? Is it hard to tell?

Are we better off for what it has accomplished, in spite of the over-$800 billion it is adding to the national debt? Or would we have been better off "taking our lumps" and saving the $800 billion?

The excellent Prof. Scott Sumner -- a specialist on the Depression, Japan's slump and such downturns -- frames things a different way. He points out there was a third option: stimulus that doesn't add to the national debt, monetary stimulus ... and that in fact monetary stimulus has been applied by the Federal Reserve anyhow, interacting with fiscal stimulus in ways that may be perverse.

Prof. Sumner, unkowingly and without granting his permission, contributes the following analysis...

~~~ quote ~~~

Everyone wants to set the debate up as follows:

1. Do you favor massive deficits or are you content to have the economy self-correct, risking high unemployment for several years?

... that is not the issue. Rather there are two distinct issues:

1. Is more AD [Aggregate Demand] desirable, or should we let the recovery take its natural course?

2. If we need more AD, is monetary expansion preferable to massive budget deficits?

Let's review a few simple ideas. Fiscal stimulus does not boost AS, it boosts AD ... So if fiscal stimulus is to help the recovery, it does so by exactly the same method as monetary stimulus - boosting AD.

I happen to favor more stimulus, although I understand that some thoughtful economists disagree with me.

I happen to think monetary stimulus is preferable to fiscal stimulus, and in this case there aren't any thoughtful economists who disagree with me. Not one.

If there was going to be one, it would be Paul Krugman. But even he admitted late last year that monetary stimulus is the first choice, and you only move on to fiscal stimulus is the Fed won't play ball...

We are running up trillions of dollars in debt precisely because the elected leaders of our country think we need more AD, and the Fed doesn't.

I understand the need for the Fed to be independent, but how about some honesty at least. If these inflation hawks really believe what they are saying, show some guts and come out and say "We are not doing more monetary stimulus because we feel a need to offset what we regard as excessive fiscal stimulus, and prevent it from raising the expected inflation rate." If they really have the courage of their convictions, then why not admit what they are doing?...

In February I said fiscal stimulus wouldn't work, as the Fed had some sort of nominal aggregate target in mind, and was going to simply offset the fiscal stimulus. And that is what happened.

When things looked scary, like a Depression was possible, the Fed announced its big program of buying Treasuries and MBSs.

Later in the year when things picked up a bit, and we were clearly going to avoid a depression, the Fed started furiously back-peddling. They started talking about ending the bond buying program and "exit strategies." Ask yourself this; what does that back and forth behavior tell you?

It tells me the Fed has some sort of implicit nominal target, and if the economy seems to fall short they'll pull out all the stops and flood the economy with liquidity.

That's why the $800 billion dollar fiscal stimulus was a complete waste of money; the Fed wasn't going to allow NGDP to fall much further than the actual 2.5% it fell. Shame on us for not figuring that out, and shame on the Fed for not explaining that to us...

~~ end quote ~~

Don't anyone answer "liquidity trap". As Krugman and Bernanke both long pointed out during Japan's deflation, a government can always depreciate the currency a bit to cure that. And monetary policy worked potently in the US during the Great Depression, as pointed out by Romer (and Sumner, visually), amid supposedly the worst liquidity trap of all.

Right now the Fed is cutting back its support for bond and mortgage security markets...
"The big question is how much mortgage rates will rise and how quickly as a result"
... which clearly is de-stimumative.

Yet the spending stimulus lumbers on, not even half done.

Fed policy is offsetting it.

People look at econometric models and/or whatever and claim the stimulus has created jobs -- but can do so only in light of the actions the Federal Reserve has actually taken.

Yet without any doubt whatsoever, if there had been no stimulus the Fed would have taken much different and greater actions to support the economy. One needs to know what the job situation would have been then, how many jobs would have been saved/created by that, and then compute the difference between that job situation and today's, to really know how many jobs the stimulus has created or saved, at its cost of $800 billion.

That is until now, regarding the first half of stimulus spending.

Going forward from here, if the Fed steers to hit its policy targets, and in doing so acts to offset effects of the stimulus (as we seem to see happening above) what will be the effect of the remaining $400 billion of the stimulus then?