Looking back at the stimulus and economic policy in severe recessions
Mark Thoma points me to an op-ed by Christina Romer, who was Obama’s head of the the Council of Economic Advisors in the first part of the administration,writing on the economic stimulus. Her perspective offers a few very insightful counter-arguments for why the stimulus is perceived by many to have ‘failed’. It also tackles head-on what Henry Blodget calls ‘the chart that will get Obama fired’:
The chart above is from the Council of Economic Advisors’ projections of the job impact of the stimulus compared with their estimates for what would happen in the absence of the stimulus. If projections were always accurate, this chart would be enough to raise questions about the effectiveness of the stimulus. But, projections are rarely always perfect descriptions of the future, and Mrs. Romer explains the divergence between reality and the projections:
When we were designing it, most forecasters estimated that the United States would lose around six million jobs… Compared with this baseline, creating three million jobs would have filled roughly half of the employment hole. As it turned out,… the correct no-stimulus baseline was a total employment fall of nearly 12 million. With a loss that big, creating three million jobs was helpful, but not nearly enough.
If you recreated the forecasts with twice the job losses in the ‘no stimulus’ projections, and had the actual recovery bill waiting to be analyzed, you would come to the conclusion “we’re going to need a bigger boat”. And when the stimulus was proposed, it was scaled back for political reasons. The Republicans and some Democrats would have balked at a stimulus of the size needed, which would have certainly exceeded $1 trillion and possibly over $1.5 trillion. Paul Krugman, for instance, criticized the size (and heavy reliance on tax cuts) in the proposed stimulus plan as not big enough before Obama was even inaugurated.
The negative campaign against the stimulus being pushed by conservatives, which not surprisingly is not entirely based on the truth, confirms something that Krugman wrote about today on his blog about whether the fact that economic growth coming out of a financial crisis is typically slower than a ‘garden variety’ recession. He highlighted the difference between saying there is usually slow growth following a financial crisis and saying that it is necessary to have slow growth after a financial crisis.
There are policies that could be used to effectively fight a recession following a financial crisis, but these policies are not usually followed. Why? Krugman explains:
“Historically, however, countries tend not to do these things [effective policies to fight the effects of a financial crisis], or not to do them on a sufficient scale. Why? Politics. Intellectual confusion. Inertia. Misplaced fears.”
The US is an example of exactly this failing, and for multiple reasons. There was the politics, for sure. Republicans today have a built in and exaggerated fear of the ‘gummiment’ doing anything (particularly with a Democratic president). There was intellectual confusion for sure. Many economist stuck their head in the sand, or were just unaware, of the vast literature and policy prescriptions for dealing with a severe recession following a financial crisis that were learned in the Great Depression. That was ‘Keynesian’ and in their minds, it had been disproved and replaced by ‘micro-foundations’ and the Real Business Cycle theory (the first is useful in some situations, where macroeconomic theory is rooted in the idea of how individuals respond to different incentives; the second is just a crock of shit).
But even without these other factors, there was a failure in forecasting the depth of the recession (or the acknowledgement that other economists like Paul Krugman might be making a good point when he criticized the stimulus as being too small in January 2009). That forecasting error made the stimulus look appropriately sized (though some would disagree with this point as well). The recession turned out to be much more severe than the models forecasted, which should have led policymakers to return to the well for some more stimulus. But by that time, the Republicans had locked the gates of Congress from doing anything that might help the Democrats in 2010 or Obama in 2012 and they had effectively decided that a worse economy was politically better for them, and screw you if you didn’t like that.