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Sunday, April 20, 2014

Stimulus helped grow debt, not economy

By Ramesh Ponnuru
Bloomberg News

Last week’s release of the February employment report set off the predictable partisan squabbling, with Democrats emphasizing the positive (227,000 new jobs) and Republicans the negative (the still-shrunken labor force and still-high unemployment rate).

Democrats say the economic recovery shows that the stimulus bill that President Obama signed in 2009 worked. Republicans deny it. Although we can’t know how the economy would be faring if Congress hadn’t passed a stimulus, we have good reason to doubt that it did much good.

Media fact-check organizations have no such doubts. Factcheck.org says it’s “just false” to deny that the stimulus has created jobs. It cites the Congressional Budget Office’s estimate that the stimulus had saved or created millions of jobs. But the CBO, as its director has explained, hasn’t really checked the effect of the stimulus. It has merely reported what the results of additional federal spending and tax credits would be if you assume that spending and tax credits are stimulative.

In other words: If you assume that stimulus works, it must have worked. This circularity doesn’t bother PolitiFact, a group that seeks to elevate the tone of our political debates but usually lowers it. Relying on the CBO and other groups that use similar methods, it says people who deny the effectiveness of the stimulus have their “pants on fire.”

Last summer, Dylan Matthews reviewed the research on the stimulus for the Washington Post and dug up six studies that found a positive effect. Three of them were based on models that assume the stimulus worked. Three of them were supposedly empirical confirmations of this effect. These three all found that states (or counties) that got more stimulus money had stronger economic performances than places that received less.

But nobody denies that the federal government can shift the distribution of economic activity. If Congress were to give me $50 billion, I am sure car dealerships and liquor stores in my area would see an uptick in sales. That doesn’t mean the nation as a whole would come out ahead. (I am willing to go along with the experiment if Congress doubts this.)

Other research on the stimulus, meanwhile, has uncovered reasons for skepticism about its effect. John F. Cogan of the Hoover Institution and John B. Taylor of Stanford University have found that the federal aid to states that was in the stimulus reduced states’ borrowing. The transfer may have helped state balance sheets, but shifting debt from states to the federal government cannot have been stimulative. The stimulus didn’t increase federal purchases significantly, they said.

Valerie Ramey of the University of California, San Diego, has found that the stimulus didn’t increase economic output or private-sector employment, although it boosted public-sector employment. (Maybe PolitiFact will give these economists a pants-on-fire citation, too.)

In a recent debate about the stimulus with Taylor, former Obama adviser Lawrence Summers made the point – a dubious one, as we’ve seen – that states with more stimulus funding have done better. He also urged the audience to “use your common sense.” That’s probably the best argument for the stimulus: Keynesian theorists can tell a plausible story about why one would expect additional federal borrowing to help a depressed economy.

But what’s often left out of that story is the role of the Federal Reserve. Take account of how fiscal policy is likely to affect monetary policy, and it becomes a lot harder to see how stimulus can do much to help the economy.

Assume, for example, that the central bank has a strict 2 percent target for inflation and is perfectly effective in hitting it. In that case, any stimulus that Congress provides is and must be canceled out by a tighter monetary policy. Or assume that the central bank always achieves a target of 4.5 percent growth in nominal income. Again, any added stimulus just causes the Fed to run a more contractionary (or less expansionary) monetary policy, and we end up with roughly the same level of output and employment.

The Fed in these situations may want Congress to provide stimulus, as Fed Chairman Ben Bernanke has repeatedly urged, because the central bank would prefer to be able to run a tighter policy itself. But listening to him would merely change the mix of fiscal and monetary policy that reached the same result.

That doesn’t mean Keynesian stimulus can never work. As Scott Sumner of Bentley University points out, it can work under certain monetary regimes. But we seem to have a central bank that wants to keep inflation in a narrow band, and this disposition limits the potential effect of any fiscal policy on the performance of the economy.

Some proponents of stimulus make the counterargument that the crisis of 2008-09 created an unusual “liquidity trap” in which the Fed, because of low interest rates, couldn’t run a sufficiently expansionary policy. But our government was perfectly capable of pursuing a highly expansionary one in 1933, when interest rates were low, and the Fed has been able to pursue unconventional policies in this crisis, too.

In retrospect, Obama would have been better off pushing for more Fed action in 2009 – for instance, the Fed could have stopped paying banks interest on reserves, announced a goal of restoring nominal income to trend, or both – and skipping the unpopular stimulus. The economy would probably be in the same shape, and we would certainly have less federal debt.

Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review.

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