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Thursday, April 26, 2012

"Ideology and Facts in the Economic Policy Debate"

Antonio Fatás:

Ideology and Facts in the Economic Policy Debate: The fact that ideology matters in the economic policy debate should not be a surprise to anyone. But the influence that ideology has has in some of the economic analysis we have seen since the beginning of the financial crisis has led to completely contradictory statements about the facts behind the causes and potential remedies to the crisis.

Via Greg Mankiw's blog I read a strong criticism of the Obama administration written by James Capretta. Quoting from his article:

When he (Obama) came into office, he favored a massive injection of new government spending into the economy in the name of “stimulus” — counter-cyclical federal activity aimed at offsetting depressed consumer demand emanating from a recession-battered private sector. The net result provides little if any boost to aggregate demand because the states — and to some extent private citizens — simply pocket the federal money and reduce their deficits and debts. Meanwhile, what federal taxpayers get is a permanent increase in the size of government.

We have all heard similar statements before which tend to be supported by references to $800 billion to $1 trillion stimulus packages and bailouts both in the US and Europe.

But have we really see an unusual expansion of government size? Quite the contrary. As I argued in a previous post, what we have seen during the current crisis is exactly the opposite. Relative to previous crisis government spending has been growing at a much slower rate this time. Paul Krugman makes an even more interesting comparison in blog, a comparison that reveals how inaccurate the above statement is. He compares government employment under the Obama administration to the Bush and Clinton administrations. The Bush administration is probably the most relevant comparison because it also started in the middle of a recession. Here is the chart from Krugman's analysis. ...

The data speaks for itself. 40 months into the Obama administration, the number of government employees (all levels of government) has gone down by 600,000. During the Bush administration the number had increased by about 700,000. A difference of 1.3 million. So where is the increase in government size? ...

[See here for another graph comparing government spending during recent recoveries.]

I don't think the evidence supports the assertion that the preponderance of the stimulus was saved rather than spent. But suppose that it was. For consumers in particular, this is a form of balance sheet repair -- they are saving to make up for losses in asset values that they were depending upon for retirement, to pay for college, and so on. Balance sheet repair does not show up in current GDP statistics, so it looks like the policy is doing nothing. But since consumers won't begin spending normally until their balance sheets are repaired, high savings allows us to exit the recession faster than otherwise (though balance sheet repair is a slow process in any case). State and local budgets --balance sheets --were also wiped out by the recession, so similar arguments can be made here. If state and local government did use this money mostly to backfill revenue losses instead of taking on new projects, that's a sign they didn't get enough help (this is also reflected in the fall in state and local employment). State and local governments have to make up for budget shortfalls somehow, and the sooner they are able to do that, the sooner the layoffs and so on stop. So although we don't see the savings component in current GDP figures, the savings allows balance sheet repair to happen faster, and that allows an earlier exit from the recession.

Again, though, there is plenty of evidence that runs counter to the claim that the stimulus did nothing. The ARRA (stimulus package) had more tax cuts than I would have preferred, and hence there was more savings and less spending than a better designed package might have produced (but the package would not have made it through Congress if it was more spending, less tax cuts). But the higher rate of saving does have benefits in a balance sheet recession.

    Posted by on Thursday, April 26, 2012 at 08:15 AM in Economics, Fiscal Policy, Politics | Permalink  Comments (31)


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