The Long Run Blog

Critical Thinking on Money, Finance, and Economics

Did The Stimulus Help?

The $64 trillion dollar question: did the vaunted stimulus package help the economy? The question is on everyone’s mind lately, especially since we hear two polar opposite characterizations of the issue. According to Keynesians and Democrats, the stimulus was a big help while according to Libertarians, Republicans and especially Tea Partiers, the stimulus was a giant “failure”. Clearly, one side is wrong, but which one?

Let’s start with understanding the proper frame of reference. We had a giant financial crisis and the economy went into a death spiral as a result. Congress did two things: at the height of the crisis, they passed TARP (Troubled Asset Relief Program but better known as “bailouts” to the likes of Citigroup, BoA, etc.) in October of 2008 as a means to stop complete collapse of the financial system. Second, they passed ARRA (American Recovery and Reinvestment Act) in early 2009, which was intended as the “stimulus” package composed of tax cuts, help to states, extended unemployment benefits, targeted tax credits and infrastructure spending. Many people confuse these separate acts even though “stimulus” is not the same as a “bailout”. To confuse matters further, the Federal Reserve also embarked on a series of monetary policies to help the situation. Monetary policy is very different from fiscal policy, but often gets lumped into the same bucket. Regardless, the question remains whether any of these helped the economy or simply increased the debt.

The first analysis seeking to answer this question was released and while it certainly won’t be the last, it does seem quite logical. Two well respected economists, Alan Blinder of Princeton and Mark Zandi of Moody’s, used the Moody’s econometric model to run a number of scenarios. Here is how it works:

Over the years, Moody’s has developed a model which predicts the economy based on a number of variables. Their model is not the only one as just about all major economists have their own. They aren’t foolproof nor do they predict the economy with the precision we’d like. These models do, however, come pretty close to getting it right. Since we can’t run experiments on the real economy, these models are all we have to conduct “what-if” analysis.

Blinder and Zandi ran several scenarios to compare with what actually happened. First, we have the base case which includes all the policy responses mentioned above and largely mirrors what actually happened. The second scenario excludes both fiscal (ARRA or “stimulus”) and financial (TARP or “bailouts”) policy responses; the third excludes financial policies (TARP) only; and the fourth excludes fiscal policies (ARRA). While the author’s report does a miserable job of presenting the results, I’ve made it much clearer below. The result? The combination of fiscal and financial policies was an enormous success!

Several take-a-ways are clear from the chart: First, the self-reinforcing nature of both the fiscal and financial policies brought about recovery much faster than either could alone. Second, the loathed and widely-criticized financial policies, otherwise known as “bailouts” (i.e. TARP) were more beneficial and powerful than the stimulus, though both are similar in magnitude of effects. Finally, without either response – and let’s not forget that many strongly advocated against doing anything- would have resulted in what could only be called “Depression 2.0”. According to the study, without these policies the economy would first be bottoming out in the fourth quarter of 2010 at an unemployment rate of over 16%! Put another way, job losses would have been twice what they are.

Let’s summarize a few key results:

Put another way, on these policies together “saved” 8.5% of GDP deterioration. The key finding of this exercise is the massive positive effect of these policies. If you think political discourse is running amok now, consider what the political arena would be like if unemployment were over 16% after three years of contraction.

To be fair, we should note the studies weaknesses. In order to run the models with alternative scenarios, some judgment was needed to estimate the effect on certain variables that TARP and ARRA had. For example, what impact did TARP have on credit spreads? Taken further, one could claim that Keynesian expectations were built into the model. Moreover, the study was not peer-reviewed and probably won’t be. These “buts” provide ample ammunition for deniers of the conclusions. However, the raw magnitude of the benefits makes it hard to see how they did not have significant positive effects. It is one thing to tweak a little bias into a model; it is career punishing to outright rig the results. Zandi works in the private sector and relies on his reputation to pay the bills, why would publish nonsense that would surely be debunked later?

Yet I still see regular references to the “failed” stimulus and “unnecessary” bailouts that only helped Wall St. Criticism still blasts the White House because they had estimated a maximum unemployment rate in the 8% range while it proceeded to 10%. Facts are facts but political ideologues will continue in their attempt to distort them. Though we can certainly pick these policies apart and point to many areas where things could and should have been done differently, the conclusion is the same: they saved us (for now) from Depression 2.0. Give credit where credit is due.

The full paper can be found here


A note to those more technically inclined: The stimulus cost roughly $800 billion and “saved” 6% of GDP or $840 billion. Broadly speaking, this means the multiplier was at least 1. So much for misguided, cherry-picked studies that “prove” the multiplier is far below one. In fact, the study noted that permanent tax cuts had the lowest multiplier while infrastructure and social programs had the highest. An increase in food stamps (1.74), financing of work-share programs (1.69) and extending the unemployment insurance (1.61) had the highest multipliers. The author’s explanation for the high multiplier of extended UI benefits: “Additional unemployment insurance produces very high economic activity per federal dollar. Most unemployed workers spend their benefits immediately; and without such extra help, laid-off workers and their families have little choice but to slash their spending. The loss of benefits is debilitating not only for unemployed workers, but also for friends, family and neighbors who may have been providing financial help themselves.”

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August 31, 2010 - Posted by | Econ Policy | , ,

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