Five Years After Stimulus, Did It Work?
Five years after becoming law, the American Recovery and Reinvestment Act of 2009 - better known as the "economic stimulus" - remains controversial and divisive. Its birthday has triggered retrospectives that suggest a tentative verdict on its usefulness.
The main contribution comes from the White House's Council of Economic Advisers. In its annual report, it reminds us that the original stimulus, costing about $800 billion, was only half the show. As its impact waned, the administration and Congress enacted other like-minded measures - the biggest were the two-percentage-point cut in Social Security's payroll tax and the extension of unemployment benefits - with a price tag of roughly $700 billion. The term "stimulus" was dropped because it proved politically toxic even if many underlying programs were popular.
Together, the spending increases and tax cuts helped stop the free fall and propel recovery, says the council. At their peak in 2010, they created about 2.5 million jobs, the council estimates. Although their boost to employment has now faded, the stimulus provided support when support was needed. Human misery was also alleviated. Unemployment benefits went to 24 million workers and aided 70 million people, including their families. All in all, mission accomplished.
Not really, retorts Stanford economist John Taylor, a stimulus critic, on his blog. "It's a tough case to make" that the stimulus jump-started the economy. Some numbers also support this skepticism.
Government stimulates the economy by spending more than it taxes. So deficits measure total stimulus. These were huge - $5.8 trillion from 2009 to 2013 - and vastly exceeded the stimulus packages alone. They reflected two other factors. First, "automatic stabilizers": In a recession, the budget shifts toward deficit because income taxes fall and spending (unemployment insurance, food stamps and the like) rises. Second, the budget had a structural deficit - a gap between spending and taxes - before the Great Recession. Yet, despite unprecedented post-World War II deficits, the recovery has been weak. In its first three years, it averaged about half the growth of earlier postwar expansions. There's the puzzle: monster stimulus, midget recovery.
How to explain the contrasting stories?
Superficially, economic stimulus seems common sense. If private-sector demand is inadequate, the public sector ought to fill the void. In practice, it's not so simple. Economists talk of "multipliers": how much an extra dollar of spending or tax cuts spurs the economy. Unfortunately, it's unclear. The Congressional Budget Office surveyed scholarly studies and found that multiplier estimates for government investment spending ranged from 0.5 to 2.5. This means that a dollar of spending generates between 50 cents and $2.50 in added output (gross domestic product). Quite a range!
Valerie Ramey, an economist at the University of California at San Diego who has estimated multipliers, says that differences among studies often reflect their assumptions of how fast the economy would have grown without stimulus - but, as she adds, we don't know that . The assumptions are educated guesses. Her studies consistently find multipliers of less than one for government purchases. Again: For an extra dollar of spending, GDP rises less than a dollar (about 80 cents by her figures).
Part of the stimulus is lost because it dampens private spending. One channel is interest rates. If higher government borrowing raises rates, it will crowd out credit-sensitive purchases (cars, housing, business equipment). This explains why deficits, when the economy is near full employment, don't likely boost growth. But it's not a problem now. The economy isn't near full employment, and interest rates have been low since 2008.
Still, the stimulus might dissipate in other ways. The economist Milton Friedman hypothesized that people tend to save one-time income gains; they calibrate spending and living standards to their permanent income. If so, temporary tax cuts may be mostly saved. Businesses may behave similarly. They may refrain from expanding factories or hiring in response to temporary spurts in government spending. Then there are imports; when Americans buy, the stimulus erodes.
All this makes for a messy verdict. When proposed, President Obama's stimulus was desirable. (Disclosure: Though disliking details, I favored it.) Regardless of multipliers, it supported the economy. It also sent a message along with the auto-industry bailout, the Federal Reserve's easy money and the Troubled Asset Relief Program: The government won't let the economy collapse. This was crucial to restoring confidence. The stimulus was a justifiable emergency measure.
But the emergency has passed. The economy, though struggling, is not failing. The administration attributes its sluggishness to many causes (household debt, Europe's problems, Washington's political discord). Maybe. But more stimulus won't cure underperformance and may perversely contribute to it. By highlighting the economy's weakness, it may magnify consumer and business caution. Pessimism becomes self-fulfilling. An economy dependent on periodic shots of stimulus is an economy in eclipse.
