The CBO Promotes a Stimulus Fantasy

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On August 27, 2010, the BEA reduced its estimate for 2Q2010 GDP growth from 2.4% to 1.6%. This is far lower than the 3.7% growth seen in 1Q2010, much less the 5.0% growth reported for 4Q2009. Total employment declined by 495,000 during the three months ending in July. Opinion polls show that more Americans believe in UFOs than believe that "stimulus" helped the economy. Yet, despite the mounting evidence, the Administration, most Democrats in Congress, and many economists are clinging to "stimulus" the way Obama once accused some Americans of clinging to guns and religion.

On August 24, the CBO released an analysis of the efficacy of the $814 billion (latest estimate) "stimulus" program entitled, "Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from April 2010 Through June 2010". This report estimated that, during 2Q2010, "stimulus" had (among other things) "Raised real (inflation-adjusted) gross domestic product (GDP) by between 1.7 percent and 4.5 percent", and "Lowered the unemployment rate by between 0.7 percentage points and 1.8 percentage points".

The striking thing about the CBO analysis is that it is "reality proof". Rather than presenting evidence that "stimulus" works, the CBO employed economic models that assume that "stimulus" works. As a result, no matter what happened to 2Q2010 GDP and employment, the CBO's calculations would always show that "stimulus" worked exactly as intended.

To estimate the impact of "stimulus" upon 2Q2010 GDP and employment, the CBO applied "output multipliers" to the reported expenditures in eight different categories. Their calculations did not include any actual economic data. Accordingly, when the BEA reduced its estimate of second quarter GDP downward by 33% on August 27, there was no need for the CBO to revisit their calculations.

The "output multipliers" assumed by the CBO were between 0.2 and 2.5 for the eight categories of "stimulus" expenditures. What this means is that the CBO's methodology assumes that a dollar in the hands of the Federal government will generate between 20% and 250% more GDP than the same dollar in private hands.

The most remarkable "stimulus" category (for which the "output multiplier" is estimated at between 0.2 and 0.6) is the one called, "One-year tax cut for higher-income people". The CBO's methodology assumes that selling higher-income people Treasury bonds for $1,000,000 and then handing the same $1,000,000 back to them via a one-year tax cut would increase GDP by somewhere between $200,000 and $600,000. The CBO report does not explain how sending the money on a round trip through Washington, D.C. would accomplish this.

The CBO unwittingly put the key intellectual error underlying "stimulus" out in plain sight on page 4 of their report, where they say:

"If someone receives a dollar in transfer payments and spends 80 cents (saving the other 20 cents), production increases over time to meet the additional demand generated by that spending, and the direct impact on output is 80 cents."

In the case presented in this passage, the CBO's "output multiplier" methodology would only be valid if the transfer payment was made with newly created money. This is because if the $1 transfer payment in question were to be financed by selling Treasury bonds, 100 cents of that dollar would have to be saved ($1 in Treasury bonds would have to be purchased) before the $1 transfer payment could be made. Given that the CBO methodology considers money that is saved to have no stimulative effect, the "output multiplier" of "stimulus" spending that was financed via bond sales could not be more than zero. In the given example above, the "direct impact on output" of the $1 bond sale coupled with the subsequent $1 transfer payment would actually be minus 20 cents.

Between January 1, 2009 and July 1, 2010, the Federal government ran a deficit of more than $2.1 trillion, while the monetary base increased by less than $0.3 trillion. Accordingly, about 87% of the "stimulus" provided during this period was financed by selling bonds. It is not clear why the CBO would believe that this spending had any net stimulative effect.

In the private sector, an investment program is judged by comparing actual results with the outcome promised at the time that the spending was approved. By this test, "stimulus" has been a colossal flop. Total employment in June 2010 was 6.0 million lower than Christina Romer and Jared Bernstein forecasted in their "The Job Impact of the American Recovery and Reinvestment Plan" report of January 9, 2009. Also, GDP growth, which should be accelerating at this point in the business cycle, is slowing down.

In truth, it would be logical to expect "stimulus" to have a negative impact on both GDP and employment. The private sector is more efficient than the public sector, so moving resources from the private sector to government via "stimulus" borrowing and spending could be expected to reduce output. Also, average government jobs pay between 14% (State and local) and 102% (Federal) more than average private sector jobs. Accordingly, transferring money from the private sector to the public sector could be expected to "destroy or prevent" net jobs.

If you go by the evidence rather than the CBO's "faith based" methodology, it is hard to avoid the conclusion that the $814 billion "stimulus" program has, in fact, deepened and prolonged the recession. Prosperity is possible, but "stimulus" is not the answer.


Louis Woodhill (, an engineer and software entrepreneur, and a RealClearMarkets contributor.  


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