Commentators are taking note of the five-year anniversary of the fiscal stimulus that President Obama enacted during his first month in office. Those who don’t like Obama are still asking “if the fiscal stimulus was so great, why didn’t it work?” What is the appropriate response?
Those who think that the spending increases and tax cuts were the right thing to do have given a number of responses, which sound a bit weak to me. The first is that the stimulus wasn’t big enough. The second was that the Great Recession would have been much worse in the absence of the stimulus, perhaps a replay of the Great Depression of the 1930s. (The media are fond of this line of reasoning because it allows them to escape making a judgment. They can just say “nobody knows what would have happened otherwise.”) The third response is that the fiscal stimulus was short-lived, and in fact was reversed by the Congress by 2010.
The year 2013 marks the 100th anniversaries of two separate major institutional innovations in American economic policy: the Constitutional Amendment enacting the federal income tax, ratified on February 3, 1913, and the law establishing the Federal Reserve, passed in December 1913.
It took some time before the two new institutions became associated with the explicit concepts of fiscal policy and monetary policy, respectively. It wasn’t until after the experience of the 1930s that they came to be viewed as potential instruments for managing the macro-economy. John Maynard Keynes, of course, pointed out the advantages of expansionary fiscal policy in circumstances like the Great Depression. Milton Friedman blamed the Depression on the Fed for allowing the money supply to fall. [Tools of fiscal policy used by governments, in addition to tax rates and tax deductions, are spending and transfers. Tools of monetary policy used by central banks include interest rates, quantities of money and credit, and instruments such as reserve requirements and foreign exchange intervention used in various (non-US) countries.]
The National Journal asks: “Is the Obama administration’s stimulus plan helping to create or “save” 650,000 jobs, as the president and his aides say? Is that an appropriate way to measure the stimulus’ impact?”
I am astounded by claims that fiscal stimulus under recession circumstances doesn’t create jobs. Or at least I am astounded when such claims come even from some reputable economists. Do they think that a construction job on a road-building project doesn’t count as a real job if the funding comes from the government? More likely, they think that the increase in demand doesn’t raise output in the aggregate, because the federal debt crowds out private production and so someone else somewhere loses his or her job? But that would be hard to believe, at a time when the Fed is keeping interest rates at zero, long-term interest rates are also quite low, and capacity is lying idle. Moreover, Republican lectures to Democrats about the evils of the national debt take real chutzpah, after Presidents Reagan, Bush I and Bush II increased the debt ten-fold during periods when no national emergency required it.
Martin Feldstein and others predicted that the tax-cut component of the 2009 fiscal stimulus package would have substantially less expansionary bang-for-the-buck than the spending component of the package, because much of the tax cut would be saved, as had been the case with the 2008 tax cut. (“Bang for the buck” in this case could be defined as demand stimulus divided by budget cost.) We knew this from Milton Friedman’s permanent income hypothesis, or even from good old Keynesian multiplier theory.