What if They Don't Know How to Fix This?

The 'they' in the post title are economists. While there always many schools of thought, the amazing thing about this current financial crisis is that we are truly in uncharted territory. Two of the most influential economist bloggers are admitting as much about the stimulus plans being discussed:

Tyler Cowen in the Marginal Revolution:

My point is simple: it is very hard to find examples of successful fiscal stimulus driving an economic recovery. Ever. This should be a sobering fact. The New Deal doesn't count because fiscal policy wasn't very expansionary then. American participation in World War II doesn't count. Nazi Germany during the 1930s doesn't count. I'll cover Japan in the 1990s and other examples soon.
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The bottom line is this: we are being asked to believe that a big, trillion or even multi-trillion fiscal stimulus can boost the current macroeconomy. If you look at history, there isn't good reason to believe that. Any single example, such as the Nazis, can be knocked down for lack of relevance or lack of correspondence to current conditions. Fair enough. But the burden of proof isn't on the skeptics. It's up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery. Right now we're mostly at "It wasn't really tried." And then a mental retreat back into the notion that surely good public sector project opportunities are out there.

So what you have is the possibility of faith -- or lack thereof -- that our government will spend this money well.

And that is under "emergency" conditions, with great haste ("use it or lose it"), with a Congress eager to flex its muscle, and with more or less one-party rule.

For me, that's not enough.

Greg Mankiw:

Skepticism, rather than unequivocal opposition, is the right word. When contacted, I said the same things I have been saying on this blog: that monetary policy is not out of ammunition, and that tax cuts are potentially more potent than spending increases. I might have added that I feared a spending-based stimulus to address the current short-term crisis might lead to a long-term increase in the size of government, but I doubted that concern would sway Team Obama. In general, I think economists need a large dose of humility when evaluating alternative proposals to deal with the current downturn, as there is still a lot we do not understand

All articles referenced are copied in full at end of post.

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Tyler Cowan's Blog
Fiscal policy and the burden of proof

I'd like to drive home the point that the case for fiscal policy has not yet been made by its advocates (the rest is under the fold)...

I believe that most current advocates of a huge fiscal stimulus have two major arguments in mind. The first is that "when resources are unemployed, in principle government spending can put them back to work, times are dire so we need this." The second is the Galbraithian point that public sector expenditure has been starved for a long time so in principle there are plenty of good ways to spend money through government. In the predominant mental model on this topic, it is believed either of these arguments suffices to justify a large fiscal stimulus. In the debates I sometimes find that when one claim is criticized there is a mental switch back to the other.

Don't let those switches distract you. My point is simple: it is very hard to find examples of successful fiscal stimulus driving an economic recovery. Ever. This should be a sobering fact. The New Deal doesn't count because fiscal policy wasn't very expansionary then. American participation in World War II doesn't count. Nazi Germany during the 1930s doesn't count. (Read Matt Yglesias's response; the point however is that maybe Hitler couldn't have easily spent the money on something else in a rapid and effective fashion; if he could have they why can't we find more examples of a fiscal-policy lead recovery elsewhere?). I'll cover Japan in the 1990s and other examples soon.

Don't be mesmerized by a static, aggregated AD-AS diagram into thinking surely it must be easy. Whether the government can target unemployed resources effectively, and deliver the right stimulus in time, is a major question and so far the evidence isn't so convincing. Keep in mind there are good reasons why truly major fiscal stimulus hasn't been tried very often.

Here's Free Exchange on the research behind fiscal policy. They write:

Today, Mr Cowen links to a(nother) piece of macro research on stimulus multipliers that finds in favour of tax cuts before declaring that "the science isn't there", to support deficit spending as stimulus.

The point is not that I think tax cuts are much better than government spending as stimulus; I don't. The NBER piece I cited considers the possibility that tax cuts bring a multiplier of as large as five. I say no way. The point is not to argue for tax cuts. The point is to note that this is the best research that the highly reputable NBER can come up with on the topic. What does that say about prevailing standards of evidence and proof in the area as a whole? It means they are very weak and that we know very little. This is not "the evil and corrupt WSJ Op-Ed page," this is the NBER and the researchers have done as good a job as others on this topic or maybe better. And what they have produced still isn't very believable.

The bottom line is this: we are being asked to believe that a big, trillion or even multi-trillion fiscal stimulus can boost the current macroeconomy. If you look at history, there isn't good reason to believe that. Any single example, such as the Nazis, can be knocked down for lack of relevance or lack of correspondence to current conditions. Fair enough. But the burden of proof isn't on the skeptics. It's up to the advocates of the trillion dollar expenditure to come up with the convincing examples of a fiscal-led recovery. Right now we're mostly at "It wasn't really tried." And then a mental retreat back into the notion that surely good public sector project opportunities are out there.

So what you have is the possibility of faith -- or lack thereof -- that our government will spend this money well.

And that is under "emergency" conditions, with great haste ("use it or lose it"), with a Congress eager to flex its muscle, and with more or less one-party rule.

For me, that's not enough.

Posted by Tyler Cowen on December 18, 2008 at 12:52 PM in Economics
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Gre Mankiw's Blog
Thursday, December 18, 2008
Stimulus Spending Skeptics
An AP story reports:

Obama advisers, including Christina Romer and Lawrence Summers, have been contacting economists from across the political spectrum in search of advice as they assemble a spending plan that would meet Obama's goal of preserving or creating 2.5 million jobs over two years....Only one outside economist contacted by Obama aides, Harvard's Greg Mankiw, who served on President Bush's Council of Economic Advisers, voiced skepticism about the need for an economic stimulus, transition officials said.

Skepticism, rather than unequivocal opposition, is the right word. When contacted, I said the same things I have been saying on this blog: that monetary policy is not out of ammunition, and that tax cuts are potentially more potent than spending increases. I might have added that I feared a spending-based stimulus to address the current short-term crisis might lead to a long-term increase in the size of government, but I doubted that concern would sway Team Obama. In general, I think economists need a large dose of humility when evaluating alternative proposals to deal with the current downturn, as there is still a lot we do not understand.

I am sure I am not the only person in the economics profession skeptical of spending increases to stimulate the economy. See, for example, GMU economist Tyler Cowen. If the new administration wanted to find more skeptics of stimulus spending among professional economists, I could come up with some possible candidates for them, but the Obama economists probably already know who those likely skeptics would be.

By the way, House Republican leader John Boehner is compiling "a list of credentialed American economists who would like to add their voices to the list of stimulus spending skeptics."
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