Wednesday, August 3, 2011

Why wasn't the stimulus bigger?

That's a question not many seem to want to ask. That's especially the case for many conservatives who think the federal gov't is the same as an ordinary household, or even states. To them there shouldn't have been any stimulus at all. Now that a liberal is in the white house, deficits are the worst thing ever and the reason for our economic troubles.

But the current deficit is just a symptom of our economic problems, not the cause. And the stimulus Obama signed off on is a significant chunk of the deficit. Yet we still have a really crappy economy with 9% unemployment. The stimulus was supposed to stall the decline and even add jobs. It didn't happen the way the administration said it would. Here is why:

Output in the third and fourth quarters fell by 3.7% and 8.9%, respectively, not at 0.5% and 3.8% as believed at the time. Employment was also falling much faster than estimated. Some 820,000 jobs were lost in January, rather than the 598,000 then reported. In the three months prior to the passage of stimulus, the economy cut loose 2.2m workers, not 1.8m. In January, total employment was already 1m workers below the level shown in the official data.

We can't know exactly how things would have played out in a world in which key policymakers had better data. If the true scope of the economic disaster in the fourth quarter had been clear, however, it seems certain that Ms Romer's models would have shown a need for more stimulus, that the White House would have agreed to push for more (and perhaps a lot more), and that Congress would have been much more receptive to a bigger bill. A drop of 8.9% does seem much more terrifying, after all, than a 3.8% decline. Bigger stimulus would have reduced the economic deterioration in subsequent months. The Fed might also have been more aggressive.

I encourage you to read the whole thing because it gives a good timeline. But basically, the economic models that determined how much money would be in the stimulus were going off of numbers that severely underestimated how many jobs were lost and how much the economy contracted. As the author says, its hard to know exactly how much more money the administration would have called for if they were working with the actual numbers. And we don't know if congress would have passed more.

But its important to know what happened because many people look at the situation without this context and jump to the conclusion that the stimulus did nothing and deficit spending is not the solution to recessions like the one we had. They even take the opposite view and say we need to cut spending. But in reality, we should have spent more. And we should be spending more right now. The other thing we should take away from this context is how important accurate information is. If we can't know how bad economic situations are while they are happening its extremely difficult to expect the people in charge of policy to be able to get the right policy enacted. I think Matt Yglesias' suggest of more automatic stabilizers is probably the best solution to that problem.

As for the effects of all of this (the actual stimulus and a hypothetically bigger one) on the deficit, it doesn't matter right now. Or if you insist it does, it surely doesn't matter more than the millions of people unemployed right now. What the hysteria over the deficit really is about is people not understand economics. They view the deficit as the cause of the problem instead of the symptom. So they think that cutting it will improve the economy. What we need to do is better inform people that this is the opposite of what we should be doing. And its certainly something Obama and Democrats should have done a better job of explaining. Because from now on it will probably be more difficult to enact stimulus spending when we need it. And that will just prolong economic suffering.

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