The Congressional Budget Office (CBO) has produced a new report estimating that the $862 billion stimulus has thus far saved or created 1.5 million jobs.
Yet the CBO’s calculations are not based on actually observing the economy’s recent performance. Rather, they used an economic model that was programmed to assume that stimulus spending automatically creates jobs—thus guaranteeing their result.
Logicians call this the begging-the-question fallacy. Mathematicians call it assuming what you are trying to prove.
The CBO model started by automatically assuming that government spending increases GDP by pre-set multipliers, such as:
- Every $1 of government spending that directly purchases goods and services ultimately raises the GDP by $1.75;
- Every $1 of government spending sent to state and local governments for infrastructure ultimately raises GDP by $1.75;
- Every $1 of government spending sent to state and local governments for non-infrastructure spending ultimately raises GDP by $1.25; and
- Every $1 of government spending sent to an individual as a transfer payment ultimately raises GDP by $1.45.
(note that all CBO figures in this post represent the midpoint between their high and low estimates)
Then CBO plugged the stimulus provisions into the multipliers above, came up with a total increase in gross domestic product (GDP) of 2.6 percent, and then converted that added GDP into 1.5 million jobs.
The problem here is obvious. Once CBO decided to assume that every dollar of government spending increased GDP by the multipliers above, its conclusion that the stimulus saved jobs was pre-ordained. The economy could have lost 10 million jobs and the model still would have said that without the stimulus it would have lost 11.5 million jobs.
The debate over the efficacy of Keynesian stimulus is essentially a debate over the correct multipliers. Some believe the multipliers are high, others believe they are as low as zero (or even negative). Testing the stimulus requires testing the multipliers. Yet by simply assuming large multipliers, CBO effectively pre-ordained its conclusion that the stimulus worked, regardless of what actually happened in the economy.
Cross-posted at National Review’s The Corner.
My Corner post from last Wednesday — pointing out that government “stimulus” spending does not add new purchasing power to the economy because the government must first borrow that purchasing power out of the economy — caused a stir among liberal bloggers Brad DeLong, Matt Yglesias and Stan Collender. Their posts suggest they likely didn’t actually read the report I linked to — which anticipated and answered their counterarguments.
Brad DeLong predictably relied more on insults than analysis. Eventually, he asserted that my point that government “stimulus” cannot alter short-term demand must be false, since it would also mean that demand (and therefore income and spending) must always be fixed, making economic growth impossible. But this ignores that demand growth can come from sources other than fiscal policy.
Recovering from a recession requires first correcting the imbalances that caused the recession. Thereafter, economic growth is a function of productivity and labor supply. Rather than raising immediate productivity or labor supply, government spending (and tax rebates) typically redistributes existing demand from one group of people to another. This is zero-sum.
Yet demand can still grow other ways. Demand is nothing more than purchasing power, which is a function of goods and services provided and sold. Income, by definition, results from productive activity. When productivity increases (thus increasing employment and eventually wages), income increases and demand increases, all in tandem. So the key to increasing demand is to allow the economy to correct its imbalances and then to encourage productivity and labor supply.
Matt Yglesias argued that, during a recession, government spending can put unused resources to work. The problem is that, even in a recession, the spending must be financed by borrowed dollars that would have otherwise been employed elsewhere in the economy. Congress can borrow $10 million from the residents of Anytown to re-open an idle factory in Flint, Michigan. But this leaves Anytown’s residents with $10 million less to spend, which (by the same logic) will cause the idling of resources there. So rather than create new economic activity and multiplier effects, the stimulus has merely transferred them to a new town (my report covers the case of foreign borrowing as well).
Stan Collender asserted that people and businesses aren’t spending their money, so Congress can increase demand by transferring it from “savers” to “spenders.” This argument — which I dealt with at length in my report — ignores the existence of the financial system. Savings do not drop out of the economy. Nearly all people invest their savings, or put it in banks, which lend it out to others to spend. Thus, the financial system transfers one person’s savings to someone else who can spend it. The only savings that drop out of the economy are those hoarded in mattresses and safes.
Collender may contend that recession-weary banks are hoarding savings well beyond the legal minimum reserves. Yet even when banks hesitate to lend their deposits, they invest them in Treasury bills to keep them circulating through the economy and earning interest. In fact, the federal funds market — where banks lend each other any excess cash at the end of the day — exists because banks refuse to sit on unused cash even overnight. Thus, even in recessions, one person’s savings quickly finance another person’s spending.
Yes, we hear about “excess reserves” in the banking system. But those aren’t customer deposits being hoarded in massive bank vaults. Rather, they represent a glut of new dollars held at that Federal Reserve that have not yet been injected into the economy. Held at the Fed, those reserves are not financing the stimulus (more here and here).
Stimulus spending advocates like Collender must be able to show that nearly all the money lent to Washington would have otherwise sat idle in mattresses and bank safes (where it could not be consumed, invested, or deposited in banks for investment spending). Otherwise, Washington is merely a middleman transferring purchasing power from one part of the economy to another — and the justification for government spending as stimulus collapses.