Fiscal Stimulus: The Evidence Based View, As Opposed to the Keynesian View

I hear, too often these days, people saying: "well, but fiscal policy only works if you take the Keynesian view." But it's not the Keynesian view: it's the evidence-based view.

And it's the monetarist view too, although in the monetarist view the explanation is a little roundabout: fiscal policy by increasing the amount of government debt outstanding raises interest rates, which increases the money multiplier and thus the money stock (as banks take advantage of higher yields by stretching their reserves further to cover more deposits), and further increases the velocity of money (as households and businesses find it more expensive in foregone interest to keep their wealth in cash, and so try to spend their cash more rapidly).

Nevertheless, when you do the math, the effects of expansionary fiscal policy through the monetarist bond-supplies-and-interest-rates-and-money-multiplier-and-money-velocity channel is exactly the same as the effects of expansionary monetary policy through the national-income-accounting-income-expenditure channel. (Walras's law, you know: that in fact was one of the major points of Hicks (1937).)

Here's Christina Romer with evidence on the current episode:

The Argument from the Consensus of Other Countries:

Virtually every major country has enacted fiscal expansions during the current crisis. They have done so... because it works:

The Argument from the Second Derivative of Production and Employment:

The rise in GDP growth from the first quarter to the second was the largest in almost a decade, and the second largest in the past quarter century:

The Argument from Forecasters' Models:

[A]nalysts estimate that fiscal stimulus added between 2 and 3 percentage points to real GDP growth in the second quarter:

The Argument from Cross-Country Comparisons:

[W]e started with a set of forecasts of growth in the second quarter of this year that were made last November – after the crisis had hit, but before countries had formulated their policy response. We then collected analysts’ recent best guesses for what second-quarter growth will be in those countries. This figure shows the relationship between how countries’ second-quarter growth prospects have changed from what was expected back in November, and the countries’ discretionary fiscal stimulus in 2009:

The Argument from Looking Across States:

States that received more funds lost fewer jobs:

On the theoretical side, it is very hard to build a model in which fiscal expansion has no effect on nominal income. You need [a] infinite-horizon rational households without liquidity constraints, [b] no distributional effects, and [c] government purchases providing utility in a manner that is a perfect substitute for private consumption spending. Otherwise it just doesn't go through.

Comments

[MinAkkar20:]

You don't need an economist to tell you that giving people money for nothing in the short run will boost economic activity. If you look at our stimulus bill the majority of it is for unemployment, welfare, and state & local government payroll. These all provide for consumption, not investment. When two components of GDP are government spending and consumer spending of course GDP will increase under a stimulus like ours. That doesn't mean it "works". It merely means we are borrowing from future growth for current consumption. Your three conditions listed at the bottom of your article are telling because none of them exist in our stimulus plan.

Also, there is a difference between certain countries in the chart. One is that China can fund stimulus from government reserves. In doing so, it is foregoing purchasing treasuries to invest in domestic production. Meanwhile, the US is borrowing/creating fiat money to fund its stimulus. Our politicians understand nothing about the marginal utility of debt...

Aug 13 08:50 AM

[Gregman2:]

So, it would appear that the monetarist thesis, with respect to velocity of money has not panned out?

Aug 13 12:32 PM

[It Figures:]

Your "evidence" is anecdotes. Your experiment lacks a control. Besides the consensus thinking of Wall Street and some academics, where's your proof a recovery wasn't already in the works - stimulus or not?

It was October, before the election, that Buffett publicly said buy stocks. Many others did as well. Do you think they didn't know a recovery was around the corner, well before we even elected a President, much less any talk of size or shape of a stimulus package?


As for the argument that it must work because everyone is doing it - is that a joke? Politicians spend money, whether they have it or not, because that's what they do. Show us some instances of when they DON'T spend and you will be more persuasive.


This recovery is what standard business cycle theory, and automatic stabilizers, are all about. Downturns are followed by upturns, stimulus or not.

Did the stimulus influence the upturn? Probably. Did it cause it? Not proved.

Aug 13 11:26 PM