Liars, Damn Liars and Averagers: The Wall Street Journal on Stimulus

Thursday’s WSJ opinion article “Stimulus Spending Doesn’t Work” should be titled “In the long run, stimulus spending doesn’t work because we are all dead.” The analysis of stimulus over averaged periods by Robert Barro and Charles Redlick seems to ignore Keynes famous guidance on economic analysis: “The long run is a misleading guide to current affairs. In the long run we are all dead.”

The article looks at three types of stimulus: Defense Spending, Non-Defense Spending, and Tax Cuts. There seem to be errors in each analysis but I don’t have access to the actual work so I could have the details wrong. Apologies in advance and an invitation to the authors for corrections.

First of all, Defense Spending is not intended for stimulus, so including it in an analysis of stimulus spending is wrong unless your intent is to prove the obvious. They probably proved that you should not increase defense spending if your intent is stimulus, but they averaged in times that just don’t apply to today. WWII should not have been included in this analysis as it was a nondiscretionary event involving total takeover of the economy by the government and conscription of every able bodied man 18 to 26 into the military or military activities. Modern defense spending is discretionary, at least at the margin where stimulus spending would take place so Vietnam, Cold War and Iraq spending are most representative of the effects of increased defense spending. These should be analyzed as discrete events to determine if starting a war gives more stimulus that just building non-productive weapons.

They stated that non-defense spending was more important than defense spending as stimulus and then dismissed analysis of it as “problematic” because government spending goes up with GDP increases. This is a surprising problem for Dr. Barro to have because he is a trained physicist as well as an economist and must be familiar with the concept of different physical states. It would be just as problematic to try to judge the properties of water without measuring the temperature that determines if it is ice, liquid or steam.

Once you recognize that the economy has different states, it is a pretty easy issue to get around and handled everyday in economic research. The Romers did a nice job in their analysis of the effect of taxes (see link below) by looking at the legislative reason for the tax change. One even easier method is comparing non-defense deficit spending as a percent of GDP to percent GDP growth. I’ve previously done a chart (below) of the total budget deficit (including defense) vs. % GDP growth and you can see a strong mirror image pattern that indicates strong negative correlation. This means that as total deficit stimulus spending becomes more negative, GDP grows faster. Removing defense spending should make this analysis indicative of the stimulative effect of just non-defense spending.

(Note: I originally did this analysis to point out that excessive deficit spending during a time of full employment from 2003-2007 seems to have resulted in the current recession. Too much of a good thing is bad.)

The tax analysis contains the biggest misuse of averages. The tax analysis looks at only the period from 1950 to today during which top tax rates were being cut from 84% to 35% on income and 25% to 15% on capital gains. FICA did increase from 2.2% to 10.8% but it covers only part of earned income so it is offset by income tax cuts. During this period, the marginal tax rate generally moved down and GDP generally grew so this is going to generate a correlation. This correlation is meaningless if the Great Depression and WWII is left out as this is when taxes were raised to high levels. It sounds like they did look at of discrete periods in this analysis but found reasons to discard some periods. The Romers in The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks did a better job of looking at the effect of tax changes during the post 1950 period though they did not directly address the issue of the general decline in tax rates.

The real bottom line is that because averages were used and data was excluded, the analysis does not indicate anything. The data they have may hold the secret to stimulus spending but they have not mined it yet.

The day this article came out, the market fell 2.5% from the sudden realization that things were not as good as thought. The claim in the WSJ that stimulus does not work eliminated the only tool left to moderate the decline and probably made the market decline worse.

Disclosure: None for this article

Comments

[logicalthought:]

>>The day this article came out, the market fell 2.5%... The claim in the WSJ... probably made the market decline worse.<<

lol... Yeah, sure-- a WSJ editorial drove down the market... Only in Rupert's DREAMS!

Oct 04 08:23 AM

[notsosmart:]

does WSJ really matter anymore. by the time its printed & delivered,in todays world,its old news.also,they have an agenda like everybody else.you have to think & figure out for yourself & trust to luck in this ponzi/casino wall st game.

Oct 04 09:39 AM

[socrateazz:]

I believe stimulus can work. But the effect is a later dampening in the economy from taking wealth back out of the economy. On the other side calling The actions of the last year a stimulus is like blowing up a balloon and saying the balloon is lighter because we added hot air. Seems to be true but is it? Stimulus is a short term thing and the Bush tax cuts were a very good example of such. The problems within the economy are systemic and manipulated by people I would call stupider than fools. They are so sure their beliefs are real that they ignore reality in favor of belief which does incidentally seem to be actuality

Oct 04 03:35 PM

[FourBrane:]

Socrateazz, tax cuts are not stimulative. It is shocking to hear so many intelligent people pretend that they are. What happens to tax money? The government spends every dime (and more), so taxed money always returns very quickly to the economy. On the other hand, individuals--most especially the wealthy--will generally "invest" large portions of the savings they get from tax cuts. Money they gamble on Wall Street is seldom productive or stimulative. Very little will ever cause a factory to increase output or a farmer to plant more corn. A significant portion winds up in Goldman-Sachs' shiny pockets or is lost into thin air when valuations decline. High stock prices just mean that the factory management rakes in millions in options money, pour their profits back into Wall Street buying some other company's stock so that a few more executives can pull billions out via their options packages. In short, six or seven thousand individuals get showered with cash beyond anyone's wildest need. It's like pouring all the fertilizer and rain on a ten square yards while the other acreage is left to fend for itself. That's not useful stimulation.

Oct 04 06:49 PM