A Reply to Jonathan Chait on Stimulus

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CRITICS AUGUST 23, 2010

A Reply to Jonathan Chait on Stimulus

Jonathan Chait has responded to my post about our lack of knowledge about the practical effects of stimulus spending. He seems to be taking on opinions that aren’t mine.

Chait begins his reply by claiming that I “oppose any stimulus at all.” This is a position which I did not present in the post, and which I do not hold. In fact, I have consistently advocated stimulus in the face of the current crisis, and generally in venues that are not as hospitable to this idea as The New Republic.

I was arguing in my post that we should approach stimulus with appropriate humility about our knowledge, not that we should never execute such a policy. That’s why the sentence in my post that immediately follows those Chait excerpted, is: “What I am trying to describe here is not a policy per se, but an attitude of epistemic humility.”

Chait then moves on to criticize the reasoning behind my imagined position against any stimulus spending.

His first argument is that he was only saying we can’t measure stimulus precisely, but that we still know enough to act with confidence:

First, and more importantly, I was arguing that the precise effect of the stimulus can't be measured. That doesn't mean we have no idea whether it worked. There is a general, though not unanimous, consensus within the economic field that increasing spending or reducing taxes temporarily increases economic growth. Basically, we do know the rules -- increasing the deficit in order to pave some roads and cut taxes for middle-income people will increase the size of the economy; the primary debate is just how much.

Now, it's true that the conservative movement has invested a great deal of time into throwing cold water on this basic consensus. I think this campaign should be viewed as largely political.

Chait correctly identifies this as the most important of his arguments, so I’ll spend the most time replying to it. The problems with this criticism are that: (1) it is false, (2) it is a straw man, and (3) by far most important, it doesn’t address my point.

1.       It is false.

Chait is trying to define the position that stimulus will not increase output as intellectually illegitimate. (Though, again, this is not a claim that I have made.)

It is certainly true that a large majority of professional economists accept the view that “increasing spending or reducing taxes temporarily increases economic growth”—but that is very far from claiming that disputing it is largely a political campaign. Robert Barro, Professor of Economics at Harvard, John Cochrane, Professor of Finance at the University of Chicago, and Casey Mulligan, Professor of Economics at the University of Chicago, have each separately argued that it is somewhere between plausible and likely that the multiplier for stimulus spending under relevant conditions is indistinguishable from zero (i.e., that stimulative spending will not materially increase economic output). According to surveys of professional economists reported by Greg Mankiw, about 10 percent of economists do not agree with the statement that “Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy.” Both the Wall Street Journal and the Financial Times have run opinion columns expressing the view that a multiplier of zero is a plausible to likely theory.

I have not been afraid to call out influential conservative activists when I believe they are engaging in crank refusal to accept a scientific finding. But in a genuinely scientific field which has accepted a predictive rule as valid to the point that there is a true consensus—such that the only reason for refusal to accept it is crankery or, in Chait’s terms, “politics”—you don’t usually see: several full professors at the top two departments in the subject, when speaking directly in their area of research expertise, challenge it; 10 percent of all practitioners in the field refuse to accept it; and the two leading global general circulation publications in field running op-eds questioning it.

2.       It is a straw man

If the U.S. government were to borrow and spend $1 trillion with the sole result of increasing U.S. GDP in Q4 2010 by $1, it would have “temporarily increased economic growth”—but no sane person would advocate such a policy. It would not be, in either the common-sense meaning of words, or in the terms of my post, a stimulus policy that “worked.” The relevant policy question is whether stimulus spending “temporarily increases economic growth” enough to make such a policy rationally advisable . Economists are all over the place on their estimates for impact of stimulus policy across the range that is relevant to the policy decision.

A great many leading economists may accept the proposition that enough stimulus spending will probably cause at least some increase in output for a short period of time in some circumstances, yet are still uncomfortable with the kind of stimulus spending strategy that is the actual subject of current political debate. In 2009, James Buchanan (1986 Nobel Laureate in Economics), Edward Prescott (2004 Nobel Laureate in Economics), and Vernon Smith (2002 Nobel Laureate in Economics) promulgated this statement:

“Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we do not believe that more government spending is a way to improve economic performance.”

3.        It doesn’t address my point

It is nerdy-sounding, but I believe critical to this discussion, to distinguish between measurement and knowledge. I made a very strong claim about measurement, and a very specific claim about knowledge.

I claim that we cannot usefully measure the effect of the stimulus program launched in 2009 at all. We can call this a “natural experiment” all day long, but in the absence of a control case, we cannot know what output would have been had we not executed the policy. Econometric models are not sufficient to estimate this counterfactual. Therefore, there is no achievable level of output in the United States in 2010, 2011, and so on that would enable a definitive answer to the question, “What was the effect of stimulus spending on output?” See, for example, in my original post, the response of leading economists when confronted by unemployment with stimulus that turned out to be higher than they projected unemployment would be without stimulus:

Ms. Romer famously projected in January 2009 that without government support, the unemployment rate would reach 9%, but with support the government could keep it under 8%. It’s 9.5% today.

Some Obama administration officials privately acknowledge they set job-creation expectations too high. The economy, they argue, was in fact sicker in 2009 than they and most others realized at the time. But they insist unemployment would have been worse without the stimulus.

All potentially useful predictions made about the output impact of the stimulus program are non-falsifiable. Failure of predictions can be simply justified by this sort of ad hoc explanation after the fact.

And pace Chait’s argument that private forecasters’ models all estimate a positive effect from the stimulus (implicitly because they all econometrically estimate a lower counterfactual than actually occurred), see Stanford Professor of Economics John Taylor’s analysis that adds to this list alternative economic models from the European Central Bank and Harvard that show no material effect of the stimulus. This argument will always degenerate back into endlessly dueling regressions, because there is no ability to adjudicate among them via experiment.

This does not mean that we have no knowledge about the potential effects of stimulus spending. It simply means that we have no scientific knowledge about this topic. Macroeconomic assertions about the effect of a proposed stimulus policy are not valueless, but despite their complex mathematical justifications, do not have standing as knowledge that can trump common sense, historical reasoning, and so on in the same way that a predictive rule that has been verified through experimental testing can.

When using stimulus to ameliorate the economic crisis, we are like primitive tribesmen using herbs to treat an infection, and we should not allow ourselves to imagine that we are using antibiotics that have been proven through clinical trials. This should not imply merely a different feeling about the same actions, but should rationally lead us to greater circumspection.

Chait moves onto to his second argument, which is that in the grand scheme of things $800 billion is not really that much money in comparison to the size of the financial crisis and the other potential future calls on the treasury:

Second, we are not really taking a "wild risk" by devoting $800 billion to mitigating the deepest economic crisis since the Great Depression. The long term fiscal cost of the stimulus is quite minimal

Sorry, no sale. $800 billion is a ton of dough, even for the U.S. government. You can’t rationally justify a spending program simply by claiming that it addresses a very big problem—you also have to make the argument that it will really do something about the problem. If I proposed spending $800 billion dollars of the people’s money pursuing a cure for cancer based on Pyramid Power, this would be a bad idea even if I could present a chart that showed the fiscal cost of cancer over the next 40 years dwarfed this amount of money. The overall advisability of any given proposed stimulus program is a contested question rather than crank theory, but that response goes directly to the point—the open issue that advocates must address is how effective it will be.

Chait then moves on to his third and final argument:

Third, Manzi suggests that remedies be as narrowly targeted as possible, reversible, and tested prior to implementation. The stimulus was pretty narrowly targetted. It consisted of spending and tax cuts designed to increase consumption. It is completely reversible in the sense that the spending and tax cuts are temporary.

I guess “narrowly targeted“ and “completely reversible” are subjective terms.

I haven’t reviewed the final law in detail, but I did take a pretty close look at the House bill as the stimulus debate proceeded in 2009. As of that bill, only about 1/7th of the spending portion of the bill (about $600 billion was spending and about $200 billion was changes to tax law) was expected to be spent in fiscal 2009. A majority of the spending was projected for fiscal years 2012 and beyond. To pick a couple of big items, about $20 billion was for “Medicaid and Medicare incentive payments to encourage providers to improve healthcare IT” and another roughly $19 billion was for “energy efficiency and renewable energy programs,” both of which may be excellent ideas, but it’s hard to see these kinds of long-term infrastructure projects being targeted on rapid expenditures to ameliorate a recession. Even the $45 billion or so on classic infrastructure like roads and bridges was mostly projected to be spent in the out-years.

How reversible would be the combination of various infrastructure investments (“Well, congressman, we could stop the construction with half the bridge done”) and increases in various unemployment, welfare, education and other social services programs—which together comprise the bulk of the spending—is a debatable political question. But imagine two illustrative scenarios. First, the U.S. emerges over the next few months into a recovery. The government, subject to normal grumbling, is mostly given credit for handling things the right way. Obama is reelected in 2012 and Democrats regain or retain control of Congress. Or second, we realize that we are in Japan-style decade of stagnation. Unemployment is stuck in the neighborhood of 10 percent. The mood of the country is deeply pessimistic, and government programs are a lifeline for a good chunk of the population. In which of these two scenarios is it realistic to expect that the 2009 increases to food stamps, unemployment compensation, healthcare benefits, or HUD housing assistance will really be rolled back in 2012–2015? Neither, as far as I can see.

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posted in: critics, the financial times, wall street journal, united states, casey mulligan, edward prescott, greg mankiw, james buchanan, john cochrane, john taylor, jon chait, jonathan chait, robert barro, vernon smith, european central bank, harvard, stanford, the university of chicago

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