The Stimulus Spending Bill: Is It Working at All?

In the November 2, 2009 TIME magazine artilce "The Stimulus Spending Bill: Is It Working at All?," Justin Fox explains that much of the criticism of stimulus spending is misguided.

The $787 billion American Recovery and Reinvestment Act that Congress approved last February was the first major legislative accomplishment of the Obama White House. Lately, it has also become one of Washington's most frequently tossed political footballs.

Here's the play-by-play from a few days in mid-October. House Republicans wrote (and released to the public) a letter to the President in which they claimed that with the unemployment rate at 9.8%, "it is now evident that the massive 'stimulus' spending bill enacted months ago has been unsuccessful." Obama economic adviser Larry Summers stepped up to play defense. "Thanks largely to the Recovery Act ...," he wrote, "we have walked a substantial distance back from the economic abyss and are on the path toward economic recovery."

The next counter came in a memo to House Republicans from economist and former John McCain adviser Douglas Holtz-Eakin, who wrote, "Jobs keep disappearing ... and the Obama Administration's only apparent plan is to double down on a failed strategy for economic stimulus." The next day, the White House went on offense, hailing a preliminary report on stimulus job creation (30,000 jobs directly created or saved by the first $16 billion in spending). House minority leader John Boehner retorted that such exulting was "beyond the pale" because "3 million private-sector jobs have been lost since it became law."

Who's right here? Well, first, the Republican argument that the stimulus is a bust because jobs have been lost fails a basic logic test. After last fall's global financial shock, the job market was going to be thrown for a loss no matter what. The issue is whether the number of job losses is greater or lesser than it would have been in the absence of the stimulus. "You can't answer these questions without a compared-to-what," says Jared Bernstein, economic adviser to Vice President Joe Biden, who is overseeing the stimulus. "We can have good arguments about the baseline, but a critique that doesn't evoke the baseline is useless."

I got my rough baseline from a conversation at the height of last fall's financial panic with Barry Eichengreen, an economist at the University of California, Berkeley, who is an expert on the Great Depression. "I doubt that we'll be able to avoid double-digit unemployment," he told me. "But I'm still confident we can avoid 24% unemployment like in 1933."

By that standard, we're doing O.K. But Bernstein and Christina Romer, the chairwoman of the President's Council of Economic Advisers, made the mistake of providing a more optimistic baseline last January — a forecast in which unemployment peaked at 9% without the stimulus bill and stayed below 8% with it.

Unemployment has of course passed both those mileposts and is probably still rising. ("I have noticed," Bernstein says dryly.) This overshoot says more about the inadequacy of economic-forecasting models than about the efficacy of the stimulus. But the White House cites these same kinds of models in claiming that the stimulus added between 2 and 3 percentage points to economic growth in the second quarter and 3 points in the third quarter. This may be correct as far as general direction — my unscientific assessment (a.k.a. guess) is that it is — but the exact numbers are probably bunk.

The political back-and-forth on the stimulus bill is the ultimate in bunk, though, because it ignores most of the fiscal stimulus provided by Washington so far. Anytime the Federal Government spends more than it takes in, it creates fiscal stimulus. That stimulus (deficit) was $1.4 trillion for the just-ended fiscal year, up about $1 trillion from the year before. The stimulus bill accounted for just $200 billion of that increase, according to the Congressional Budget Office. Bailing out banks and other financial firms cost $245 billion. A $419 billion drop in tax receipts (due mainly to recession, not legislation) without an offsetting spending cut was the biggest factor in the deficit's rise. Then there are the trillions of dollars the Federal Reserve put into asset purchases and other programs — surely the biggest stimulus of all.

Why don't we hear constant political debate about these other stimulus efforts? Presumably because they were the result of bipartisan legislation or were the doing of the nonpartisan Fed. That is to say, the Obama Administration can't take full credit for the bulk of the stimulus, and the Republicans can't disown it. So neither side talks much about it. Over the coming year these other forms of stimulus will — one hopes — be ratcheted back, while stimulus-bill spending will peak. At that point the great stimulus debate might actually start to matter. Until then, there's better football to be watched elsewhere.

The (confused) economics of cash for clunkers

According to Justin Fox in his August 4, 2009 article "The (confused) economics of cash for clunkers" in TIME magazine:

It all began a year ago with a suggestion from a prominent economist. Wrote Princeton University's Alan Blinder in the July 27, 2008 New York Times:

Economists and members of Congress are now on the prowl for new ways to stimulate spending in our dreary economy. Here's my humble suggestion: “Cash for Clunkers,” the best stimulus idea you've never heard of.

Now, of course, cash for clunkers is a spectacularly successful—and controversial—reality. The rebate program that rewards people for turning in older gas hogs and replacing them with more efficient new cars has run through its $1 billion in funding in a matter of weeks. The House voted 316-109 Friday to expend another $2 billion on the program. In the Senate it's looking to be more of a battle. The most interesting debate about Cash for Clunkers, though, may be the one among economists.

Blinder, a respected former Federal Reserve vice chairman and member of President Clinton's Council of Economic Advisers, pitched cash for clunkers as a program to stimulate the economy in a way that was both environmentally friendly (because it got polluting, gas-guzzling cars off the road) and helped the poor (because low-income Americans tend to be stuck with the least-efficient cars). The idea of cash for clunkers wasn't new—such programs have existed at the state level ever since the Clean Air Act amendments of 1990 encouraged states to pursue market-based approaches to improve air quality. What was new about Blinder's pitch was its combining of environmental objectives with Keynesian economic ones.

Now that cash for clunkers is reality, can we say that it has achieved those objectives? Well, as so often with economic matters, the answer seems to be, it depends.

* Stimulus. By all accounts the program has driven a rush to car dealers. Auto sales in July were at their highest pace in 11 months. In an e-mail to clients Monday, Credit Suisse economist Neal Soss revised his economic growth forecast for the third quarter from 1.3% to 2.0%, and for the fourth quarter from 2.0% to 2.5%—all on the basis of cash for clunkers' success. Of course, to believe this you have to believe the Keynesian story that deficit spending by the government actually can stimulate the economy. There's a rearguard of conservative economists who think that such spending has little impact, but their arguments haven't been very convincing lately (Justin Lahart has a nice summing-up of the debate in the WSJ today). There are other economic concerns about cash for clunkers, though. It distorts incentives, which over time can lead to all sorts of weird side effects (economist Steven Levitt suggested, back when Blinder first proposed the idea, that "one of the most visible responses to this program" might be "a new market for mechanics fixing up cars that don't run at all just enough so that they can be driven to the government's lot to collect the cash,"1 and commenters to this blog offered a several caveats of their own when I floated the idea last fall). Also some economists caution that the boost in economic growth brought by junking older cars and replacing them with new ones may be mostly chimerical—since the lost value of the junked old cars isn't reflected in economic statistics. Still, seen strictly as a means of getting money temporarily flowing into a particularly stricken part of the economy, cash for clunkers does seem to be working spectacularly well. For whatever that's worth.

* Environment. Cash for clunkers programs arose in the U.S. and Europe in the 1990s as environmental measures intended to get the most polluting cars off the road. The two main assessments I've been able to find of their effectiveness, a 1992 study (pdf) by the late and lamented Office of Technology Assessment (OTA) of an early cash-for-clunkers pilot program in Southern California and a 1999 report by the European Conference of Ministers of Transport (ECMT), both came down on the positive side, but only barely. The design of the program was deemed crucial. The initial California program was aimed only at pre-1971 vehicles, which made it very effective because those cars predated modern emissions standards and concerns about fuel economy—they were truly clunkers. Schemes to scrap cars that were less old and decrepit, the OTA said, would deliver less bang for the buck. The ECMT, meanwhile, concluded that "cash-for-scrappage" programs (where you just turn in your old car and get a check) could be cost effective ways of reducing emissions but that "cash-for-replacement" programs (the payment for scrappage is contingent upon buying a new car) generally were not—in part because stimulating the production of new cars meant increasing emissions from manufacturing. The current U.S. cash for clunkers program is (a) not targeted only at older vehicles (vehicles more than 25 years old aren't even eligible) and is (b) a cash-for-replacement scheme. So it probably can't stand on its own as a positive environmental step, even though the gas mileage of the new vehicles purchased so far has been encouragingly high. There is, however, an intriguing international complication: In a new paper, economists Lucas Davis and Matthew Kahn describe how the North American Free Trade agreement has enabled big-time exports of used cars from the U.S. to Mexico. This export flow has improved the gas mileage and emission standards of the Mexican automotive fleet—but because it has enabled Mexicans to keep driving cars that in the U.S. would have been scrapped, Davis and Kahn estimate that it has increased overall emissions. A cash for clunkers program would slow the export flow to Mexico, thus reducing at least that particular source of auto emissions (while also depriving some Mexicans of cars, of course).

* Income distribution. A cash-for-scrappage program—which is what Blinder was suggesting a year ago—could potentially be a boon to poor people who could replace their clunkers with less-polluting and more fuel-efficient but still cheap used cars. In the interest of boosting the beleaguered auto industry, the current cash for clunkers program requires that those who turn in old cars buy brand-new ones. No help for the poor there.

In short, the economic verdict is ... complicated. But what did you expect?

Update: Now I've gotten Alan Blinder's (brief) take on how things are panning out:

"I always thought that cash for clunkers would be an effective stimulus, but it seems to have exceeded expectations. It would be a shame to cut it off here. The original bill was way under-budgeted.

That said, I wasn't happy with the design details, which pay too little attention to environmental concerns."

1. bryanfromhouston points out in the comments that Levitt's concern doesn't apply to the cash for clunkers bill that Congress actually passed, which requires those who trade their clunkers in to have had them insured for at least a year.

Should regulations of markets be simplified?

In his June 26, 2009 TIME magazine article, "Dumbing Down Regulation," Justin Fox argues for simplified regulation of markets:

If only our financial regulations were dumber! It's not a cry you hear often. But phrased a little differently, it may be the most cogent criticism of the convoluted regulatory approach of recent decades--and one that applies to most of the Obama Administration's financial-reform proposals.

The argument goes like this: the biggest flaw in current financial regulation is not that there is too little of it or too much, but that it relies on regulators knowing best. We regulate because financial systems are fragile, prone to booms and busts that can have harmful effects on the real economy. But regulators aren't immune to the boom-bust cycle. They have an understandable habit of easing up when times are good and cracking down when they're not. In doing so, they often amplify the ups and downs of markets rather than modulate them. (Watch TIME's video of Peter Schiff trash-talking the markets.)

You can spin this into a case for reduced regulation--regulators are likely to mess up, so why bother? But it can also point toward an approach based not so much on discretion as on rules, the simpler the better. I first encountered this argument last fall in the work of left-leaning blogger Matthew Yglesias--he advocated "crude measures" like the old ban on interstate banking. Lately, though, I've been hearing similar suggestions from those of a conservative, University of Chicago bent. "When you give a lot of discretion to regulators, they don't use the tools that are given to them," Chicago economist Gary Becker said at a conference this spring. His prescription: rules, not leeway.

The antidiscretion case has been made for years with regard to Federal Reserve monetary policy. Becker's Chicago teacher Milton Friedman thought that instead of tweaking interest rates, the Fed should just automatically increase the money supply 3% to 4% a year. Measuring the money supply in an era of financial innovation has turned out to be awfully hard, so in recent years believers in an automated Fed have turned to an equation concocted by Stanford economist John Taylor that takes in inflation, current economic growth and long-term-trend growth and churns out a suggested Fed interest-rate target. Taylor and some other conservatives have said that if the Fed had followed his rule in the early 2000s, all would be well today. There's no way of knowing if this is true, but it's hard to see how it could have led to a worse outcome than the monetary course chosen by the smarties at the Fed.

As for other forms of financial regulation, many conservatives long thought that few, if any, were needed, but the crisis has changed some minds. Alan Greenspan's famous October admission that his antiregulation ideology had failed was a landmark on this front. Federal judge and Chicago Law School professor Richard Posner's new book, A Failure of Capitalism, is another. In it, Posner fingers financial deregulation as a major cause of the crisis. He's less clear about what we ought to do now, although one of his suggestions very much fits the crude-measure standard: we should consider raising income taxes on high earners "in order to reduce their appetite for risk-taking."

Capital requirements are an area in which many observers think dumbing down is in order. Regulators spent decades fine-tuning their risk-weighted capital rules, in some cases using the supposedly sophisticated risk models developed by banks themselves. The result was ratios of debt to capital that topped 35 to 1 at some investment banks. Oops! A simpler, cruder standard (say, 10 to 1) surely would have worked better.

Then there's the 1933 Glass-Steagall Act, which separated commercial banking from other financial endeavors. By the time Congress repealed the law in 1999, it seemed utterly out of step with the times, but now many economists are wondering if there is something to the idea of separating risky financial activities from essential ones. Or we could tax financial transactions, a policy suggested as far back as 1929 by Virginia Senator Carter Glass (he of the Glass-Steagall Act) and now identified most closely with the late Yale economist James Tobin. In the 1970s, Tobin proposed a tax on currency trades to throw "sand in the wheels" of international finance and damp speculation.

Larry Summers, now the top economic adviser in the Obama White House, was a proponent of such taxes in the 1980s and early 1990s. There's no hint of them in the Administration's 88-page white paper on financial regulation. There is talk of higher capital requirements, tougher consumer-protection standards and new rules for derivatives. But taken as a whole, the document sketches a regulatory approach that still relies heavily on judgment and smarts. Maybe it's time for some dumbing down.

The Myth of the Rational Market

In "The Myth of the Rational Market," Justin Fox explains how the assumption that markets are rational is a fallacious one.