Friday, January 14, 2011

Failing Stimuli and the Great Recession

Policymakers in the United States have thrown everything they can at the "Great Recession."  Putting aside efforts to rescue specific firms (like AIG or GM) or industries (TARP), which seem to me more complicated cases, the federal government has taken both of its big anti-recession dogs for a walk: fiscal stimulus (borrowing money against future revenue collections to spend now) and monetary stimulus (printing more money to put into circulation).  Neither seems to be doing much, though.

The economy is growing, but its not growing fast enough to add enough to keep up with growth in the labor market.  In general, the whole situation seems like a major win for real business cycle theory.  Having said that, though, I think there is some reasonable historical  evidence that Keynesian and monetarist interventions have had more substantial, positive effects on economic growth. That leads me to some interesting questions: Have the effects of stimulus interventions declined over time?  Have we reached a tipping point beyond which stimuli are not longer sufficiently beneficial in the short run to justify their long runs costs?

My hunch about the first is that stimulus activities are less effective than they used to be for at least reasons.

1. Better information and increased sophistication.  Individuals and firms---particularly the latter---are increasingly better informed about economic policy and its implications (via increased formal education about economics in business education, new sources of economic analysis like cable business news channels, and widely accessible computerized forecasting tools for example) and more sophisticated in their approach to using policy information in spending and investment decisions.  Increasingly, economic actors see through stimulus actions---we know that a deficit has to be repaid by future taxes and that more money in circulation just reduces the value of the dollars we already had.  Handing out stimulus checks or Monopoly money won't catalyze as much new activity from those waiting for the boomerang to come back at them.  Our collective animal spirits are harder to manipulate than they used to be, which reduces the aggregate effectiveness of a stimulus policy.

2. Less elite consensus about the value of stimulus.  Same idea in some ways.  A stimulus depends on motivating "spontaneous optimism rather than mathematical expectations."  A stimulus works (if it works), in part, because it creates confidence.  When people get more confident, they pull money out of their savings accounts, CDs, and mattresses to invest in new ventures and to buy stuff.  Firms get capital to expand, retailers profit, manufacturers get more orders, win, win, win.  When political elites and professional economists give us a unified diagnosis of our economic malady and, in unison, propose taking the same medicine, ordinary economic decisions makers in firms and families may actually get the psychological boost they need to flip their mindset from hoarding to binging (at the margins, of course).  When politicians and economists disagree amongst themselves and express only mixed support for a proposed solution, even the same policy enactment will have less impact on psychological dispositions to spend and invest.  This would reduce the effect of a stimulus policy.

3. Globalization.  Even if the US government can stimulate US consumers into spending and investing, we are increasingly spending and  places besides the US.  Let's just say that Nancy Pelosi's claim that a dollar of stimulus spending nets two dollars of economic growth is right.  In 1960, almost all of that second dollar stayed in the US.  American consumers largely bought products made in American factories, and American investors largely invested in American firms.  In 2010, not so much.  A stimulus program in the US may, indeed, stimulate just as much total economic growth as it did in the past, but that economic growth is dissipated globally.  Again, this would reduce the effectiveness of stimulus policies for growing the domestic economy, and, as a result, Americans would end up subsidizing economic growth in other countries.

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