{"id":18363,"date":"2012-02-24T18:29:42","date_gmt":"2012-02-24T07:29:42","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=18363"},"modified":"2012-02-24T18:29:42","modified_gmt":"2012-02-24T07:29:42","slug":"the-lesson-for-the-europeans-is-that-the-us-fiscal-stimulus-worked","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=18363","title":{"rendered":"The lesson for the Europeans is that the US fiscal stimulus worked"},"content":{"rendered":"

\t\t\t\tToday, I was reading the latest report from the US Congressional Budget Office – CBO’s Estimates of ARRA’s Economic Impact<\/a> – which shows that the American Recovery and Reinvestment Act of 2009 (ARRA) has been successful in increasing real GDP growth in the US and reducing the rise in the unemployment rate. Some simple calculations reveal that in the absence of the ARRA US economy would still be in recession. That is, taking a European trajectory. There is also evidence that the Obama administration were presented with analysis that showed that a much larger stimulus than was chosen was necessary, yet this information was suppressed in final documents that were the basis of the fiscal intervention. It seems that the neo-liberal ideologues within the Obama camp deliberately undermined the fiscal intervention and so its impact, while positive, was far less than was required. I also read an interview with the ECB president, Mario Draghi today. The ECB is now pushing fiscal austerity as the only way out of the Euro crisis. In juxtaposition to the US experience, the Europeans remain fixed to the view that saving the flawed institutional structure (that is, the EMU) is a higher priority than insuring that people prosper. The lesson for the Europeans is that the US fiscal stimulus continues to work.
\n
\nThe New Yorker published an interesting article (January 30, 2012) – The Political Scene – The Obama Memos<\/a> – which details <\/p>\n

The New Yorker article said that the “fifty-seven-page memo to the President-elect, dated December 15, 2008, written by Larry Summers, his incoming director of the National Economic Council” framed the approach that Obama took in dealing with the crisis as he considered his presidency.<\/p>\n

The document “which has never been made public” indicated that the “The U.S. economy had lost two million jobs that year; without a government response, it would lose four million more in the next year”. You can see the final memo – HERE<\/a>.<\/p>\n

The advice that the in-coming President was given by Summers was that “the government was already spending well beyond its means” and that the challenges of the crisis would require a politically difficult “explosion of government spending”.<\/p>\n

Evidently, Christina Romer sought a larger deficit and was asked by the “incoming chief of staff, Rahm Emanuel” – “What are you smoking?”. The hawkish nature of the Obama response was also driven by “Peter Orszag, the incoming budget director”.<\/p>\n

The Summer’s memo stressed the “economic” need to constrain the size of the stimulus. In other words, there was no case made on political grounds (that is could not get through the US Congress).<\/p>\n

The Obama options (maximum stimulus of $US890) was less than 50 per cent of the estimated output gap in 2009 and 2010.<\/p>\n

The New Yorker quotes the memo as saying:<\/p>\n

\nAn excessive recovery package could spook markets or the public and be counterproductive … [none of the options] … returns the unemployment rate to its normal, pre-recession level. To accomplish a more significant reduction in the output gap would require stimulus of well over $1 trillion based on purely mechanical assumptions – which would likely not accomplish the goal because of the impact it would have on markets.\n<\/p><\/blockquote>\n

So the Obama decision-making was driven by mainstream macroeconomics textbook fears about crowding out. Why didn’t Obama ask Summers to explain how it was that Japan had run rising budget deficits for around 17 years (at that time) yet still managed to maintain interest rates (and bond yields) and around zero over that period?<\/p>\n

Summers might have taken time to understand how the Bank of Japan manages liquidity in the monetary system to achieve zero interest rates. The point is that there is no robust between budget deficits and interest rates.<\/p>\n

Currency-issuing governments can always maintain a low interest rate environment, irrespective of the current fiscal stance.<\/p>\n

The crowding out hypothesis is based on a flawed understanding of the way banking operates. Subject to capital constraints, banks stand ready to lend to credit-worthy customers on demand. There is no finite pool of savings available which public and private debt compete for as is envisaged in the whole classical loanable-funds doctrine.<\/p>\n

There was an interesting follow-up to the New Yorker article in the US Magazine The new Republic<\/a> this week (February 22, 2012).<\/p>\n

The article – The Memo that Larry Summers Didn’t Want Obama to See<\/a>. added some further understanding to the development of the 57-page memo..<\/p>\n

The article written by Noam Scheiber detailed how the “57-page memo that Barack Obama’s incoming economic team prepared for him in late 2008” was edited by Larry Summers to exclude a larger stimulus option.<\/p>\n

Noam Scheiber presents a comparison<\/a> between the original draft document and the final document authored by Summers. He also makes the Original Romer Memo<\/a> available.<\/p>\n

The substantive difference is that the Romer proposals included a $US1.7 trillion stimulus which would have closed the estimated real GDP gap (that is, restored the CBO estimate of full employment – which as you will appreciate is biased upwards).<\/p>\n

The following Table compares the two stimulus options. The top rows show the original Romer proposal (3 options) while the actual Memo presented two options – $US655 and $US880 billion.<\/p>\n

It is also clear that Romer was using larger fiscal multipliers than were used in the final memo. This probably reflects the fact that Summers and Orzag were deficit hawks and probably struggled with prospect of proposing a major fiscal stimulus.<\/p>\n

\"\"<\/a><\/p>\n

<\/div>\n

So from the outset, Obama deliberately set about allowing the US economy to deteriorate and he knew that the unemployment rate was going to rise to at least 7.3 per cent and he chose to forgo (on the estimates available) approximately 2.4 million jobs across the US.<\/p>\n

Noam Scheiber provides a chronology of how the the original draft was altered and that the larger fiscal stimulus proposal was “dismissed … as impractical”.<\/p>\n

It is clear that the stimulus wasn’t large enough given that the US Congressional Budget Office currently estimates the US GDP gap<\/a> to be somewhere between 5.3 and 5.6 per cent. Which suggests that the Romer-Summers estimates of the gaps were rather conservative to say the least.<\/p>\n

This is not to say that the fiscal stimulus was introduced was ineffective. It’s really a debate about how much of the GDP gap the government chose to close.<\/p>\n

The US Congressional Budget Office released its latest (February 22,2012) – CBO’s Estimates of ARRA’s Economic Impact<\/a> – which shows that the American Recovery and Reinvestment Act of 2009 (ARRA) – aka as the fiscal stimulus – “had the following effects in the fourth quarter of calendar year 2011 compared with what would have occurred otherwise”:<\/p>\n

\n