by Mario Rizzo
In Sunday’s New York Times, Paul Krugman says:
“From the beginning, I argued that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow over time — and that the stimulus has played a significant role in pulling the economy out of its free fall.”
He admits a mistake of a sort. However, he does say that fiscal stimulus is the “[l]ast and probably least, but by no means trivial…[of] the deliberate efforts of the government to pump up the economy.”
The over-all theme of the article is that big government is our salvation.”[U]tter catastrophe no longer seems likely…Big Government, run by people who understand its virtues, is the reason why.”
Post hoc ergo propter hoc?
How do we know that fiscal stimulus played a non-trivial or any helpful role in the apparent easing of the rate of decline in economic activity? I think we need a theory and evidence.
Now, of course, there is no dearth of Keynesian theories – all leading to same policy conclusion. If recession, then more (government) spending. But what is the mechanism by which about $70 billion in extra spending (this is the amount of the total stimulus package now spent) reduces the rate of increase in unemployment and reduces the rate of decrease in output in a $14 trillion economy? If my advanced arithmetic is correct this is ½ of 1 percent of the GDP. What kind of Super Multiplier is that?
However, things are more disturbing than that. Just a couple (or so) weeks ago President Obama said that not enough of the stimulus had been spent yet and so it was too early to expect results. But mirabile visu! The Almost Recovery has appeared. (It seems more like political opportunism instead.)
Climbing higher on the disturbance ladder, we see that the early (Jan.) simulations of the economy with stimulus versus the economy without stimulus were quite off the mark. We are already worse off (in unemployment) than we were supposed to be with the stimulus. We are about where it was said we would be without the stimulus. Did the stimulus have no effect? Quite impossible, of course!
Climbing even higher on the ladder. People may react to these failed predictions as simply failed forecasts because things were even worse than we had first thought (Larry Summers’s argument). The future is hard to predict.
But the past and present are also hard to predict. What do I mean? The statement that the stimulus has already saved or created a certain number of jobs is not a brute fact – like the presence of the table upon which I am writing. (This is not literally a brute fact, but let that pass.) It is the implication of a theory or a model about how the economy is supposed to work. Suppose the economy is hypothesized to function as a more or less Keynesian mechanism. Let us say that looking backward, the model fit the actual economy’s behavior over the relatively normal past. We shock or “stimulate” it with various amounts of spending. Then, if previous relationships hold, we get results.
Since forecasting is usually a terribly inaccurate business, using a model – no better than any – to tell us what would have happened if we did not have the stimulus is not likely to produce reliable results – even under normal conditions. Is it reasonable then to think that such a model or models based on past data will fit these abnormal times? Recall economists of many stripes have been telling us that we are in unprecedented times.
When such models are used for forecasting, the future comes into actuality and we see how far wrong we were. But contrary-to-fact worlds don’t occur to test the “prediction” of how well off we would have been. (How well do these models predict where we are? We’ll have to see.)
Let me go back to Krugman’s article. I italicized an interesting phrase. Big government can work when it is run by people who understand its virtues. He should have said big government can work when it is run by people who themselves determine how well it works.
The pop-Keynesian intellectual trap tightens.