Why It’s Hard to Make the Unpopular Stimulus Look Good

Some columnists have been using the 5-year anniversary of the 2009 discretionary fiscal stimulus package to claim that it worked to jump-start the economy.  It’s a tough case to make.  The very word “stimulus” has become a dirty word because so many Americans view it as a failure.

So the new argument admits that the stimulus failed politically, but chalks that up to a misinformed public that does not understand that it was a success economically.  Thus Ed Luce’s piece in the Financial Times is headlined “RIP Obama stimulus: funeral for a policy success,” while John Cassidy adds in the New Yorker that “Obama’s unpopular stimulus won’t be the last,” and Michael Grunwald writes in Time that “Politically, the White House lost the argument over the stimulus long ago, but it’s still nice to see the facts in black and white,” referring to report coming out of the White House arguing that the stimulus worked.

To make this case one has to claim that there is wide agreement among economists (not just current White House economists) that the stimulus worked.  Thus Ed Luce writes, “Rarely has the gap between the US public’s perception and that of economists been greater.”  But there is simply no such consensus among economists.  My research and that of others, shows that there is little direct empirical evidence that it had a significant effect. At best, there is divided opinion among economists about the stimulus.  Indeed, there has always been great deal of disagreement among economists on the efficacy of these temporary “Keynesian” stimulus packages. And during the 1980s and 1990s there was a huge amount of skepticism of their usefulness.

How do the new pro-stimulus arguments deal with the fact that there is clear disagreement?  Some ignore it and simply assert that there is agreement.  Others claim, as does John Cassidy, for example, that the economists on the “it didn’t work” side, such as John Cochran and me, actually favor these stimulus packages.  John Cassidy refers and links to a Wall Street Journal article of mine written after the 2008 stimulus but before the 2009 stimulus.  But that article was explicitly critical of the Keynesian temporary stimulus package then under consideration and eventually enacted.  It explicitly argued against such “temporary, targeted, timely” policy actions proposing instead “permanent, pervasive, predictable” policy.   It is no where near favoring the type of package that was enacted in 2009 (or in 2008).

Posted in Stimulus Impact

A Small Step Toward Monetary “Coordination” at the G-20?

This weekend’s G-20 statement reiterated the concerns—largely coming from emerging market countries—about unconventional monetary policies (UMP). But the language of the central bankers and finance ministers was subtly softened. In July and October 2013 the G-20 statements contained warnings about such monetary policies’ “adverse implications for economic and financial stability” and the need to “manage their spillovers on other countries.” But this weekend it simply said central bankers should be “mindful of impacts on the global economy,” adding that “reduced reliance on easy monetary policy would be beneficial in the medium term for financial stability.” So rather than saying the policy is harmful it said that removing it is beneficial.

This statement is remarkably mild compared to the candid views of some central bankers, such as Raghu Rajan who said this about unconventional monetary last summer before he joined the Reserve Bank of India, “Never in the field of economic policy has so much been spent, with so little evidence, by so few.”

But I think it is more than simply a diplomatic effort to seek a more agreeable tone.  The central bankers and finance ministers seemed actually to agree that a gradual and transparent tapering of UMP is appropriate now, regardless of what they think of the past effects of UMP.

It also gives more meaning and credibility to the boilerplate pledge repeatedly appearing in recent statements that “monetary policy settings will continue to be carefully calibrated and clearly communicated.”  It perhaps is even a small step toward a bit more coordination in the sense used in a BIS paper I presented to central bankers gathered in Switzerland last June: “Going forward the goal should be an expanded rules-based system similar to the 1980s and 1990s which would operate near an international cooperative equilibrium. International monetary policy coordination—at least formal discussions of rules-based policies and the issues reviewed here—would help the world get to this desirable situation.”

Posted in International Economics

Another Anniversary: The Macro Alliteration Wars

Before we get too far away from the 5th anniversary of the 2009 stimulus signed into law on February 17, 2009 (or the 6th anniversary of the 2008 stimulus signed into law on February 13, 2008 ), it’s fun to recall the alliterative mantra associated with these packages.  The mantra is often attributed to Larry Summers, who in testimony before the Joint Economic Committee of Congress on January 16, 2008 asserted that “A stimulus program should be timely, targeted and temporary.”  (Doug Elmendorf and Jason Furman—now at CBO and CEA—used the same language in a Brookings report).

Larry’s mantra apparently persuaded many who listened, and a stimulus package with exactly these three characteristics was passed a few weeks later.  Unfortunately that stimulus did not jump start the economy (see this AER paper). So when the discussion of another stimulus began after the presidential election of 2008, I argued against it.  In testimony before the Senate Budget Committee on November 19, 2008 I said, “Going forward, we clearly need a new set of principles and a new mantra. Based on recent and many past experiences as well as much economic theory, and in keeping of course with the need for alliteration, I recommend an alternative stimulus mantra: permanent, pervasive, and predictable,” and then outlined my preferred economic strategy with these characteristics at the hearing and in the WSJ.

The alliteration game then quickly when viral. In a November 25, 2008 blog post, called Competing Alliteration, Greg Mankiw listed his readers’ suggested ways to describe the stimulus then being considered:

big, bloated, and borrowed.

immodest, immoral, and imbecilic.

clumsy, corrupt, and counterproductive.

expansive, extensive, and expensive.

weighty, worrisome, and wayward.

politicized, pandered, and pathetic.

socialized, silly, and sorry.

random, record-setting, and ridiculed.

ultimate utilitarian utopianism.

absolutely abjectly apocalyptic.

Unfortunately, none of these caught on in time.  When Christina Romer called me in December to ask about my views, I repeated my Budget Committee recommendation, saying that another “temporary, targeted, and timely” program would be a mistake. Neither Romer nor Summers, now both going into the Obama administration, were persuaded, and the 2009 stimulus package was passed. I discussed the results in my previous blog post.

Posted in Stimulus Impact

Next Time Remember the Lessons from Stimulus Packages

It’s the five-year anniversary of the 2009 stimulus package. I’ve done a slew of empirical research on the stimulus in those years from predicting in advance that its impact would be small to estimating afterwards that its impact was small.  I also wrote over 25 posts on the subject on Economics One, which are listed below with links.  Some posts provide new evidence. Others summarize my research with John Cogan and Volker Wieland, or refer to congressional testimony. Still others are about debates with Alan Blinder, Paul Krugman, Christina Romer, Larry Summers, and Mark Zandi. As a whole the findings summarized here provide evidence that the stimulus was not successful in jump-starting the economy or in stimulating sustained growth. Similar results were found in stimulus packages in the 1970s. Keeping a record may help us remember the lessons so we don’t do it again next time. 

Valuable Dissent to the Transportation Research Board’s Special Stimulus Report, Jan 18, 2014

New Model Validation of Stimulus Impacts, Apr 16, 2012

More Debates about the Stimulus Debate, Mar 5, 2012

Debating Stimulus and Harvard and Stanford, Mar 2, 2012

Not More of the Same Model Simulations!, Sep 25, 2011

Two Congressional Hearings on the Second Stimulus and Alternatives, Sep 14, 2011

Don’t Stay the Course, Sep 7, 2011

No Near-Consensus Among Economists for Another Stimulus Package, Aug 16, 2011

No, A Bigger Stimulus Would Not Have Worked Either, Jul 4, 2011

How to Resolve the Stimulus Debate: Use Data, Not the Same Models Over Again, Jul, 2011

Why the Stimulus Failed to Boost Infrastructure in the US: A Comparison With China, Mar 25, 2011

The Empty Chairs at the ARRA Hearing, Feb 16, 2011

Models Used for Policy Should Reflect Recent Experience, But Do They? Dec 29, 2010

Stimulus Math: Many Multiples of Nothing is Still Nothing, Dec 9, 2010

More Evidence on Why the Stimulus Didn’t Work, Oct 30, 2010

TV Fiscal Stimulus Debate Reveals Some Agreement, Jul 31, 2010

More on the Blinder-Zandi Working Paper on the Crisis, Jul 29, 2010

Latest Data Continue To Show Little Impact of Government Stimulus on GDP, May 1, 2010

Macro Model Disagreements and Reality, Feb 22, 2010

Stimulus Anniversary Blog, Feb 17, 2010

One Year Later and More Evidence that the Stimulus is Not Working, Feb 3, 2010

From Fiscal Stimulus and Fiscal Anti-Stimulus, Jan 12, 2010

Measuring the Impact of the Stimulus Package with Economic Models, Dec 30, 2009

Jobs saved: PR or Fact? Nov 6, 2009

National Accounts Show Stimulus Did Not Fuel GDP Growth, Oct 30, 2009

Despite claims, data continue to show small impact of stimulus, Oct 24, 2009

Is the Stimulus Working? Sep 20, 2009


Posted in Stimulus Impact

Should Policymakers or Macro Models Be Taken to the Woodshed?

There’s a good debate going on about the usefulness of macro models, and in particular whether the so-called New Keynesian models let us down or even helped bring on the financial crisis and the Great Recession.

This weekend Noah Smith argues that the new Keynesian models were built for the “last war” and thus missed macro-financial connections or the zero interest rate bound needed to understand the Great Recession and slow recovery. Simon Wren-Lewis writes that the models omitted key factors by focusing too much on rational expectations and other micro-foundations which “crippled the ability of New Keynesians to understand subsequent real world events.” And back last summer Paul Krugman in Macroeconomists at War wondered if these models were being used much at all, saying “It would be interesting to know how many graduate departments were in fact teaching New Keynesian macro in 2008. My guess is that a fair number weren’t.” Underling the debate is an implicit view that New Keynesian models deserve much of the blame for the poor economic performance in recent years, and should be “taken to the woodshed” as Chris House put it.

For what it’s worth, here are my thoughts on these issues based on years of building, using, and teaching such models.

A defining characteristic of New Keynesian models is the combination of “wage-price rigidities” and “rational expectations.” Early examples are the stylized models by Stan Fischer and Ned Phelps and me (published back-to-back in the JPE) and the empirically estimated econometric models based on staggered price setting. Old Keynesian models prior to this did not have rational expectations, and new classical models did not have sticky prices. The Mankiw and Romer book New Keynesian Economics was a collection of such models. An up-to-date compilation of models since then—with special focus on empirical models used in practice for policy in many different countries—is contained in Volker Wieland’s model data base, and the new paper by English, Lopez-Salido, and Tetlow explains the Fed’s current New Keynesian model.  Of course some New Keynesian models are better than others; some are still quite stylized, but others are fully estimated and fit the data well.

What was the motivation for the new models? They were originally designed to be an improvement over existing policy evaluation models (old Keynesian and new classical) which could then be used to find better policies than the failed policies of the 1970s. In these models, monetary policy had important effects and rational expectations techniques made the models more useful for many policy issues. The new models were not designed to explain the Volcker recessions of the early 1980s. As defined here, the models came before those recessions.

What about the rules versus discretion debate? As a technical matter, the very nature of the rational expectations assumption built into the models meant that the policy evaluation was originally about alternative policy rules rather than discretion—interest rate rules, money growth rules, exchange rate rules, etc.

What about the zero bound? It was not ignored.  From the start of research on interest rate rules, the zero bound on the interest rate had to be taken into account in the policy rule simulations. In my 1993 book (Chapter 6) the interest rate was set at a small positive value (say .01) whenever the formula gave a rate below that value.

What about graduate teaching? Some graduate programs began teaching such models early on. Jim Tobin asked me to team teach a graduate course with him in 1980 to get the ball rolling at Yale. Fischer and Olivier Blanchard taught the models at MIT. Ben McCallum taught them at Carnegie-Mellon. David Romer, Carl Walsh and Mike Woodford wrote textbooks which featured such models. Several Stanford grad students (John Williams, Volker Wieland, and Andrew Levin) learned about the models and went to the Fed where they helped introduce them there. I continued to teach a course based on these models after I returned from Washington in 2005 and still do. Lars Svensson, Jordi Gali and others were teaching the models in Europe. Of course the ideas took a while to catch on in some schools, and in a few cases they never caught on.

What about the macro-financial connection?  Research by Tobin and Brainard, Gurley and Shaw, Brunner and Meltzer was available when the new Keynesian models arrived, and Ben Bernanke, Jordi Gali and Mark Gertler had already made enough progress in the 1990s that Mike Woodford and I included it in the Handbook of Macroeconomics (Volume 1C, Chapter 21), published in 1999 long before the Great Recession. (Mark Gertler and Nobu Kiyotaki will be doing a “follow-up” chapter in the forthcoming new Handbook of Macroeconomics edited by Harald Uhlig and me.)   But my experience was that when it came to fitting models to data the lack of good flow of funds data led researchers to focus on financial market prices rather than quantities, with the financial frictions appearing as interest rate spreads. Recent theoretical research and better data are improving this situation. Of course, economists should try to improve their models to make then more useful for policymakers, and it is certainly a worthy task to improve our understanding of the credit channel.

One can criticize the rational expectations/sticky price models by saying that they do not admit enough rigidities, or have only one interest rate, or do not have money or credit in them, or simplify too much with rational expectations. But simplified versions of models, which frequently boil down to only three equations, should not be confused with more detailed models used for policy. Many of the models listed in Volker Wieland’s model data base are more complex, have time varying risk premia in the term structure of interest rates, an exchange rate channel, and more than one country.

I do not see the evidence that these models led policy makers astray or were a cause of the financial crisis. To the contrary I have argued that the general policy recommendations of these models—which generally took the form of particular monetary policy rules for the interest rate instrument—were not followed by policy makers in the years leading up to the crisis though they followed them during the Great Moderation. Ignoring the recommendations was the problem rather than the recommendations themselves. These models did not fail in their recommendations. Rather the policymakers failed to follow the recommendations.



Posted in Financial Crisis, Teaching Economics

The Policy Rule Debate at the Yellen Hearing

Rules-based monetary policy received special focus during Janet Yellen’s inaugural hearing and the second panel immediately following on which I was a witness.  In fact, the Chairman of the Committee, Jeb Hensarling, devoted a good part of his opening questioning of both Yellen and me to the subject, so the hearing transcripts will offer a rare opportunity to contrast different sides in the debate  over whether it was appropriate to deviate from rules-based policy in recent years. 

In his opening line of questions on why the Fed has deviated from a rules-based policy, Hensarling quoted from FOMC transcripts going back to January 1995 in which Janet Yellen said referring to the Taylor rule that “following such a rule…is what sensible central bankers do.” 

A key part of Janet Yellen’s response was: “I have tried to argue and believe strongly that while a Taylor Rule…or something like it…provides a sensible approach in more normal times like the Great Moderation, under current conditions when this economy has severe headwinds from the financial crisis and has not been able to move the funds rate into negative territory that rule would have prescribed,  that we need to follow a different approach and we are attempting through our forward guidance to be as systematic and predictable as we can possibly be…

Having listened to this back and forth, I decided that when the time came for the second panel I would simply open with a 5-minute case for sticking to policy rules in recent years, instead of a 5-minute summary of my written testimony as I had planned and as is customary.

So after being recognized I opened as follows (as transcribed from a C-SPAN video clip):

I would like to use my opening remarks to refer back to the initial set of questions and answers to Chair Yellen that you began with. They have to do with the role of policy rules in formulating of monetary policy. It seems to me that the case can be made that monetary policy would have been far better in the last few years had it been based on a predictable set of policy rules.  Moreover I think that if policy moved in that direction we would more quickly move to a more sustainable higher growth rate.  There has been a tremendous amount of research and historical work on policy rules.  There continues to be interest to what you referred to as the Taylor rule, based on research of many people over many years, not just me.  This research has indicated that when the Fed has followed rules close to that, performance has been very good.  Historian Allan Meltzer in particular notes the period from 1985 to 2003 as one when the performance of the U.S. economy was extraordinarily good in historical comparison and that was a period when the Fed adhered pretty closely to one of these rules.  I think if in the last 10 years policy had been guided this way, the performance would have been much better.  If during 2003, 2004, and 2005, the Fed had followed a rule like this, we would not have had the excess risk taking, we would not have had the search for yield, we would not have had as much of a housing boom as we had, and therefore the financial crisis and the great recession would have been much less severe.  If during the period since the financial crisis, the Fed had adhered to this kind of a policy rule, we would not have had to have the quantitative easing that has been so questionable, we would not have had to have the forward guidance that has been so debatable in its effects and the predictability of the economy I think would have been much better and therefore economic growth would have been better in those circumstances.  And I want to emphasize such a rule would certainly not preclude the very important actions the Fed took during the panic of 2008, its classic lender of last resort role which helps stabilize the financial markets. 

It’s because of this success of policy rules that I recommend that legislation be put in place to require the Fed to report on its policy rule.  It would be a rule of its own choosing—that’s the responsibility of the Fed.  But if it deviated in an emergency or for other reasons, the Fed through the Chair would be required to report to this committee and to the Senate Banking Committee about the reasons why.  We’re not close to that right now, some argue that could be done on a procedural way rather than through legislation but I think there’s some promising signs that we could be going in that direction:

Number one, the Fed recently adopted a 2 % inflation target.  That is exactly what the Taylor rule recommended 20 years ago.  Moreover the European Central Bank, the Bank of England and the Bank of Japan have also adopted that target.  There’s an international congruence which adds durability to that.

Number two, the forecast of the current FOMC, long term forecast for the interest rate is 4 %.  If you combine that with the 2 % inflation target, you have a 2 % real interest rate.  That’s exactly what that rule recommended 20 years ago. 

There’s a consensus now that the reaction of central banks and the Fed in particular should be greater than 1 when inflation picks up.  There is debate about what the reaction should be in the case of a recession.  Some argue it should be larger, some smaller.  And that is a difference of opinion. 

 But the fourth reason why I think we’re in a position to move in this direction, more so in the past is statements of Chair Yellen herself.  She has indicated that policy rules like this are sensible, they’re good, they work well.  She emphasizes: “That’s in normal times”.  She would also argue these are not yet normal times.

 There’s debate about when we will be back to normal or whether we are already back to normal.  It’s seems to me therefore the debate is not over whether we should follow a policy rule like this, it’s about when.  Thank you Mr. Chairman.

More on this debate can be found in my responses and Yellen’s responses to Hensarling’s questions, but the  above gives a flavor of the discussion.

Posted in Monetary Policy

Why Did CBO Wait?

Why did the Congressional Budget Office (CBO) wait until now to inform the Congress and the rest of the country about the large negative effects of Obamacare on employment and hours of work?  (See CBO Budget and Economic Outlook pp 117-127). The disincentive effects on labor supply and demand were well known from the time the law was passed, and, more importantly, before the law was passed.  A more timely analysis could have altered or even stopped the legislation.

The CBO asked itself this question in its report (See section “Why Does CBO Estimate Larger Reductions Than It Did in 2010?” on page 118), answering that it  “reviewed new research about those effects” referring to 2013 working papers by Casey Mulligan and to others. But similar research was done earlier. In fact it’s pretty old and straight forward. My colleague Dan Kessler reported some of his findings in an article How Health Reform Punishes Work  in the Wall Street Journal in April 2011, and I blogged about it here.  In fact, the nature of the disincentive effects was so straight forward that I lectured about them in my Economics 1 course at Stanford and put them in my Principles of Economics text.

But regardless of when and whose research on disincentives was done outside the CBO, isn’t this the type of policy evaluation research that the CBO was created to conduct and report to the public in order to inform debate about proposed legislation?

Posted in Regulatory Policy, Teaching Economics