Does fiscal stimulus work?

Ben Chu

obama 150x150 Does fiscal stimulus work? In his Sunday Times column, Dominic Lawson argues that Obama’s $800bn fiscal stimulus package didn’t work:

“Christina Romer, the chairwoman of the president’s council of economic advisers, declared back in January 2009 that this money would have a Keynesian ‘multiplier’ effect of 1.57 – that is, $1.57 worth of economic activity would be generated by each dollar of state spending – and that it would lead to a one percentage point fall in unemployment. Instead, as most independent economists acknowledge, there has been next to no multiplier effect; and the unemployment rate has actually risen.”

Not sure about that.

The non-partisan Congressional Budget Office did an analysis of the effect of the stimulus package in May 2010 and came to the conclusion that the package:

  • Raised the level of real (inflation-adjusted) gross domestic product (GDP) by between 1.7 percent and 4.5 percent
  • Lowered the unemployment rate by between 0.7 percentage points and 1.8 percentage points
  • Increased the number of people employed by between 1.4 million and 3.3 million
  • Increased the number of full-time-equivalent (FTE) jobs by 2.0 million to 4.8 million compared with what those amounts would have been otherwise.

The CBO also warned that:

“The effects of [the stimulus package] on output and employment are expected to gradually diminish during the second half of 2010 and beyond.”

And that’s what has indeed happened. With US growth more or less collapsing in 2011 as stimulus was withdrawn.

54341994 us gdp 464 Does fiscal stimulus work?

That suggests not that stimulus didn’t work, but that it wasn’t big enough and wasn’t maintained for long enough.

Lawson also argues austerity brought Britain out of recession in the 1930s:

“The facts are that in ‘austerity’ Britain between 1932 and 1937 GDP increased by more than 25%, consumption by more than 13%, and employment by more than 16%.”

But he’s making the same mistake as Dominic Sandbrook. It was a combination of leaving the Gold Standard and rearmanent that pulled Britain out of the 1930s slump, not fiscal austerity.

Still, one can understand why it’s difficult for Lawson to give credit to the former factor considering that he thinks we should never have left gold.

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  • HJ777

    If it worked like that, all the government would have to do would be to print money and shower it on the population to create ‘demand’.

    The great fallacy is that government deficit spending creates ‘demand’ which will then drive growth. How come it didn’t work in the Soviet Union and Eastern Europe then? How come it has just failed in the US? How come it has failed for well over a decade in Japan? Demand and supply are two sides of the same coin – if you think you can separate them, then you are pursuing a path based on a complete misunderstanding.

    Money is simply a way of trading resources. If the government spends it, then it is allocating resources, not creating them. If the government allocates resources, then those same resources aren’t available to someone else to decide how to allocate – there is no stimulus effect unless you are convinced that government allocates resources more economically efficiently than the market. If you think that governments are best equipped to allocate resources within an economy then you haven’t been paying attention.

  • HJ777

    It’s obvious that the fiscal stimulus just postponed the problem at the expense of making it worse.

    We had a decade long credit-fuelled debt binge. The idea that the solution is yet more of the same is implausible. Correction must come, and the sooner this is recognised and the pain faced, the less the eventual pain and the sooner we get out of this mess.

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