Russ Roberts’ Congressional Testimony on the Stimulus

Russ Roberts testified before Congress on the effects of the economic stimulus package.

… Over the last two years, the American Recovery and Reinvestment Act of 2009 has injected over half a trillion dollars into the US economy in hopes of spurring recovery and creating jobs.

The results have been deeply disappointing. Job growth has been anemic while our deficit has grown, limiting our future policy options. Fourteen million workers are unemployed. The unemployment rate among African Americans is over 15%. This is an American tragedy.

What went wrong? Why were the predictions so inaccurate?

There have been two explanations. One is that the economy was in worse shape than we realized. The only evidence for this claim is circular—the standard Keynesian models under-predicted unemployment.

I agree with this, and it’s why Krugman’s repeated claims that there wasn’t enough stimulus really bug me. Krugman acts as though there’s no empirical doubt about the effects of fiscal stimulus, even though there’s no empirical proof fiscal stimulus works. He treats the failure not as any possible evidence against fiscal policy but as definitive proof of insufficient fiscal policy.

I prefer a simpler explanation: the models that justified the stimulus package were flawed. Those models were broadly based on the Keynesian notion that the road to recovery depends on spending. In the Keynesian worldview, all spending stimulates. Somehow, subsidizing university budgets in the Midwest or paying teachers in West Virginia helps unemployed carpenters in Nevada. That may be good politics. It’s lousy economics.

This part gives me pause. Giving more money to teachers in West Virginia allows them to either spend or invest more, and that ultimately helps somebody somewhere. My concern with fiscal policy is Friedman’s, that it doesn’t actually add to spending and investment, but just displaces private spending and investment. But if in fact it is adding spending and investment, then paying teachers here helps someone else besides them, even if it’s not specifically Nevada carpenters.

This isn’t the first time the Keynesian worldview was wildly inaccurate in predicting the impact of changes in government spending. Look at the beginning and end of WWII.

Keynesians frequently argue that the military spending on WWII ended the Great Depression.

Certainly unemployment fell to nearly zero because of the war. But did the war create an economic boom? There was a boom for the industries related to the war. But there was little prosperity for the rest of the country. The war was a time of austerity. Government spending didn’t have a multiplier effect on private output. It came at the expense of private output.

What about the end of the war, when government spending plummeted?

Paul Samuelson, a prominent Keynesian, warned in 1943 that when the war ended, the decrease in spending combined with the surge of returning soldiers to the labor force would lead to “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” He was not alone. Many economists predicted disaster.

What happened? Government spending went form 40% of the economy to less than 15%. And prosperity returned to America. Unemployment stayed under 4% between 1945 and 1948. There was a short and mild recession in 1945—while the war was still going on. But the economy boomed when government spending shrank and price controls were removed.

I am constantly mystified by the folks who think WWII ended the Depression. We took about ten million men who were unemployed and put them in uniform, then restructured the economy almost completely on command-and-control lines. A necessary task, I would agree, but not exactly an economic recovery–certainly not one anyone would like to emulate as a solution to our current slump, especially with a return of ration cards for gasoline, eggs, shoes, etc.

We are told that the failure of the current stimulus proves it simply wasn’t big enough to get the job done. But it is equally plausible that the opposite is true—that government intervention in the economy prevented the recovery.

I am sympathetic to the politicians, particularly presidents, who face tremendous pressure to be seen to be doing something. After all, look at George H. W. Bush–the economy was in fact recovering by the election of 1992, but he was crucified for appearing to not be doing enough to fix the economy (mea culpa, I voted against him for that reason). But I am not sympathetic to people who don’t fact that pressure but still insist that the government had to act, that it was with certainty an absolutely necessary thing to do to save the economy. Really? And how do we know that? What’s the evidence for it? As we saw a couple days ago, leading Keynesian Paul Krugman says we’ve never actually tried real Keynesian stimulus. So without real testing, how can we be so sure it’s necessary?

The truth is that our knowledge of the complex system called the economy is woefully inadequate and may always remain that way. We ask too much of economics.

Economics is an explanatory science, not a predictive one, just like evolutionary biology. For some reason, people think that’s ok with biology, but mock economics for it.

Even our best attempts to measure the job impact of the stimulus spending make this clear. In November of 2010, the CBO estimated that the stimulus had created between 1.4 and 3.6 million jobs. Not a very precise estimate.

But even this estimate was more of a guess than an estimate. The CBO estimates didn’t use any of the actual employment numbers after the stimulus was passed. Instead the CBO based its “estimates” on pre-stimulus relationships between government spending and employment, relationships that failed to predict the magnitude of our current problems.

The CBO’s results and those of other forecasters using multi-equation models of the economy are not science but pseudo science–what the economist F.A. Hayek called scientism—the use of the tools and language of science in unscientific ways.

I’m not an anti-quant. In fact as a political scientist I regularly find myself defending quantitative work from colleagues who despise it and condemn its value (always without understanding it, of course). But I know just enough mathematics myself to know that simply attaching values to variables doesn’t create empirical accuracy. I’d be appalled if the economics profession quit doing quantitative work, but before we commit to major, and costly, public policies on the basis of quantitative analyses, we really ought to have some certainty that that those analyses have substantial external validity.

So where does that leave us?

Let’s get back to basic truths.

When you’re in a hole, stop digging. Stop running deficits of over 1.5 trillion dollars. Act like grownups and get your fiscal house in order. Stop spending 25% of what we produce. Stop wasting my money and giving it to your friends. Stop passing legislation that makes it hard to figure out what the rules of the game are going to be. Get out of the way. Make government smaller and give us a chance to do what comes naturally—seeking ways to make profit, avoid loss and work together. That is the only sustainable path to prosperity.

I very uneasily argued against the fiscal stimulus approach. Uneasily because I wasn’t that certain in my opposition–based on my knowledge of economics I doubted the value of fiscal stimulus and was concerned about vastly increasing government spending and borrowing, but I, too, felt the pressure against just doing nothing. In fact I was firmly convinced that doing nothing would work, given time. But how much time?

But both the Keynesians and anti-Keynesians now agree the fiscal stimulus didn’t do diddly. They Keynesians say it’s because it wasn’t large enough, and Krugman makes this somewhat plausible by noting that state and municipal spending dropped so much that the federal spending only compensated for it, without actually increasing total spending (although he usefully doesn’t count the tax cuts as part of the stimulus, which sounds a lot like cooking the numbers to me). Given the exorbitant cost of running a fiscal stimulus program large enough to persuade Keynesians it’s a true stimulus, and the already unsustainable deficits we’re running, it sounds like a tremendously risky experiment. And as Scott Sumner points out (same link as above), the government has had trouble spending the money from the first stimulus package (in fact there’s a good chunk that’s not yet been spent at all), so adding even more to that package probably wouldn’t do much to help (how much unspent money do you have to add to prior unspent money to create a stimulus?)

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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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33 Responses to Russ Roberts’ Congressional Testimony on the Stimulus

  1. ppnl says:

    I am constantly mystified by the folks who think WWII ended the Depression. We took about ten million men who were unemployed and put them in uniform, then restructured the economy almost completely on command-and-control lines. A necessary task, I would agree, but not exactly an economic recovery–certainly not one anyone would like to emulate as a solution to our current slump, especially with a return of ration cards for gasoline, eggs, shoes, etc.

    Well what effect did WWII have on the depression?

    One problem I always have with economists is that it seems like they talk about any injection of cash as as if it didn’t matter how it was done. Thus printing up cash and dropping it out the back of a helicopter seems to be as good as anything else.

    The thing about WWII spending was it was highly goal directed. It created a vast amount of capitol goods, created brand new technologies and entire new industries. At the same time it convinced individuals to lower expectations and live frugally. At the end of the war you had massive manufacturing capacity, new technologies and pent up demand. Given political realities I just don’t think you can do this without a war. Command economies fail exactly because the chosen goals are politically driven rather than being forced by things beyond politics.

    I cannot believe you voted against Bush the greater. He is the last republican candidate for president that I had absolutely no problem with. Clinton was not bad but Bush would have been better. The republican party has been in a death spiral ever since. I hope it reached its low point with Bush the lesser. I see no clear evidence of that yet.

  2. D. C. Sessions says:

    RE: tax cuts as stimulus.

    I cite Mencken on simple solutions. People want simple answers and they tend to react very negatively to “that depends.” When your economy (as in many really poor places like Bangladesh) is unable to progress due to lack of capital as an enabler of labor, it makes sense to put resources towards capital: the old “leisure class” analysis of primitive societies.

    When you have an economy where there is so much concentrated wealth without an outlet that you have one securities bubble after another and where the demand for safe places to put it drives real estate bubbles and runs the interest on government bonds to near zero, pumping more money into capital isn’t going to do much good.

    Tax cuts as stimulus are limited by the circumstances. If you grant that the current economy is limited by lack of demand (as polls of small businesses indicate) then reducing taxes on people who already invest most of their income isn’t going to stimulate the economy in useful ways.

    It depends.

  3. James Hanley says:

    D.C.:

    When you have an economy where there is so much concentrated wealth without an outlet that you have one securities bubble after another

    I keep hearing that, but not from any of the economists I find persuasive. It seems more of a pop wisdom idea than anything else.

    ppnl: Your comment is thought-provoking, and will take more consideration to respond to. I regret that I may not have time this weekend (classes today, college hockey tonight, two day swim meet on the other side of the state Sat and Sun, classes Monday), but I promise to get back to it, unless AMW or JamesK beats me to it with a better comment than I can make.

    Briefly, all I can say is (and it’s not actually a rebuttal to your point at all) the economists of the time didn’t see it as you do. The learned frugality smacks an awful lot of insufficient demand, which Keynesians saw as a primary problem, and all that manufacturing capacity then would just look like excess capacity.

    As to voting against Bush I in ’92, I was young, and more susceptible to the influence of symbolic politics. But I mostly share your view of him (I wouldn’t say I have “absolutely no problem” with him, but my problems with him are pretty mild).

  4. Will H. says:

    I believe the position that the stimulus didn’t work relies on unclear objectives.
    Government spending does indeed raise GDP.
    That said, “recession over” does not equal “recovery.”
    The current excess of capital indicates to me that the tax cuts were misdirected, and further cuts would likely be ineffective.
    But it does call into question the policy of QE2. That’s just adding more force to the existing kinetic energy. It looks like the reduced activity, and notably high unemployment, is what is preventing that excess liquidity from being realized in the form of inflation. But it has to happen sooner or later.
    More than anything else, the increase of capital reserves would indicate that the intended effect of the stimulus was a bit off the mark; definitely an unintended consequence. And I believe that same phenomenon would indicate that an increase in the size or scope of stimulus spending would be imprudent.
    It seems to me that there are other factors that they’re not taking into account (or perhaps weighting properly), other barriers to economic activity that they would prefer not to discuss. And I would suspect that the reasons for that are entirely political. That’s your bag, Hanley. I don’t know these clowns, and I don’t recognize the dance that they’re doing, but I know a circus when I see one.

  5. Scott Hanley says:

    I’m still mystified as to why the argument that WWII ended the Depression should be mystifying. Sure, it was an economy that’s artificial in many ways. But it was also temporary and at the end of the war there was a successful transition back to a much less command-and-control economy.

    Krugman’s been clear on what he considers a Keynesian stimulus: enough spending to make up for the lost private spending. The New Deal didn’t approach those levels, and Obama’s stimulus even less so. Only the war spending has reached those levels. And it was directed at activities that employed people. Combined with rationing, that meant the working classes were acquiring more money than they could spend (personal savings rates reached 25% during the war) and when rationing was lifted, they could buy, people could sell, etc. It still seems to make a plausible case for demand-side intervention (setting aside the question of political feasibility).

  6. ppnl says:

    The learned frugality smacks an awful lot of insufficient demand, which Keynesians saw as a primary problem, and all that manufacturing capacity then would just look like excess capacity.

    I don’t see how anyone could claim that there was insufficient demand during WWII. It is true that many people had money that they were not spending on goods. But that was often because it was illegal to do so. Demand in certain goods was not so much reduced as suppressed. Instead the money was put into capitol goods and new technologies. It can be seen as a massive savings program.

    There is a sense in which money is not wealth. It is the capitol goods that define what we can have. Cash is just a kind of game token that circulates according to the rules and facilitates the dispersal of consumer goods. If consumer goods are not being dispersed then it would seem to be a problem with the rules of the game.

  7. James Hanley says:

    ppnl,

    Did people learn to be frugal, or did they go on a spending binge with all their pent-up demand? There’s a contradiction in there. If they learned to be frugal, and stuck to it, there would be insufficient demand to reinvigorate the economy. If they spent out all their pent-up demand, then they didn’t really learn frugality.

  8. James Hanley says:

    As a general note, I’d add that the claim that it was WWII spending which ended the Depression relies on the assumption that such spending was necessary–that the cause of the length of the Depression was the on-going failure of the gov’t to engage in real fiscal stimulus.

    I find that argument to be BS. FDR’s economic policies were the equivalent of a poorly trained surgeon hacking randomly at the body of an ill person, then thinking they hadn’t recovered because the hacking hadn’t been severe enough. I don’t know why it’s such anathema to think that it was actually the government’s actions that extended the Depression. There seems to be an assumption that the actions were basically good, just insufficient. But there’s no evidence for that. The “basically good” assumption is pretty weak, I think.

  9. James K says:

    DC Sessions:
    I’ve seen no evidence supporting a relationship between wealth concentration and bubble formation. The best experiments I’ve read about suggests bubbles are a product of human psychology and the main reason we’ve been getting more of them lately is that there’s a lot more money sloshing around in the financial markets.

    ppnl:

    I don’t see how anyone could claim that there was insufficient demand during WWII. It is true that many people had money that they were not spending on goods. But that was often because it was illegal to do so.

    In economics “demand” means somethign you’re willing and able to pay for. If market exchange is blocked by law, that does reduce aggregate demand in the same way saving does. Keynesian theory states that saving is bad in recessions, and that driving people to save would therefore be bad.

    There is a sense in which money is not wealth. It is the capitol goods that define what we can have.

    This is true, but a little simplistic. Not all capital goods are the same, this is one of the simplifications macroeconomists make that make me suspicious. In WWII a lot of capital goods were created, but they were pretty much all military hardware that has no value in producing consumer goods. All that capital became effectively worthless once the war ended, so it can’t have contributed to the post-war recovery.

  10. ppnl says:

    James Hanely,

    Well “learned frugality” was your phrase not mine. I simply said they were convinced to be frugal. It was not a habit but rather was (and was seen as) a distortion.

    The question is not “Was public spending necessary for ending the depression?” but “Did WWII spending end the depression faster than it would have ended otherwise?”. I remain skeptical that purely politically driven public spending can have the same effect as WWII. It is just the nature of the political beast that it will screw things up.

    James K.,

    In economics “demand” means somethign you’re willing and able to pay for. If market exchange is blocked by law, that does reduce aggregate demand in the same way saving does. Keynesian theory states that saving is bad in recessions, and that driving people to save would therefore be bad.

    That is my point. Demand was very high during WWII but it was very distorted. And the saving was not the same as holding cash either. They were storing up industrial capacity and concentrating know how in a way that allowed entire new industries and technologies to emerge.

    Not all capital goods are the same, this is one of the simplifications macroeconomists make that make me suspicious. In WWII a lot of capital goods were created, but they were pretty much all military hardware that has no value in producing consumer goods. All that capital became effectively worthless once the war ended, so it can’t have contributed to the post-war recovery.

    I think most of the capitol goods and all the technological know how were more or less directly transferable to civilian production. An assembly line that produces tanks can easily be converted to producing cars and I think many aircraft lines were converted to producing cars. The steel production, coal production and the entire supply line of raw materials is nearly unchanged.

  11. D. C. Sessions says:

    I’ve seen no evidence supporting a relationship between wealth concentration and bubble formation. The best experiments I’ve read about suggests bubbles are a product of human psychology and the main reason we’ve been getting more of them lately is that there’s a lot more money sloshing around in the financial markets.

    And that money sloshing around in the financial markets (which was what I referred to) is owned by … ?

    It’s not being pumped into those markets by the people living paycheck to paycheck. To a rough approximation it’s coming in according to the savings (or investment) rate of their demographics — which are a very long ways from uniform. Concentrate income in a demographic with a high savings/investment rate and it’s not a huge stretch to expect that savings/investment will increase. That is, in fact, the premise behind most of our recent tax cuts.

  12. Will H. says:

    I think you can look at the current situation to see that asset bubbles are not a product of wealth concentration, and that it is the relatively unsophisticated investor which tends to get bit the hardest there. The seasoned investor is more likely to take profit on the long position and move on to the next trade.
    You see this with gold right now. Interest rates are very low, which makes holding a cash instrument unattractive. Better returns are to be had with commodities. So gold has become the new savings account, for now. Anyone that goes in to that trade with the same strategy as a long position on a growth equity is going to get bitten. But there are no profits realized until the exit is confirmed.
    Several bubbles going on right now in commodities, and in financials.
    But the trend has been to increase dividend payouts rather than to increase capital investment. So liquidity issues are not a problem.

  13. James K says:

    DC Sessions: So you’re saying that if rich Americans were spendthrifts the world would be a better place?

    Will H: I have seen experimental evidence suggesting that low interest rates promote bubble activity. Score one for the Austrians I guess, though the irony of supporting an Austrian theory with an empirical investigation is simply too delicious.

  14. D. C. Sessions says:

    I have seen experimental evidence suggesting that low interest rates promote bubble activity. Score one for the Austrians I guess

    I’m amazed that the Austrians are alone in this; it’s a rather obvious consequence of easy money looking for something to invest in. Behavioral economics and game theory.

  15. James Hanley says:

    ppnl–

    The question is not “Was public spending necessary for ending the depression?” but “Did WWII spending end the depression faster than it would have ended otherwise?”. I remain skeptical that purely politically driven public spending can have the same effect as WWII. It is just the nature of the political beast that it will screw things up.

    The last sentence of this snippet belies the first. The last sentence still assumes public spending of some sort is necessary. I think that’s very questionable and you’re assuming it’s a given.

    D.C.–

    there is so much concentrated wealth without an outlet that you have one securities bubble after another and where the demand for safe places to put it drives real estate bubbles a

    I think that’s wrong. The tech stocks bubble was not the consequence of concentrated wealth without an outlet, but people seeing the potential of high-tech firms. And the real-estate bubble was a consequence of low interest rates and the government rules that eliminated the tax on the capital gains of home sales. Show me the evidence of wealth without an outlet, and the mechanisms by which it is put into bubbles that aren’t a consequence of people seeing an actual outlet, a real investment opportunity.

  16. ppnl says:

    The last sentence of this snippet belies the first. The last sentence still assumes public spending of some sort is necessary. I think that’s very questionable and you’re assuming it’s a given.

    I don’t see how you get this.

    First, I don’t see anyone arguing that public spending is necessary for recovery from a depression. The only argument is that it is desirable because it causes a more rapid recovery.

    Second, the reason I asked about the effect of WWII is because you seemed to suggest that it had no effect on the depression. That seems unlikely to me but I wanted your thoughts on it.

    Third, I point out that it would be hard to recreate the profile of effects that war spending had with an artificial public spending program. For example tossing cash out the back of a helicopter probably isn’t going to cut it. There is a horrible risk of just creating public dependency on that public spending. It is just the nature of the political beast that it will screw things up. It may be possible in principle but I’m very skeptical that it can be done in practice and there are horrible risks.

    The best argument for public spending isn’t for recovery but to limit the scale of the decline. That spending must go into effect rapidly if it is to have any effect.

  17. Scott Hanley says:

    As a general note, I’d add that the claim that it was WWII spending which ended the Depression relies on the assumption that such spending was necessary

    No, it doesn’t. It depends on the assumption that such spending is salutary, which is supported by the observation that unemployment was virtually eliminated and that persistent unemployment did not return after the war. Maybe that’s wrong, but I don’t think it can be dismissed so breezily. The only claim you’ve advanced so far is the observation that the war economy is nothing you would want to maintain forever; I don’t disagree with that, but that doesn’t refute its possible role as a jump start. And I agree with ppnl – you’ve offered a scenario in which the greatest fiscal act in US history plays no role at all, for good or ill. I still don’t understand it.

  18. D. C. Sessions says:

    The best argument for public spending isn’t for recovery but to limit the scale of the decline. That spending must go into effect rapidly if it is to have any effect.

    Oh, I’m not so sure of that. Do recall that the USA has an enormous backlog of deferred maintenance on public infrastructure. Water and sewer systems, bridges, stuff like that. As I understand it, those are already at the point where the negative present value of the repairs exceeds the cost of the repairs themselves. So we’re going to pay for them regardless.

    Right now, money is cheap: record low rates on bonds. Which means that putting off the maintenance to when money costs more is just plain stupid.

    Now add the fact that hiring people to do the work is also cheap (putting people to work reduces unemployment, welfare, etc. costs if nothing else) and you have a strong case for major public spending regardless of your ideas of Keynesian stimulus.

  19. Will H. says:

    James K: I was unaware the Austrian school actually did research into such matters.
    I look at it as a simple substitution effect. And capital tends to gravitate toward its most efficient use. For some, this means a higher return, and they will be more likely to substitute away from conventional savings plans, while for others the increased maintenance of the account would negate any efficiency gains.

    Other than that, it should be pointed out that a substantial part of the stimulus package was geared toward recovery rather than stimulus; in particular, the infrastructure projects are notoriously slow for disbursements, and should be seen as “recovery” (restoring previous level of GDP) rather than “stimulus” (bringing GDP out of the negative).

  20. James K says:

    DC Sessions: Essential maintenance is a good thing to spend money on regardless of its merits as stimulus so I agree with you there, but hiring people for the hell of it isn’t particularly clever. People who have a job aren’t looking for work, so you can stunt the recovery by hiring up unemployed people just for the sake of employing them. A temporary extension of welfare would be a better idea.

    And the current cost of money is an issue, but so is the very high debt burden of the US government. Now might be the time to give austerity a go, the sooner you startthe less disruption it will cause.

    Will H: They don’t, it wasn’t an Austrian that made the discovery, it just happens to fit with the Austrian theory of business cycles.

  21. ppnl says:

    Oh, I’m not so sure of that. Do recall that the USA has an enormous backlog of deferred maintenance on public infrastructure. Water and sewer systems, bridges, stuff like that. As I understand it, those are already at the point where the negative present value of the repairs exceeds the cost of the repairs themselves. So we’re going to pay for them regardless.

    Oh I agree that we should be spending on infrastructure. In a sense by letting it decay we are spending down an asset. Thus I consider the sorry state of our infrastructure as part of our deficit. But it is something we should do anyway regardless of the economy.

    The US seems to be spending more on military than the rest of the world combined. Does this make sense? This seems absolutely insane to me given our debt problem.

  22. D. C. Sessions says:

    hiring people for the hell of it isn’t particularly clever. People who have a job aren’t looking for work, so you can stunt the recovery by hiring up unemployed people just for the sake of employing them. A temporary extension of welfare would be a better idea.

    A huge portion of the workforce in the USA is temporarily employed. With unemployment close to 10%, hiring a few to do needed short-term work:
    a) Won’t dry up the available labor,
    b) Keeps skills from going rusty,
    c) Actually gets some value beyond keeping them alive, and
    d) Won’t remove them from the labor pool once unemployment declines.

    There’s another factor that is sometimes overlooked WRT the Depression-era CCC: it took a bunch of healthy young men out of their ‘hoods and put them to work in other parts of the country where they’d have something to do besides stir up trouble. Another of those, “FDR may have kept the USA from full-up revolution” arguments. I don’t know about the “revolution” part but if you look at the crime statistics vs. demographics and employment it’s hard to avoid the conclusion that lots of young unemployed men are Not a Good Thing — law enforcement costs do a bit to offset CCC-type programs.

  23. James Hanley says:

    Scott: unemployment was virtually eliminated. Technically, yes, but let’s be serious about the fact that essentially shifting all your unemployed people into the military isn’t really the same as creating economically productive employment.

    you’ve offered a scenario in which the greatest fiscal act in US history plays no role at all, for good or ill.
    Where did I say it played no role for ill? What’s your evidence that WWII didn’t delay recovery for four more years, just as the combination of Hoover and FDR policies seems to have delayed recovery for about a decade?

    ppnl:I don’t see anyone arguing that public spending is necessary for recovery from a depression. The only argument is that it is desirable because it causes a more rapid recovery.

    Scott: It depends on the assumption that such spending is salutary

    But nobody’s actually demonstrated that. You all are making a post hoc argument. Look, government spent shitloads of money for four years while not letting anyone buy anything–then a recovery happened, and it happened “more rapidly.”

    More rapidly than what? The decade of failed policies that preceded it? OK, I’ll grant it clears that very low hurdle. But I think it’s an exceptionally simplistic argument that ignores a host of other factors, including: a) vastly increased demand from Europe as it was rebuilding; b) the sheer optimism that people had after winning WWII which encouraged them to invest and build; c) the government shuttling lots of GIs into college, which both reduced the possible unemployment rate (that was a big purpose of the GI Bill–it replaced conscription, just as conscription replaced the CCC as a way of keeping young men from having nothing to do) and created a more educated workforce.

    To make a serious argument for fiscal stimulus, you have to overcome the problem of mere substitution–that government spending/investment is merely replacing private spending/investment. And unless you believe everyone was just sticking their money under the mattress, that argument’s a bit hard to support. One of you mentioned the increased saving during WWII–much of that was in the form of loans to the government, through the purchase of war bonds. Displacement, substitution, not additional investment or spending.

  24. James Hanley says:

    Re: Infrastructure. That’s nearly always a good thing to spend on. Unfortunately, except for road projects, it often doesn’t have much political bang-for-the-buck. Here in Michigan we’re proposing to cut spending on sewer upgrades for the city of Detroit. It may be necessary to delay that spending, given the state of our economy and budget, but it’s also very costly as Detroit spills hundreds of thousands of gallons of incompletely treated sewage into the Great Lakes system each year. Meanwhile, we’re spending massive amounts of money on the military to protects ourselves from largely fictional threats.

    Re: the CCC. A great program. Probably did little economically, but kept tens of thousands of young men too tired to cause much trouble. And a lot of their infrastructure projects are still going strong today.

  25. D. C. Sessions says:

    To make a serious argument for fiscal stimulus, you have to overcome the problem of mere substitution–that government spending/investment is merely replacing private spending/investment.

    I don’t see any convincing arguments that government spending always displaces private spending. I don’t think anyone is arguing that government spending never displaces private spending, which brings us to cases: how do we tell which is which?

    And unless you believe everyone was just sticking their money under the mattress, that argument’s a bit hard to support.

    This implicitly assumes that there is something called “money” which is conserved in the same sense that mass/energy are. The countering proposition is that it is possible for an economy to suffer from a net lack of “money:” I can’t buy something I need from you because I lack the right colored pebbles to do so, and because you can’t get those pebbles from me you can’t buy stuff you need from James, and because James can’t get the pebbles he can’t buy stuff from ppnl, who would love to buy some stuff from me.

    That’s exactly what happens when you try to scale a barter economy beyond the village level, and why “money” had to be invented in the first place.

  26. Scott Hanley says:

    shifting all your unemployed people into the military isn’t really the same as creating economically productive employment.

    No, it’s not the same. But again, you’re arguing that artificial employment can’t be useful as a temporary expedient, simply because the expedient isn’t your ultimate goal. Maybe there are sound reasons for that assumption, but it looks like a non sequitur to me.

    What’s your evidence that WWII didn’t delay recovery for four more years

    Well, the fact that GDP in 1946 was well over twice that of 1939, and grew from there. Unless you want to argue that the US economy all along had the potential for a one-time 100% growth rate that was merely held in check by bad policies, I don’t see how that can be accounted for unless wartime spending did more good than harm.

    And I, too, don’t understand how the displacement theory holds during recessions. The Robert Higgs article that you recommended clearly indicates that private investment shrank far more than government investment increased during the 1930’s, and increased at the same time that government investment was exploding during the 1940’s. If there’s some conservation of investment, then how does that happen?

    You asked earlier, “I don’t know why it’s such anathema to think that it was actually the government’s actions that extended the Depression.” I can believe that may have been the case. In fact, I’m constitutionally disinclined to favor one factor as The Explanation. But if I allow that the New Deal was done in a way that was counter-productive to recovery, how does that makes a refutation of fiscal policy? Both claims still fit neatly into the narrative that the spending was too small to replace lost demand, while the erratic (and unprecedented*) policies scared the bejeebers out of private investors and put yet an extra brake on any potential recovery. They can’t both be valid?

  27. James K says:

    Scott Hanley:
    As Milton Friedman put it: there’s nothing as permanent as a temporary government programme. The problem is that even if temporary employment programmes would be a good idea you can’t count on the government discontinuing them when they need to, why that would be “destroying jobs” and we can’t have that, can we?

    Even if there is a theoretical role for make-work programmes (and I still doubt that), real-world governments can’t be trusted to apply them responsibly.

  28. D. C. Sessions says:

    Well, the fact that GDP in 1946 was well over twice that of 1939, and grew from there.

    GDP was growing during most of the Great Depression. There were only two rather short periods when it declined.

    Like today, though, employment did not recover anything like as quickly as production.

  29. James Hanley says:

    D.C.,

    This implicitly assumes that there is something called “money” which is conserved in the same sense that mass/energy are. The countering proposition is that it is possible for an economy to suffer from a net lack of “money:”

    And you’ve just made the monetarist’s argument.

    Fiscal policy doesn’t create more money, monetary policy does.

    And I’m an advocate of monetary policy.

    Thanks.

    Really.

  30. Scott Hanley says:

    James K,

    Well, that’s a different question, and I don’t disagree. God knows that our military is viewed as a massive make-work program to this day. But you’re saying that massive spending is a solution that has serious long-term dangers and drawbacks; James H. is saying it made no contribution to a solution at all. I’m on board with the first argument, but still skeptical about the second.

  31. James Hanley says:

    Scott,

    And I, too, don’t understand how the displacement theory holds during recessions. The Robert Higgs article that you recommended clearly indicates that private investment shrank far more than government investment increased during the 1930′s, and increased at the same time that government investment was exploding during the 1940′s.

    Private investment shrank during the Depression because the money supply decreased. First, there was less money in the economy. Second, because there was less money, individuals and banks held onto more of what they had due to the scarcity (to the extent there was a fiscal policy problem there, it was caused by the monetary problem). See here and here for example.

    Clearly if there was less money available, private investment could shrink more than government investment grows. In fact it would have to, and that’s a more straightforward explanation than, “everyone was sticking lots of money under their mattresses,” because it relies solely on deductive logic, rather than assumptions about human behavioral response. And it in no way implies that the increase in government investment didn’t displace private investment–private individuals had less money available to invest/spend, and government displaced some of that lesser amount, making it lesser yet. Is it really plausible to say that displacing even more of it would have helped the economy rebound?

    I don’t know about the money supply in the 1940s specifically, but I do know we were off the gold standard then, so it would have been much easier for the Fed to pursue a loose money policy. I think the Fed’s policy in the 1940s matters a little bit to your argument.

    I can’t vouch for it’s accuracy, but here’s a graph showing the money supply booming in the 1940s. If it’s correct, it’s quite a support for the monetarist argument.

  32. D. C. Sessions says:

    Fiscal policy doesn’t create more money, monetary policy does.

    When up against the zero lower bound, you need both. Monetary policy loses traction then and you need a borrower who will actually spend the money rather than hoard it — which is what banks in the 30s did (building reserves) and what banks and corporations are doing right now.

    A Friedmanesque monetary analysis treats Keynsean stimulus as the government being a borrower of last resort who will actually put money into circulation rather than sitting on it.

    I don’t know about the money supply in the 1940s specifically

    Like today, the Government was issuing bonds like toilet paper. At the same time, Government programs were employing people and businesses (which very often borrowed money for capital expansion to pursue government business, thus returning the reserves to circulation.) The velocity of money increased, thus increasing the effective money supply independent of explicit Fed action.

  33. James Hanley says:

    When up against the zero lower bound, you need both.

    I haven’t been persuaded of that. It just means you need to use different monetary tools than interest rates. Say, something like this. So far as I can see it’s not monetary policy that gets stuck; it’s just the one particular tool of it.

    You didn’t answer my question about the 1940s. What was happening with the actual money supply?

    And as I noted above, the reserves that were being built in the early ’30s were likely a response to the shrinking money supply. Sure government can take the money from them and spend it. Or government could just pump enough money into the system to make hoarding no longer such a rational behavior. Since the private sector spends and invests more efficiently, that’s probably a better approach. And just substituting gov’t spending/investment for missing private spending/investment won’t solve the problem long term if the money supply remains tight.

    And we haven’t even touched on the problem of timing fiscal policy.

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