How Timidity in Washington Wrecked the Economy

By DEAN BAKER

We now have even more evidence that inept policies from Washington are causing enormous suffering across the country. It is not quite the line that the right-wingers are pushing. The new evidence is that the stimulus worked and was in fact more effective than had been predicted.

The new evidence comes in the form of a study by two Dartmouth professors, James Feyrer and Bruce Sacerdote. Past estimates of the impact of the stimulus on jobs and the economy relied on simply plugging the tax breaks and spending into standard macro models and reporting the predicted effect. In this sense, the impact of the stimulus was actually built into the model. However this new study directly measures the impact of stimulus spending on employment across states, comparing the number of jobs created to the amount of spending.

The study consistently finds significant results over a wide range of specifications. This means that states that got more stimulus money had more jobs. The multipliers varied across specifications and types of spending but the range was 0.5 to 2.0. (The multiplier is the ratio of the change in GDP to the amount of stimulus spending. If the multiplier is 1.5 this means that $1 billion in stimulus increases GDP by $1.5 billion.) While the authors view their multiplier estimates as being somewhat below those predicted by the standard macro models, given the nature of their study their estimates are almost certainly higher than would be expected.

The approach used in this study almost certainly understates the true multiplier effect for the stimulus because it is effectively measuring the in-state multiplier. In other words, it is measuring how much $1 billion spent in Indiana will increase the size of Indiana's economy.

This will certainly be far less than its impact on the U.S. economy for three reasons. First many of the people hired for stimulus related projects are likely to live out of state. If Indiana contracts to rebuild Indiana Harbor (adjacent to Chicago), it is virtually certain that many of the workers will come from Illinois. This will be true of spending in any state with major population centers near the border (e.g. New York City, Philadelphia, Chicago).

The second reason is that much of the inputs are likely to come from out of state. Very little of the steel, asphalt or other materials connected with an infrastructure project will come from the state where the project is taking place.

The third reason that the study would understate the multiplier is that the re-spending from stimulus is far more likely to go out of state. This is not just because many people may cross state lines to do shopping or go to restaurants. Even if a person were to go to a store or restaurant in state to spend the money they earned through working on a stimulus project, much of the money would end up going out of state.

An appliance or video game may have been made in the United States, but it would be unlikely that it was made in Indiana, or whatever state's spending is being investigated. Similarly, the food served in a restaurant may have been grown in the United States, but probably not in Indiana.

For these reasons, measuring the amount that stimulus spending in Indiana led to an increase in the size of Indiana's economy is going to hugely understate the actual multiplier for the country as a whole. The range of multipliers found in this study suggests that the actual multiplier for stimulus spending is quite likely higher than the 1.5 in most macro models.

This is hugely important for macro-policy debates because it suggests that more stimulus would provide a further boost to the economy and reduction in unemployment. This means that the only reason that we are sitting here with 25 million people unemployed and underemployed is that the politicians in Washington are too intimidated by the Wall Street deficit hawks.

The deficit hawks have used their enormous political power and control over the media to shut down any further discussion of stimulus. They have managed to completely dominate public debate with their brand of flat-earth economics. They are using the crisis that was created through their greed and incompetence to reduce hugely valued public benefits, like Social Security and Medicare. And, now they are using the crisis that they have created for state and local governments to destroy public sector unions.

This looks really awful because it is. Our nations' leaders are deliberately inflicting enormous pain on tens of millions of people to advance their political agenda. This new study helps to prove this fact.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.
This column was originally published by TMP Cafe.