NCPA - National Center for Policy Analysis


March 13, 2009

A recent paper by a trans-Atlantic team of four economists -- John Cogan and John Taylor of Stanford University and Tobias Cwik and Volker Wieland of Goethe University -- subject the Obama Administration's stimulus to the most recent Keynesian scholarship.

The White House estimates of 3.6 million new jobs is based on an "Old Keynesian" model on the impact of government spending, while the new models adjust for the rational behavioral response to the stimulus by businesses and consumers.  The White House figures, by economists Christina Romer and Jared Bernstein, also assume zero interest rates for a minimum of four years.  The alternative assumes, more reasonably, that as growth returns interest rates will also rise, says the Wall Street Journal.

What the four economists found:

  • The Administration's estimates for stimulus growth were six times as high as they could produce under a modern Keynesian simulation.
  • By their estimates, the stimulus would produce, at most, 600,000 jobs and add perhaps .6 percent to gross domestic product (GDP) at its peak.
  • That's nowhere near a multiplier of 1.5 and suggests the $800 billion would have been better devoted to business tax cuts or fixing the financial system.
  • That's $1.3 million in spending per job.

According to the Journal, the Administration is itself worried that its stimulus will come up short, while it fears Congress won't abide another round.  Already the outside intellectual godfathers of the Obama plan are denying paternity, claiming the biggest spending bill since World War II is "too small."   So now they and Summers want the rest of the world to ride to the rescue by repeating our mistakes, says the Journal.

The problem isn't the size of Obama's fiscal stimulus but its design.  If countries in Europe want to help the recovery, they'd do better to try marginal rate tax cuts on income and investment -- the sort of fiscal policy that actually changes incentives to work and invest.  Then we could watch and see which approach encouraged recovery faster.  But the last thing Europe should do is follow Larry Summers and the out-of-date Keynesians down the spending road to nowhere, says the Journal.

Source: Editorial, "Old Europe Is Right on Stimulus," Wall Street Journal, March 12, 2009; and John F. Cogan, Tobias Cwik, John B. Taylor and Volker Wieland, "New Keynesian versus Old Keynesian Government Spending Multipliers," Goethe University, February 2009.

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