Fiscal Effects of Government Spending, Or: What Macroeconomists Don’t Know

In a long and extremely persuasive piece for National Affairs, Harvard Economics professor Greg Mankiw argues that, even if you’re sympathetic to Keynesian economic theory, there’s very little clear evidence to support the claim that government spending makes the best fiscal stimulus. Moreover, despite the efforts of the Obama administration to track the effects of last year’s spending-heavy stimulus package—through self-reports and through modeling—the data gathered don’t really tell us much about the actual overall effects of the stimulus. “The fiscal-policy decisions of the past year and a half have not been implausible or inexplicable,” writes Mankiw, “but they have also not been empirically shown to work. The data point to other approaches.”

On the stimulus, Mankiw is unquestionably right. The stimulus reports that have come from the administration and the Congressional Budget Office don’t rely on actual measurements of job-creation outputs. They measure the dollar value of the inputs, and then feed those measurements into their models. But their models are obviously unreliable, because the predictions they’ve made have turned out to be wrong. So we don’t know what the effects of the stimulus are, and we don’t have a good way to measure them.

And that feeds into larger point that Mankiw makes, which is that macroeconomics is a relatively young science and there’s still a lot that its practitioners don’t really know. As a result, he argues, economists dealing with macro effects ought to be far more humble about their work and their conclusions. I’d actually take this a little further and argue that pundits, wonks, politicians, and policymakers of all stripes ought to be more humble about what we know and don’t when it comes to public policy—and beyond that, about what public policy can actually accomplish. At times, certain politicians will let slip the truth that what they’re doing is, at best, pretty speculative—see Chris Dodd’s admission that, on the new financial bill, “no one will know until this is actually in place how it works”—but in general, there far too much certainty in Washington, both about how things work and what the government can actually achieve.

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  • ||

    Somehow this seems very appropriate to link to here :

    http://townhall.com/columnists.....art_are_we

    wish we could just 'opt' out of any help from our 'elite betters'.

  • ||

    Macroeconomics, the endless quest to prove that somehow someway one plus one really does equal four.

  • Keith||

    Microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things economists are wrong about generally.

    - P.J. O'Rourke

  • The Economy||

    It's Bill Clinton, stupid!

  • Richard Head||

    Does this skepticism about economic modeling count for predictions of the economic effects of climate change? cuz those are whack; we understand the climate way better than economics.

  • Fist of Etiquette||

    Years from now economists will examine tree rings from various inner city school districts and from that tell us exactly where the stimulus money was most effective.

  • ||

    I have often made the point that people who say "I don't understand economics" yet claim to understand ecology are simply idiots. Ecology and economics both have similar feedback loops and interdependencies, yet ecology has of the order 10^4 more variables. If you can't understand economics, then there is no way in hell you can understand ecology.

  • ||

    Primum non nocere is just as applicable in economics as it is in medicine.

  • ||

    Not to the economists who the government is listening to today, apparently.

  • Bryan||

    I don't even know that its what we don't know, as much as we don't know what we want.

    During good times many complain about the "winfall profits" of corporations.

    During down times, we want stimulus to stimulate those same businesses into profits so that they can provide good paying jobs.

    If people were paying attention, they'd wish right now that their company had been getting and saving those windfall profits so they wouldn't lose their jobs.

    But no, in 2 or 3 years when things are humming along again workers will go back to complaining about how sad it is that their employer is making millions.

  • Reverend Bayes||

    So nice to see an economist finally learning something from empirical data. I was getting tired from spinning in my grave.

  • ||

    I think our general knowledge of economics is usually pretty good, it's when we think we can take that general knowledge and use that to come up with models that create specific predictions we get in trouble.

    For example, the ideas of supply and demand and subsitutin are fairly simple, if prices go up demand will go down, and consumers will switch to subsitues if available.

    But to take this basic knowledge, and perdict that this bit of stimulus will have these effects is bullshit.

  • ||

    I can't tell you how many people I have talked to who try to argue that:
    1)Minimum wage laws do not create unemployment
    2)Free trade destroys (net) jobs or ships them overseas
    3)Rent control works, and we need it in Seattle to reduce the high cost of housing
    4)Government paying people to do work that doesn't add value to society or goes unused is still a good thing because it employes people, and they spend their income on things, which adds back to the economy.

    In other words, I think there is still a lot of work to do on the general public's knowledge of intro level economics.

  • TallDave||

    It doesn't help that the teacher's unions are actively working to decrease their understanding.

    Give us 20 years with vouchers and I bet we can have people quoting F.A. Hayek on the street.

  • ||

    +1

  • Chad||

    1)Minimum wage laws do not create unemployment

    Actually, there is little evidence that it creates unemployment at all among adults. There does appear to be a loss of jobs among teenagers.

    2)Free trade destroys (net) jobs or ships them overseas

    It probably creates net jobs in the long run, but in the long run we are all dead. It certainly destroys many individual peoples' livelyhoods.

    3)Rent control works, and we need it in Seattle to reduce the high cost of housing

    Agreed.

    4)Government paying people to do work that doesn't add value to society or goes unused is still a good thing because it employes people, and they spend their income on things, which adds back to the economy.

    Government rarely pays anyone to do something of no value, no more often than the private sector does.

  • TallDave||

    2. Gains from trade. Look it up.

    4. Either you've invented some new meaning for "government," or you misstated "regularly" as "rarely."

  • Corduroy||

    Of course minimum wage does not create unemployment, that is as long as the gov't maintains an inflationary environment. Which is why most people are terrified of deflation when it comes. Wage inflexibility and inflation go hand in hand.

  • Corduroy||

    Correcting myself here - Stagflation does exist. Which only further disproves Chad's assertion number 1.

  • Mike Laursen||

    I’d actually take this a little further and argue that pundits, wonks, politicians, and policymakers of all stripes ought to be more humble about what we know and don’t when it comes to public policy—and beyond that, about what public policy can actually accomplish.

    One point that should never be lost is that all of these folks aren't even really following Keynes. They are just using a extra bullshitty pseduo-Keynesian economics as justification for the spending they wanted to do in the first place.

  • LarryA||

    So we don’t know what the effects of the stimulus are,

    Zip.

    and we don’t have a good way to measure them.

    I still can’t find a job.

  • Psychic Octopus||

    I remember what one of my economics professors used to say: Microeconomics is a science, macroeconomics is a religion.

    You might disagree about how much science microeconomics really is, but it about sums up how macroeconomics is at times indistinguishable from faith.

  • Alan Vanneman||

    '“The fiscal-policy decisions of the past year and a half have not been implausible or inexplicable,” writes Mankiw, “but they have also not been empirically shown to work. The data point to other approaches.”'

    Well, that depends on who's doing the data. Mark Zandi Chief Economist for Moody’s Analytics, told Congress that "The economy has made enormous progress since early 2009. A year and half ago the global financial system was on the brink of collapse and the economy was engulfed in the Great Recession, the worst downturn since the Great Depression. Real GDP was plunging at an annual rate of more than 6%, and monthly job losses were averaging close to 750,000. Today, the financial system is operating much more normally, real GDP is advancing at a nearly 3% pace, and monthly job growth—excluding temporary hiring for the 2010 census—is nearly 125,000.

    "This dramatic turnaround is largely due to the aggressive and unprecedented response of monetary and fiscal policy. The Federal Reserve Board has implemented an effective zero interest rate policy and made a wide range of efforts to support the flow of credit throughout the financial system. The Treasury Department has required the nation’s largest bank holding companies to conduct public stress tests. The FDIC has increased deposit insurance limits and guaranteed the issuance of bank debt. Congress and the Bush administration passed the Troubled Asset Relief Program, creating a fund that was ultimately used to support the banking system, the auto industry, and the housing market. And under both the Bush and Obama administrations, Congress passed a series of fiscal stimulus efforts ranging from expanded benefits for unemployed workers to aid for state and local governments to tax cuts for businesses and households. While the effectiveness of any individual aspect of the policy response can be debated, there is no question that the overall policy response has been very successful."

    Mankiw, for what it's worth, had his own stimulus proposal--temporarily eliminating the payroll tax but allowing states to claim that revenue in order to avoid cutting state spending. Greg, of course, is a Republican, and while he piously chides Administration economists for politicizing their analysis, more or less forgets that he was head of Bush's Council of Economic Advisors and, among other things, swallowed the Bush tax cuts, the war in Iraq, and the Bush Prescription Drug Program. Greg can talk the jive when he wants to.

  • TallDave||

    Yeah, except that's a bunch of crap. Compared to other recoveries, this one is going very badly by nearly all measures. Also, the initial crisis was caused by government housing stimulus in the first place -- as it turned out, giving home loans to everyone who wanted them wasn't such a great idea.

  • Chad||

    TD, banking crises historically take about five years to resolve themselves, and big ones even longer. You can't compare this recession to little blips like the .com bubble.

  • TallDave||

    Credit markets are working. The problem is that Democrats have created so much additional fear, uncertainty, and costs that growth has been stifled. That's why corporations have historic amounts of cash sitting on the books not being invested in anything.

  • Corduroy||

    I consider this last bubble an extension of the .com bubble which was "resolved" by the Fed holding interest rates at an arbitrary low level for way too long. Of course, this will be followed by yet another even bigger bubble a few years down the road, probably the currency itself.

  • BakedPenguin||

    Oh yes, an economist for a ratings bureau. Given the incredible accuracy with which ratings bureaus have scored companies for which they have had near total information, we should gladly take at face value their statements for the entire economy, for which they have far less info.

  • TallDave||

    But their models are obviously unreliable, because the predictions they’ve made have turned out to be wrong.

    Hey, that doesn't mean anything. Just ask the AGW crowd.

  • 2010||

    Of course, I'm just the warmest year since record keeping began in 1880.

  • WTF||

    Which proves AGW just like the record cold temps and snowfalls we had a few months ago disprove it.

  • 2010||

    Globally, I mean.

  • TallDave||

    Globally? Ha! You're warmest in the Arctic, where there are barely any measurements.

    Anyways, you're much less warm than the models predicted...

    http://wattsupwiththat.com/201.....e-missing/

    ...which of course led AGWers to totally re-examine their assumptions and stuff. Not.

  • TallDave||

    Not without a lot of "adjustment" you aren't.

  • WTF||

    there far too much certainty in Washington, both about how things work and what the government can actually achieve.

    See, the problem is the notion, held by so many in Washington, that there is this inherent, driving need for the government to actually "achieve" something. Too many of them sit around thinking of things for them to DO, to "improve the lives of the American people."

    It would improve my life if they would just leave me (and my money) the fuck alone.

  • ||

    "See, the problem is the notion, held by so many in Washington"

    People in Washington hold this notion because so many people want big brother to take care of them.

  • ||

    Mark Zandi Chief Economist for Moody’s Analytics, told Congress

    No need to read further.

  • ||

    On CNBC this morning, Rick Santelli begged to differ with Mr. Zandi.

    Zandi is using the same models which predicted that unemployment would not rise above eight percent if the stimulus was passed.

  • Coeus||

    From the title, I expected this article to be several hundred pages long.

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