Romer '92: It's Not the Filled-In Holes, It's the Buckets of Money


Is Christina Romer wrong about stimulus now or was she always wrong? The moribund chairwoman of the president's council for economic affairs became a cautionary example of government-induced intellectual decay during her disastrous tenure. At issue: Whether Romer's early-nineties research on the Great Depression demonstrated that stimulus spending failed outright to spur growth (as people like me claim) or would have spurred growth if the spending level had been increased (as Romer now suggests).

The question has lost some urgency thanks not only to Romer's departure but to the manifest failure of the American Reinvestment and Recovery Act to deliver its promised results. But it remains interesting because Romer entered office armed with a study proving every dollar of federal spending carried a multiplier of $1.55—a position seemingly at odds with her earlier claim that increasing the monetary base (and specifically not government spending programs) had been the only effective weapon against stagnation in the 1930s.

Romer has tried to reconcile the contradiction by claiming her work has been misinterpreted. She's been abetted by media symps like The El Neoyorkino's Ryan Lizza, who wrote last year:

Conservatives had seized on the paper to disprove the efficacy of fiscal stimulus, but Romer's point wasn't that Roosevelt had spent too much to no purpose; it was that he hadn't spent enough.

Is this accurate? Thanks to reader Dennis Nichols for laying down the mellow groove [pdf] of Romer's 1992 Journal of Economic History article [pdf] "What Ended the Great Depression?"

The 1992 piece announces itself as a rebuttal to previous studies (including Milton Friedman and Anna J. Schwartz's 1963 study A Monetary History of the United States) that cast doubt on federal spending shemes: 

[T]he rapid rates of growth of real output in the mid- and late 1930s were largely due to conventional aggregate demand stimulus, primarily in the form of monetary expansion…

The emphasis that these early studies placed on policy inaction and ineffectiveness may have led the authors of more recent studies to assume that conventional aggregate-demand stimulus could not have influenced the recovery from the Great Depression…

Despite this conventional wisdom, there is cause to believe that aggregate-demand developments, particularly monetary changes, were important in fostering the recovery from the Great Depression. That cause is the simple but often neglected fact that the money supply (measured as MI) grew at an average rate of nearly 10 percent per year between 1933 and 1937, and at an even higher rate in the early 1940s. Such large and persistent rates of money growth were unprecedented in U.S. economic history… [By contrast], the average annual growth rate of M1 [during the "normal" period 1923-1927] was 2.88 percent.

But Romer '92 is quite clear in her position that fiscal policy – i.e. government revenue and expenditure decisions – did not work in the thirties. By "aggregate demand stimulus" Romer means both fiscal policy (which she downplays) and monetary policy (which Romer—along with Friedman and Schwartz, Federal Reserve Chairman Ben Bernanke and others—believe brought about GNP growth in the thirties). The generally precise Romer spells out the difference for us:

Using this approach, the estimated multiplier for monetary policy is 0.823 and the estimated multiplier for fiscal policy is -0.233.

Romer's math is full of Greek letters, so maybe she can explain how these two multipliers add up to 1.55. But to get a sense of how thoroughly Romer '92 disbelieved in the digging/filling-hole model of stimulus, consider that she was even willing to doubt the stimulative effects of the Second World War—the biggest, bloodiest, most expensive hole in the history of fiscal stimulus:

That monetary developments were very important, whereas fiscal policy was of little consequence even as late as 1942, suggests an interesting twist on the usual view that World War II caused, or at least accelerated, the recovery from the Great Depression. Since the economy was essentially back to its trend level before the fiscal stimulus started in earnest, it would be difficult to argue that the changes in government spending caused by the war were a major factor in the recovery.

I don't see how any of this goes beyond the post-Friedman/Schwartz consensus that raining money from a helicopter is the way to spur economic activity. Without defending devaluation of the currency, it is possible to see how printing money could inflate commerce: You're debasing everybody's dollars but at least leaving individuals to decide how to spend the miserable things.

But fiscal policy, as we have now relearned with immense pain, effort and lost opportunity, does not spur a recovery. To her credit, Romer '92 realized this. To her shame, Romer '09 tried to square the circle and failed. This is worth keeping in mind if she is seriously being considered to take over the San Francisco Fed.

RelatedThe Hill calls the White House economic team "exhausted," and there's more support for the theory that supergenius Larry Summers is eating the great economists of America.  All that time he spends catching flies while the President is talking? Don't be fooled. He's scheming. Always scheming.