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Another Surprise Contraction

June 8, 2010

I’ve said this before, but I think I need to say it again.  When the financial crisis hit in the fall of 2008, I initially found myself on the do-nothing side of the fiscal stimulus argument.  My logic was that fiscal policy had historically proved to be ghastly inept at combating recession—people save their tax cuts and their stimulus checks during downturns, and anything new that federal spending can add to the economy (like infrastructure spending) takes forever to initiate—and that therefore our response should be strictly monetary as it usually is.  Unfortunately, by February, interest rates had been at zero for four months and the economy was still hemorrhaging jobs.  At that point, you have to try something.  The “something” that we got was the American Reinvestment and Recovery Act, which, despite misguided CBO calculations, preceded an enormous contraction of the American money supply, cost a gargantuan amount of money, and failed to produce anywhere close to as many jobs as it propounded to.

I say all that to say this: both Yglesias and Ezra Klein (shocker) flagged this nugget from Stephen Gordon about expansionary fiscal policy since the beginning of the recession.  It turns out that we don’t have an expansionary fiscal policy:

It’s important to remember that the proper measure for fiscal stimulus is not spending by the federal government; it is spending by all levels of government. And when you look at the contributions to U.S. GDP growth (Table 1.1.2 at the BEA site), total government spending has been a drag on growth over the past two quarters. The increases at the federal level have not been enough to compensate for the spending cuts at the local and state levels.

So, fiscal contraction by state and local governments as a result of decreased tax revenues due to the recession has basically been cancelling out the expansionary policy of the federal government.  This, after some of us had been saying that the stimulus, the hallmark of the President’s counter-recession plan, was poorly designed because—among other things—a considerable share of the money was going to shore up state and local budgets.  Here’s something I wrote about two months ago:

Despite what others have observed, I think conservatives, by and large, believe that just because the stimulus has indeed created some jobs—a maximum of half of what it was supposed to (Wait!  Wait!  We haven’t spent all of it yet!  Well, what’s the point of the “jobs bill” then?)—does not mean that it wasn’t a “flop”.  As Frum points out, it has probably had even less effect than CBO claims because a significant portion of the funds went to state governments, which promptly directed the resources toward preserving government jobs, which pay more than private sector ones.  Indeed, as everybody begins to agree that the stimulus has already had its greatest possible effect on unemployment—it probably peaked a long time ago—is it really that big of a stretch to say that the rest of the unspent money will do more harm than good to our long-term economic prospects?

A graph from the original post shows that despite budget streamlining from state and local governments via the stimulus, they’re still bleeding jobs.  So, what does this tell us?  I expected something along the lines of “China doesn’t have this problem—our federalism is preventing us from stimulating our economy”, but that’s not what I got.  This is Yglesias’s conclusion:

Looked at comprehensively, what the country has been implementing is a mild version of the conservative policy prescription for boosting growth—fire bureaucrats and trim spending. And it’s not working very well. And with continuing economic weakness, state and local governments are set for further trimming even as federal stimulus winds down. This is going to be a disaster. Nothing about having economically pressed jurisdictions lay off huge quantities of teachers is going to improve the situation.

Uh, okay.  Interesting how people can say for months that all conservatives care about is tax cuts and preserving corporate interests and then mention a “conservative policy prescription for boosting growth” without saying anything about tax cuts.  Again, the question is not whether we should have had any federal stimulus, it’s how the ARRA was designed.  And all evidence indicates that it has done a disastrously poor job of doing what it was supposed to.

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