I decided to take the plunge and read “How the Great Recession Was Brought to an End” by economists Alan Binder (Gordon S. Rentschler Memorial Professor of Economics, Princeton University) and Mark Zandi (Chief Economist, Moody’s Analytics). Binder and Zandi conclude that the various stimulus programs and creative use of montary policy over the last two years were instrumental in preventing Depression-like economic conditions, stabilizing the economy, and setting the country on a path of recovery. Despite my skepticism, I was prepared to give this research a try because I have found Zandi’s past economic commentary to be generally insightful and, most importantly, devoid of the ideological rants or dogma that seem to plague too much economic analysis. Still, I was prepared to nitpick at every flaw and find reasons to cling to my skepticism. Instead, my doubts about the efficacy of stimulus and monetary policy were eased a little by this well-structured and carefully considered study.
The paper starts with a high-level summary of the findings:
“In this paper, we use the Moody’s Analytics model of the U.S. economy—adjusted to accommodate some recent financial-market policies—to simulate the macroeconomic effects of the government’s total policy response. We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0. For example, we estimate that, without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by some 8½ million jobs, and the nation would now be experiencing deflation.
When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing—we estimate that the latter was substantially more powerful than the former. Nonetheless, the effects of the fiscal stimulus alone appear very substantial, raising 2010 real GDP by about 3.4%, holding the unemployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls. These estimates of the fiscal impact are broadly consistent with those made by the CBO and the Obama administration. To our knowledge, however, our comprehensive estimates of the effects of the financial-market policies are the first of their kind. We welcome other efforts to estimate these effects.”
I appreciate the stated willingness to consider future work that will surely attempt to refute these findings. I can only hope that such future work is conducted with as even a hand as this study.
The main body of the study focuses on describing and explaining the numerical results from four simulations. For example, Binder and Zandi claim that the Federal deficit would have been far worse if the government had not spent anything on recovery programs. Their insistence that government spending has multiplier impacts will surely invite the howls and hoots from those who believe that government spending is typically a waste.
But it is the Appendix that provides the most colorful descriptions. You have to read the Appendix to understand the factors that went into the simulation model. The Appendix also provides the deeply interested reader detailed descriptions of how the myriad monetary and fiscal policies put America on the path to recovery. For example, there are some charts showing how important policies corresponded almost exactly with the end of the malaise they were intended to address:
- Chart 2: The Federal Reserve announces TALF (Term Asset-Backed Securities Loan Facility) and automobile ABS spreads finally top out.
- Chart 3: Cash-for-clunkers is implemented and industrial production and employment finally bottom out.
There is even a chart reminding us how fast and how far the spread between 3-month Libor and Treasury bill yields continued to expand after Congress failed to pass TARP (Troubled Asset Relief Program) the first time.
Binder and Zandi acknowledge that the economy should slow in the second half of this year given the waning impact of stimulus, but they are optimistic that the recovery underway is sustainable through 2012. They do not quite explain why they think the considerable and stubborn weakness in the housing market will not leave a more lasting stain on the recovery scenario. They provide some worrying statistics regarding the housing market:
“As of the end of June 2010, credit file data show an astounding 4.3 million first mortgage loans in the foreclosure process or at least 90 days delinquent (see Chart 4). For context, there are 49 million first mortgage loans outstanding; so this is almost 9% of the total. Mortgage servicers and owners are deciding that many of these loans are not viable candidates for the HAMP plan, and have begun pushing these loans towards foreclosure. Thus foreclosures and short sales are expected to increase measurably in the coming months, which would put even more downward pressure on house prices.”
They also expect unemployment to remain high: “Unemployment is still close to 10% at the end of 2010, but closer to 9% by the end of 2011.”
Ouch. These two combined are enough to make me appreciate the stock market’s hesitation in its celebration of strong earnings reports this quarter (until recently).
The two findings that surprised me the most involved tax cuts and the cost of unemployment insurance:
- Total tax cuts to individuals ($300B) and businesses ($100B) account for 36% of all stimulus spending. Binder and Zandi point out that the tax rebates in 2008 to lower- and middle-income households were largely spent but the overall impact was muted by the rapid increase in savings by high-income individuals who did not receive tax cuts: “The saving rate for households in the top quintile of the income distribution surged from close to nothing in early 2007 to double digits by early 2008.” They did not go on to conclude that tax rebates should have been extended to the wealthy. I assume it is because no practical tax rebate would have come close to offsetting the rapid and large declines in housing and stock wealth suffered by this segment of the population.
- Binder and Zandi call unemployment insurance “…among the most potent forms of economic stimulus available. Additional unemployment insurance produces very high economic activity per federal dollar spent.” To this end, unemployment insurance has cost the Federal government a whopping $300B. This is comparable to the amount of tax cuts and consumes a substantial portion of the $1+ trillion the Federal government has spent staving off the recession.
So, overall, I found this study very useful and insightful. I do not recommend it for anyone whose mind is already closed to the possibility that the stimulus policies of Presidents Bush and Obama and the monetary policies of the Federal Reserve were successful in their goals to avert an economic Depression. On the other hand, I also do not find any evidence here to justify another trillion-dollar stimulus such as the one economist Paul Krugman has recommended since near the beginning of the crisis.
I am looking forward to follow-up work on this topic. I am sure John Taylor is resharpening his pencils since his empirical work claims to reveal the ineffectiveness, even harmfulness, of the Federal government and the Federal Reserve during the financial crisis (see for example “Getting Back on Track: Macroeconomic Policy Lessons from the Financial Crisis“). Arnold Kling at EconLog is quick to rip Binder and Zandi apart for being grounded in outdated Keynesian thinking and modeling in a short piece called “What Blinder and Zandi Don’t Know.” He likens the work to astrology. (Of course, I think Kling is overly dismissive, but I do wish Binder and Zandi discussed the accuracy/success of past forecasting efforts using their simulation model).
After the acrimony and drama surrounding last year’s passage of the American Restoration and Recovery Act (ARRA), I was sure that we as a country would never learn lessons from the results from the program: if it failed, supporters would simply say we did not spend enough, and if it worked, critics would simply credit anything but the stimulus for helping. Maybe, just maybe, we can and will learn.
Be careful out there!
Full disclosure: long XHB puts