As we contemplate the future of macroeconomic policymaking (or not), it’s important to recall the stakes. We have avoided the disastrous outcome that would arisen had the plan for further massive tax cuts aimed a high income households and extensive spending cuts been implemented; however, output remains far below full employment levels. Since 2008Q1 through 2012Q3, the cumulative output loss has totaled $3.75 trillion (Ch.05$).
Figure 1: GDP (black), WSJ survey forecast GDP (red), and potential GDP (gray), in bn. Ch05$, SAAR. Source: BEA, 2012Q3 3rd release, WSJ January 2013 survey, and CBO (August 2012).
A further $0.94 trillion loss will be incurred by the end of 2013, should the economists surveyed by WSJ be proven correct on average. This makes clear that we are far from a complete recovery. However, it is important to recall that the Administration did propose additional measures that would, had we implemented them, have reduced the gap measurably. Consider where we would be had the President’s American Jobs Act been passed:
Figure 2: GDP (blue), WSJ survey forecast GDP (red), and implied by Macroeconomic Advisers’ estimates of the American Jobs Act (green squares), in bn. Ch05$, SAAR. Vertical dashed line at 2009Q1 (passage of ARRA, aka “the stimulus package”). NBER recession date shaded gray. Source: BEA, 2012Q3 3rd release, WSJ January 2013 survey, Macroeconomic Advisers (Sept. 2011), and NBER.
Macroeconomic Advisers did not incorporate into their estimates the impact from the incentive effects on employment from the payroll tax credit for new hires, so in some sense, the MA estimate understates the impact. (For contrast, consider the “Real American Jobs Act”, which was backed up by Heritage Foundation statistical analysis.)
This is an obvious point, but it bears repeating: the slow growth we have experienced thus far is partly the result of insufficient fiscal stimulus (as well as partly a result of the aftermath of a balance sheet/financial crisis, a la Reinhart and Rogoff).
I think the Macroeconomic Advisers estimate might understate how much we could have improved the situation for another reason: that is because recent evidence suggests the fiscal multiplier is larger than we thought on the basis of pre-crisis data. I’m thinking of this as I have just been writing a survey of fiscal multipliers, and one of the interesting results that has come out in recent research is the asymmetry in responses to fiscal policy conditional on the state of the economy. Auerbach and Gorodnichenko and Fazzari et al. have tackled this issue from the expansion/contraction distinction, as discussed in this post.
But I think that the most relevant finding is from Baum et al. (2012), regarding effects conditioned on the sign of the output gap:
Excerpt from Figure 2. Cumulative Fiscal Multipliers: Fiscal Expansion from Baum et al. (2012). Shaded bars indicate statistical nonsignificance.
The blue (red) bars pertain to cumulative multipliers four (eight) quarters out. The left hand side bars pertain to positive spending shocks, the right hand side bars pertain to negative revenue shocks. The bottom line is that positive fiscal shocks, particularly when the output gap is negative, are particularly expansionary.
Obviously, the prospects for further fiscal stimulus are not auspicious. Nonetheless, these results are important, if only they highlight the fact that previous estimates based on homogeneous responses to fiscal policy, might lead to misleading conclusions when applied in the current macroeconomic environment.
But more importantly, if expansionary fiscal policy is depends on the state of the economy, it would not be surprising to find contractionary fiscal policy to also be state-dependent. This is what Baum et al. also find:
Excerpt from Figure 3. Cumulative Fiscal Multipliers: Fiscal Contraction from Baum et al. (2012). Shaded bars indicate statistical nonsignificance.
The bars on the left pertain to negative spending shocks, on the right to positive revenue shocks.
Hence, we must be very careful about attempting too much fiscal consolidation right now when the output gap is so negative (further confirmation of this general principle is provided by the recent paper by Blanchard and Leigh (2013)). All something to keep in mind as certain groups demand sharp front-loaded spending cuts.
I anticipate hearing something about crowding out from the usual suspects; these fears have been abounded for the past four years. I will merely observe that if crowding out occurs via elevated interest rates, evidence is somewhat lacking for that thesis.
Figure 3: Ten year constant maturity yields on TIPS (blue) and real interest rate on ten year constant maturity Treasurys (calculated using ten year constant maturity Treasurys and expected ten year CPI inflation from the Survey of Professional Forecasters (red squares). NBER defined recession dates shaded gray. Source: St. Louis Fed FRED, Survey of Professional Forecasters, NBER, and author’s calculations.