What if Stimulus Works--But Only in Theory?
Maybe the sums we need are just too large to get through the political system.
Brad DeLong publishes a very thought-provoking piece on the persistent failure of the economy to live up to its potential post-crash. Here's the key graph, which should terrify anyone who gazes upon it:
After almost five years, real per-capita GDP is still well below its pre-crisis level. And this is not a distributional issue, where the median is dropping because the rich are hoarding too much. The amount of money available per person has actually fallen. We are not as rich as we thought we were.
Professor DeLong argues that the problem is deleveraging--we are all trying to save money rather than spend it, and in the process, we are getting the economy stuck at lower levels of output and employment than they would be if we just calmed down a bit about the future. Or rather, if the government would get off it's butt and make us calm down.
So we remain far short of full employment for the third reason. The issue is not that governments and central banks cannot restore employment, or do not know how; it is that governments and central banks will not take expansionary policy steps on a large enough scale to restore full employment rapidly.
And here I reflect on the 1930’s, and on how historical events recur, appearing first as tragedy and then, pace Karl Marx, as yet another tragedy. Keynes begged the policymakers of his time to ignore the “austere and puritanical souls” who argue for “what they politely call a ‘prolonged liquidation’ to put us right,” and professed that he could “not understand how universal bankruptcy can do any good or bring us nearer to prosperity.”
This is not a new argument, though it is particularly nicely laid out in this piece; DeLong, along with Krugman and Stiglitz and a host of other folks, has been making it for a while. It's a very plausible argument. But I have some questions.
Since the financial crisis hit, we have borrowed and spent $5.7 trillion, or 41% of 2008 GDP (7.8% of total GDP over the period). That is an enormous sum. Presumably, it has raised output somewhat higher than it otherwise would have been--just as an accounting identity, it would almost have to--and yet it has left us with unemployment in the range of 8%, and per-capita GDP that is still below the pre-crisis trend. How much would have been needed to force that growth back up to trend?
On Professor DeLong's chart, the output gap seems to be about $4,000 per capita, or $1.25 trillion. In the context of our ongoing debt, that doesn't actually seem to be so much. If you assume a multiplier on the high side, we would only need to have spent something like $600 billion dollars, perhaps over a series of years.
But this seems simultaneously too much and too little. Can it really be that adding $125 billion a year would have solved all of our economic woes? The US government has consistently gone over its projections by at least that amount several times over the last four years, and yet we are not better.
So I'm not sure I understand the counterfactual. Is it that without the $900 billion worth of stimulus that we did, plus a few later add-ons, per-capita income would now be just north of $36,000 a year? That's a Great-Depression-sized decline, without the catastrophic banking errors.
Either stimulus displays declining returns to scale, or I think we're talking about a much larger number having been needed--something closer to $1 trillion. Maybe something a lot higher than $1 trillion. After all, the output gap is an annual event; it's not something that just happens once. It's possible that we might have to spend $600 billion or $1 trillion a year, for years at a time, in order to close that cursed output gap.
Or is it that we did the stimulus too slowly--did we need it all at once, along with another $600 billion or so?
Either way, was such a thing feasible?
Would any country agree to spend an additional $1 trillion worth of stimulus in a single year, or $2 trillion (or more) in aggregate? Would markets support it? And even if they did, could the US government actually move the money through the system? Presumably, we didn't want to give out an additional $600 billion worth of food stamps. But the alternatives are either harder to move out the door (there were no shovel ready projects), or deliver less bang (tax cuts) or both.
In short, I'm wondering if rather than being tried and found wanting, Keynesianism hasn't been found impossible and left untried. Whether the amount of stimulus needed to jolt the economy back to trend isn't simply too large to pass political muster. It's hard to see a situation short of total war where that kind of money could be authorized or spent in the requisite period of time.