'Keep Spending Like Mad or Else' Chorus Grows; Stanford's Taylor Responds; Expect Press to Ignore

February 28th, 2011 3:11 PM

Late last week (covered at NewsBusters; at BizzyBlog), a Goldman Sachs economist issued a dire warning cutting current-year federal spending by a measly $61 billion, or about 1.75% of the administration's full-year projected spending total, would significantly reduce economic growth in the coming quarters. If this were so, the economy would booming beyond belief right now, given that the Obama administration ran a $800-plus billion so-called stimulus plan during the past two years, and is on track to run up over $4 trillion in reported budget deficits in a three-year period by the end of the current fiscal year. Readers will note that the economy is not booming beyond belief.

The Associated Press chimed in on Friday after the latest report on the nation's Gross Domestic Product (GDP). Expert, presumably including some geniuses at Goldman, thought it would be revised up from an annualized 3.2% to 3.3%. Oops; it came in at 2.8%. Befuddled AP reporters claimed incorrectly that reductions in state and local government spending seriously held back reported growth during the final quarter of 2010. Zheesh; the impact was only -0.29 points. The real problem is that private investment is seriously lagging, and has really never stopped lagging since the recession began in 2008.

The "Keep spending like mad or else" chorus got more help today from chief economist Mark Zandi of Moody's Analytics. This morning, the Washington Post's Lori Montgomery dutifully relayed the pile-on (bolds are mine):

GOP spending plan would cost 700,000 jobs, new report says

 

A Republican plan to sharply cut federal spending this year would destroy 700,000 jobs through 2012, according to an independent economic analysis set for release Monday.

 

The report, by Moody's Analytics chief economist Mark Zandi, offers fresh ammunition to Democrats seeking block the Republican plan, which would terminate dozens of programs and slash federal appropriations by $61 billion over the next seven months.

 

Zandi, an architect of the 2009 stimulus package who has advised both political parties, predicts that the GOP package would reduce economic growth by 0.5 percentage points this year, and by 0.2 percentage points in 2012, resulting in 700,000 fewer jobs by the end of next year.

 

His report comes on the heels of a similar analysis last week by the investment bank Goldman Sachs, which predicted that the Republican spending cuts would cause even greater damage to the economy, slowing growth by as much as 2 percentage points in the second and third quarters of this year.

 

Zandi also had bad news for liberal Democrats who are resisting sharp spending cuts: Bringing deficits down to sustainable levels will require more than a growing economy. Even if the economy recovers as expected, he writes, lawmakers will have to cut about $400 billion a year through the rest of this decade to narrow the gap between spending and revenue, and stop adding significantly to the national debt.

Maybe Ms. Montgomery and others who are relaying the "spend or else" warnings should look at what the stimulus accomplished. The answer, per economists John F. Cogan and John B. Taylor in the Wall Street Journal in December was a big fat "nothing":

The Obama Stimulus Impact? Zero

 

... data covering the first year and three quarters of the 2009 American Recovery and Reinvestment Act (ARRA) show that, despite the large size of the program, the dollar volume of additional government purchases that it has generated has been negligible.

 

... The bottom-line is the federal government borrowed funds from the public, transferred these funds to state and local governments, who then used the funds mainly to reduce borrowing from the public. The net impact on aggregate economic activity is zero, regardless of the magnitude of the government purchases multiplier.

 

This behavior is a replay of the failed stimulus attempts of the 1970s.

 

... The implication of our empirical research and Gramlich's is not that the stimulus of 2009 was too small, but rather that such countercyclical programs are inherently limited. The lesson is to beware of politicians proposing public works and other government purchases as a means to stimulate the economy. They did not work then and they are not working now.

Stanford Professor Taylor has published a rebuttal to Goldman's gibberish and Zandi's eye-candy aimed at politicians desperately looking for an excuse not to act. I'm excerpting here, because I expect the establishment press either to largely ignore it, or to completely ignore it:

Goldman Sachs Wrong About Impact of House Budget Proposal

 

Some claim that House budget proposal H.R. 1 to reduce the growth of federal government spending will cause a slowdown in the economy and even increase unemployment. Consider, for example, a recent report by Alec Phillips of Goldman Sachs which claims that the House proposal would reduce economic growth in the second and third quarters of this year by 1.5 to 2 percent if enacted into law next month. Nothing could be more contrary to basic economics, experience and facts. Unfortunately, the report has been widely cited by those wanting to hold back on this first step to restore sound fiscal policy. And the Washington Post reports this morning that Mark Zandi of Moody’s is starting to make similar claims, which should be questioned for the same reasons.

 

There are several things wrong with the analysis used in Goldman Sachs report. First, it does not take account of the beneficial effects of starting now on a credible plan to reduce the deficit. Basic economic models in which incentives and expectations of future policy matter show that a credible plan to reduce gradually the deficit will increase economic growth and reduce unemployment by removing uncertainty and lowering the chances of large tax increases in the future. The high unemployment we are experiencing now is due to low private investment rather than low government spending. By reducing some uncertainty and the threats of exploding debt, the House spending proposal will encourage private investment.

 

The analysis in this Goldman-Sachs report is based on the same type of “large multiplier” theory that predicted that the stimulus package of 2009 would stimulate economic growth. Research by me and my colleague John Cogan finds that more up-to-date theories, which bring important incentive and expectations effects into account, show far smaller multipliers. In these models a reduction in the growth of spending will immediately crowd in private investment. Moreover, by following the stimulus money, we found that in actuality the stimulus package of 2009 had no material positive effect on economic growth or employment. The same economic theory which said the stimulus would increase economic growth in the past two years, says that reversing that spending will reduce growth now. It was wrong in the past and it is highly likely to be wrong again.

It takes a special brand of chutzpah for status quo defenders like Zandi to worry about 700,000 lost jobs, when the Obama "recovery" since the recession officially ended in June 2009 still shows 228,000 jobs lost (that's right, lost).

Bill Clinton's 1992 campaign stump speeches (scroll to the bottom at the link) frequently employed the bromide that "The definition of insanity is doing the same thing over and over again and expecting a different result." In more polite terms, Taylor is telling Goldman and Zandi that their fear-mongering about slower growth, which in light of the deficits the government is running amounts to an endorsement of continued stimulus, is nuts. So is the press for swallowing it and relaying it without question.

Cross-posted at BizzyBlog.com.