What is the return on fiscal stimulus?
Menzie Chinn attempts a valiant defence of fiscal stimulus against innumerate accusations from Richard Posner and others. Posner, to be fair, has corrected his arithmetic now and restated a few of his points in a more nuanced way.
However Chinn is now having to fight a battle against his own anonymous commenters, who say things like:
So explain to me still, how an 89B (regardless of interest expense) is a good investment if we only get a 39B return. It seems even if we got a multiplier of 2, we'd still only be at 80B and that is still a negative return. It seems like we're just delaying the pain.
This comment misunderstands the nature of stimulus and imposes a meaningless standard on the "return" on government spending. Here is what has actually happened:
- The government borrows $89 billion.
Savers have handed over an asset ($89 billion in cash) in return for another asset ($89 billion of government bonds). The government gains an asset ($89 billion cash) and creates a new liability ($89 billion of bonds). Net impact on both parties: zero.
There may be a small net impact due to the difference between the discount rate on foregone current private consumption and the interest rate on government bonds, but at present this is a minor effect. Depending on the discount rate we use, the effect could go in either direction. I have therefore ignored both discounts and interest payments in the remainder of this calculation to keep the calculations simple. Feel free to disagree with this in the comments.
- The government spends $89 billion.
Let's say it gives away A in transfers and spends B on goods and services, with A + B = $89 billion.
Then the government's balance sheet is reduced by A, but the public's holdings are increased by A. Thus this is not an "investment" by the government which is meant to generate a return as if it were a private investment; it is simply a movement from one part of society to another. Society's total wealth does not change.
B is slightly more complex. Some government purchases are inefficient because they are being made on behalf of other people; on these, there is a loss in total economic value compared with the equivalent amount of private spending. Other government purchases are efficient because they are on public goods which bring a positive net benefit to society. Naturally there is an intense debate, broadly between right and left-leaning economists, about which effect predominates. But let's give the stimulus a harder challenge and assume that overall, there is a loss of 20% on B.
In the current quarter, B only represents around 25% of the total, so the economic loss overall is around 5% of the $89 billion, or $4.5 billion.
- The money - or some of it - is spent again in the private sector: the Keynesian multiplier.
I'm going to take Menzie Chinn's figures as given, as this was our starting point for the debate: so $39 billion of economic activity is created, compared to the counterfactual where no stimulus occurred. This is new activity created out of thin air (actually, out of otherwise unemployed resources) so it accrues on the positive side of the economy's balance sheet: new net wealth is created.
There is an argument that this $39 billion of GDP, based on measurable economic transactions, is achieved at the expense of non-measured benefits such as leisure time. There is some truth in this, but looking realistically at involuntary unemployment it is hard to argue that the desire for leisure is anywhere near a straight trade-off for the alternative. Some would even argue that involuntary unemployment has negative utility and not positive; but again, if we impose high hurdles for the stimulus, we can accept that there is some positive utility. I would consider it credible that the opportunity cost is a third of the GDP-measured value of the alternative: thus, $13 billion.
- Finally, taxes must be collected to repay the $89 billion.
Taxes generally create an economic loss because of both the effort required to collect them, and the incentives they create either to spend time on tax avoidance, or to reduce work effort since your income per hour worked is lower. It's not easy to agree on what that "deadweight loss" is, but Tyler Cowen suggests twenty percent or more. Unfortunately "or more" doesn't give us any guidance on the upper bound, so I'm going to use the figure of twenty percent (noting also that Tyler's views are on the libertarian side).
As Paul Krugman pointed out a few months ago, the stimulus partly pays for itself in new tax revenue. So of the $39 billion of new economic activity, somewhere between 15-35% will come back in increased federal taxes. However, this doesn't count as net benefit because once again it is a transfer. It does mitigate the argument of the deadweight loss, however.
On the figure of 20%, the economic cost of collecting this $89 billion will be just under $18 billion.
Cost = $4.5 billion + $13 billion + $18 billion = $35.5 billion
(Recall that I have tried to estimate the costs on the high side to give the stimulus a high bar to jump over.) The benefit, in this quarter alone, on Menzie Chinn's figures, is $39 billion.
So, give or take a few billion, this quarter's stimulus has paid for itself by the end of the quarter. Any remaining impact in GDP in future periods - which is likely to be substantial, perhaps the same amount again - comes for free.
What's more, the utility of a $39 billion gain in the middle of a recession far outweighs the impact of a $35 billion cost in a future period of economic growth. This aside from the argument that redistribution from richer to poorer people in general (which to some extent is a feature of nearly any stimulus package) anyway improves total utility.
Now this is an unashamedly utilitarian argument; I accept there is a libertarian case against redistribution, no matter if it does increase total welfare. But the question here is about the "return" on stimulus, and that is a utilitarian question.
All in all, Chinn's calculations (and by extension, Christina Romer's) are a pretty convincing argument for the success - on its own terms at least - of the fiscal stimulus so far.