Is This Really All They Expected?

I was puzzled by a recent Paul Krugman post that argued the current recovery is about all we should have expected from the puny $800 billion stimulus package.  I found this confusing, as during the first 4 quarters of recovery growth has averaged 3%, which is less than what I would have expected with no stimulus at all.  (Note, essentially the entire world has been recovering over the last year, regardless of fiscal policies.)

Krugman shows a bar graph depicting rising and then declining expenditures on stimulus over the past 18 months, and then compares it to a fairly similar looking bar graph showing rising and then falling RGDP growth rates.

[BTW, I would argue that he should be showing NGDP, not RGDP growth, as stimulus is supposed to directly boost AD (NGDP), and the effect on RGDP depends on both the size of the AD increase, and also any concurrent supply-side factors.  But he’d get a similar correlation.]

As I read his post, he seems to be implying that we shouldn’t be surprised that the economy seems to be grinding to a halt, as the stimulus is now ending.  But I thought the proponents of stimulus had some sort of natural rate model in mind, where RGDP tends to grow 3% per year long term regardless of what is done, and that fiscal stimulus is a way of returning to trend more quickly by stimulating private spending.  The idea was to give the economy a shot in the arm, and once the effects wore off we’d get the normal 3% growth.  Indeed perhaps a bit more that 3% if we were still below trend, as long run wage and price flexibility give the economy a sort of self-correcting mechanism.

But instead we have only grown at trend during the recovery, and we now seem to be slowing even further.  Yes, the stimulus was smaller than Krugman wanted, but this is roughly the sort of pattern I would have expected:

1. Krugman’s $1.3 trillion stimulus:  7% RGDP growth during brisk recovery, 3% thereafter.
2. Actual $800 billion stimulus:  5% RGDP growth during a slower and longer recovery, 3% thereafter.

Isn’t that the basic idea?  Remember that RGDP grew 7.7% in the first 6 quarters of the 1983-84 recovery, with deficits of only 6% of GDP, not the 12% we have now.   Now you could argue that this cycle is different.  Maybe banking problems give the economy extra headwind.  Fair enough.  But I still don’t see how that supports Krugman’s point.  He’s seems to be saying this is exactly what Keynesian demand-side theory would suggest.  But it isn’t, as growth should be much faster.

I’m not ruling out that stimulus may have helped on a ceteris paribus basis.  And I suppose Krugman would argue that the correlation he finds supports that notion.  But I must admit that I don’t have much sympathy for any Keynesians reading Krugman and assuming that this shows fiscal stimulus “works.”  Those banking headwinds were well understood when the predictions were made in early 2009.  Indeed the subsequent banking crisis has turned out to be far milder than the IMF forecast at that time (which is why banks are able to repay almost all their TARP loans, something that wasn’t initially expected.)  So if Keynesians are claiming it worked, are we to believe that in early 2009 they were promising us no recovery at all for the expenditure of $800 billion?  I say “no recovery” because we are not recovering if we are merely growing at trend.  We are treading water.

To be fair, Krugman is not one of those Keynesians claiming success, he thinks the stimulus was way too small.  Thus my post is actually directed more at the administration than Krugman.   But he does seem to be claiming that we got about what you’d expect from an $800 billion stimulus.  And thus the question in title of this post.

PS.  In my last foray into multiplier economics I misinterpreted the long run multiplier, so it is possible I have missed something simple here.  What do you think?

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