Models Used for Policy Should Reflect Recent Experience, But Do They?

Data from the Department of Commerce show that short-term stimulus funds did not go to increase federal purchases, or state and local purchases, or even consumption purchases by much over the past few years. Thus the packages did not materially stimulate GDP or employment. In a recent Commentary pieceWhere Did the Stimulus Go?” John Cogan and I review and explain our empirical research using these data.

Unfortunately, most Keynesian models have been not adjusted to incorporate these facts, so they keep making the same predictions. To cite one example, the multipliers in Mark Zandi’s model as of July 2008 are found here (page 52 of the full document, 5 of the paper) while the multipliers as of December 2010 are found here. They are virtually the same. The model assumes a multiplier from a temporary tax rebate or refund which is greater than one, even though the actual data show it was much less than one in the case of the 2008 and 2009 stimulus packages. Note that the model also assumes a multiplier from a permanent tax cut which is only about 1/3. The relative sizes of permanent and temporary effects are exactly the opposite of what basic economics implies.

Using such results people write stories like this one “Zandi Analyses Show ‘Democratic’ Measures in Tax Cut-UI Deal Boost Economy, ‘Republican’ Measures Add to Deficit Risks” from the Center of Budget and Policy Priorities, supposedly because Democrats favor temporary actions and Republicans favor permanent actions. But the “analyses” are simply old simulations from models which appear to be ignoring the facts. More consistent with the facts and the theory is that the recent tax deal will be more beneficial to the economy than the past stimulus packages because it extends the Bush tax cuts and thus makes them more likely to be permanent.

Another example of the problem with the modeling assumptions is the multiplier from “general aid to state governments,” which is assumed to be 1.36 in the Zandi model. Yet the Commerce Department data are very clear that virtually none of this aid to state governments in the 2009 stimulus (ARRA) went into government purchases; most went to reduce borrowing. Here is a diagram from the Commentary article which shows this. You cannot get a multiplier of 1.36, or even much greater than zero, when none of the funds went to government purchases and more than half went to reduced borrowing.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

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