Greg Mankiw wrote in National Affairs a couple days ago about the effectiveness and politicization of the stimulus. His analogy comparing the economy to a sick patient is great:

To understand the challenge government economists have faced over the past year and a half, it is useful to imagine the case of a physician trying to treat an ill patient. The patient presents herself in terrible shape; the physician has never treated a condition with symptoms quite like hers before; and the causes of the ailments are unclear. The doctor remembers reading about a similar case in medical school — and, trying to recall as much of his training as possible, he endeavors to come up with a theory as to why the patient is sick and to determine what will make her better.

In an ideal world, the doctor would run a controlled experiment: He would assemble 100 patients with similar symptoms, give 50 of them the medicine that seems most likely to work and the other 50 a placebo, and then see whether the patients on the medicine in fact improved. But the doctor does not have 100 patients — he has only one. So, based on his assessment of what is causing the patient’s troubles, and the most likely remedy, he takes a risk and administers the medicine.

The patient, however, returns a few weeks later; this time, her symptoms are worse. What, then, should the doctor conclude? He might decide that he gave the patient the wrong medicine. Or he might determine that the patient was even sicker than he originally thought, and thus that the medicine should be administered at an even higher dosage. Either conclusion is plausible, but there is no way the doctor can be sure. What he does know is that he must act before the situation gets even worse.

I think that’s a great way to understand the incredible inconclusiveness and frustrating state of evaluating the Obama stimulus package. Was the economy sicker than the doctor thought, and thus the unemployment being at 10% (higher than the 8% promised by Obama’s economic team) was due to lack of a big enough stimulus? Or do stimuli simply not work and the trillion or so dollars spent trying to revive the economy were all just an inefficient waste of money?

The second thing I particularly like about Mankiw’s piece is his focus on efficient spending that improves standard of living, rather than a boost in statistical GDP:

To look at it another way: If a person pays his neighbor $100 to dig a hole in his backyard and then fill it up again, and the neighbor hires him to do the same, government statisticians will report that the economy has created two jobs and that the gross domestic product has risen by $200. But it is unlikely that, having wasted all that time digging and filling, either person is better off — economically or otherwise. Each person’s net financial gain is zero, and all anyone has to show for the effort is a patch of fresh dirt in the backyard, which is unlikely to improve anyone’s standard of living.

Private individuals don’t usually spend their money on things they don’t want or need. So when money is kept in the hands of citizens, and transactions take place in the private sector, there is less cause to worry about inefficient spending. The same cannot always be said of government. This means that government spending designed to stimulate the economy must first be subjected to serious cost-benefit analysis, which is hard to do in a big rush. Not all government spending is created equal — and rushed spending is, in many important ways, likely to be less efficient and less useful than spending that is carefully planned.

Read the whole article here for an easy-to-read analysis of the stimulus and the economics profession in general.

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Greg Mankiw points out the illogical criticism being heaved at Republicans that opposed the Obama stimulus plan but still accepted money for their districts:

Let me offer an analogy.  Many Democratic congressmen opposed the Bush tax cuts.  That was based, I presume, on their honest assessment of the policy.  But once these tax cuts were passed, I bet these congressmen paid lower taxes.  I bet they did not offer to hand the Treasury the extra taxes they would have owed at the previous tax rates.  Would it make sense for the GOP to suggest that these Democrats were disingenuous or hypocritical?  I don’t think so.  Many times, we as individuals benefit from policies we opposed.  There is nothing wrong about that.

Mark Sanford tried to take a principled stance by refusing stimulus money for his state of South Carolina. While I mildly admire his courage to do so, I think it was more a political ploy than a reasonable action. Regardless of whether Sanford supported the stimulus or not, Obama got it passed and the stimulus was going to happen. That stimulus was going to be funded by Treasury-borrowing. In the end, taxpayers foot the bill. South Carolinians are part of that taxpayer base. They’re going to pay for it anyway, so why is it wrong for them to benefit from it?

Despite a 5.7% annualized growth rate in the last quarter of last year, unemployment still stands at a sobering 9.7%. How can GDP grow so much without creating new jobs? It’s simple. During the economic downturn companies stored up their surplus goods – brought on by a substantially decreased demand – in inventory. That 5.7% annualized growth reflects a lot of inventory sales – things already produced before and thus not needing any new labor.

Barack Obama has said that his number one priority this year is job creation, a noble goal. But Obama’s economic advisers also predicted that with the stimulus, unemployment would max out at 8%. They also predicted that without the stimulus, unemployment would reach as high as 9%. Looks like we’ve got worse than both predictions. I am eager to see what Obama’s plan for job creation is. Meanwhile, my skepticism of stimuli’s solvency continues.

There is economic reasoning to argue that stimulus packages, aka deficit-funded government spending, can speed up recovery in times of a recession or a depression. Recessions, Keynesians and others argue, are caused by a lack of aggregate demand – something the stimulus packages make up for. But what I find most annoying about something like a stimulus package is that regardless of its results, both sides can claim victory.

Take the most recent stimulus. Unemployment has hit higher than Obama’s economic team said it would with the stimulus. This seems to be logical grounds for anti-stimulus folks to claim that the stimulus didn’t work. But no. People like Paul Krugman and Joseph Stiglitz argue instead that there wasn’t enough of a stimulus.

Take the opposite situation. The economy rebounds tremendously. We’re back at full employment and everyone is happy. This seems to be logical grounds for pro-stimulus folks to claim the stimulus worked. But no. Opponents like Greg Mankiw or Gary Becker could merely say that this recovery would have happened regardless of the stimulus.

Unfortunately, it seems that when it comes to macroeconomics, the sheer inconclusiveness of pretty much everything makes the policy debate that much more frustrating.

The rationale behind an economic “stimulus” is that recessions or depressions are caused by a lack of aggregate demand. Because of this, governments step in to speed up the recovery by using deficit spending to make up for the decreased aggregate demand. An economic term called the “Keynesian multiplier” predicts that for every dollar spent by the government, output will rise higher than a dollar because people continue to spend the money they get in exchange for their goods and services (and save the other portion). But how successful has the last stimulus really been?

In a recent op-ed in the Wall Street Journal, Robert J. Barro and Charles Redlick, using observations from a paper that will be published soon, write:

The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller.

If this multiplier is less than one, the government is spending more than it is helping. This deficit spending is more than just inefficient, it actually crowds out investment by raising interest rates, and creates the obvious problem of long-term interest payments.

The vast majority of economists say that this economic crisis has reached its bottom in terms of output (though unemployment will continue to grow). At the same time, only 10% of Obama’s stimulus package has been spent. 10%! If we’re already on the upswing, I propose we just forget about spending the other 90%.

Barro and Redlick did briefly mention another way to stimulate the economy:

…there is empirical support for the proposition that tax rate reductions will increase real GDP.

Hmm…