Crowding Out Fiscal Stimulus: Testing the Effectiveness of US Government Stimulus Programs PDF
Preview Crowding Out Fiscal Stimulus: Testing the Effectiveness of US Government Stimulus Programs
Crowding Out Fiscal Stimulus Testing the Effectiveness of US Government Stimulus Programs John J. Heim Crowding Out Fiscal Stimulus JohnJ.Heim Crowding Out Fiscal Stimulus Testing the Effectiveness of US Government Stimulus Programs JohnJ.Heim UniversityatAlbany-SUNY Albany,NewYork USA ISBN978-3-319-45966-0 ISBN978-3-319-45967-7 (eBook) DOI10.1007/978-3-319-45967-7 LibraryofCongressControlNumber:2016954261 ©TheEditor(s)(ifapplicable)andTheAuthor(s)2017 Thisworkissubjecttocopyright.AllrightsaresolelyandexclusivelylicensedbythePublisher, whetherthewholeorpartofthematerialisconcerned,specificallytherightsoftranslation, reprinting,reuseofillustrations,recitation,broadcasting,reproductiononmicrofilmsorinany otherphysicalway,andtransmissionorinformationstorageandretrieval,electronicadaptation, computersoftware,orbysimilarordissimilarmethodologynowknownorhereafterdeveloped. Theuseofgeneraldescriptivenames,registerednames,trademarks,servicemarks,etc.inthis publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesare exemptfromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. Thepublisher,theauthorsandtheeditorsaresafetoassumethattheadviceandinformationin thisbookarebelievedtobetrueandaccurateatthedateofpublication.Neitherthepublisher northeauthorsortheeditorsgiveawarranty,expressorimplied,withrespecttothematerial containedhereinorforanyerrorsoromissionsthatmayhavebeenmade. Coverillustration:©EverettCollectionHistorical/Alamy Printedonacid-freepaper ThisPalgraveMacmillanimprintispublishedbySpringerNature TheregisteredcompanyisSpringerInternationalPublishingAG Theregisteredcompanyaddressis:Gewerbestrasse11,6330Cham,Switzerland For SarahandTom J.B.andJenn LindsayandLuke KellyandCasey ScottandRoss E S XECUTIVE UMMARY Dodeficit-financedgovernmentfiscalstimulusprogramsactuallystimulate the economy? This study exhaustively tests a wide variety of different stimulusmodels,testingthemindifferenttimeperiods,andusingdifferent regressiontechniquesinanattempttoanswerthisquestion.Fiscalstimulus programs examined include both those that cut taxes and those that increasegovernmentspending. Mostmodelsthatpredictgovernmentdeficitswillstimulatetheeconomy are Keynesian. A principal characteristic is that they are demand-driven. Eachoftheirkeystructuralequationsindicateincreasesindemandwilllead to increased supply (and employment), at least up to full employment of resources.Henceadeficit,whichincreasesgovernmentdemandbyincreas- ing government spending, or increases private demand by cutting taxes, stimulatestheeconomy,accordingtostimulustheory. Intestingwhether these stimulus programsactually work, we tookcare to test equations taken from the Keynesian model. This gives the stimulus effects of deficits, should they exist, the best possible chance of being verified empirically. 1960–2010 data on the US economy were used. A total of 228 models of the determinants of consumption, investment and theGDPweretested.Thesemodelsdifferinthevariablesincluded,thetime period tested, the regression techniques used, the level of the economy whentestingandthespecifictypeoftaxcutorspendingstimulusused.Each model is reported in detail, with differences in each subsequent model compared to the last tested. Differences in results are compared as well. The work is lengthy, but necessarily so. Our goal was to test every vii viii EXECUTIVESUMMARY conceivable model readers might feel stood a chance of showing positive stimuluseffects.Thatway,whateverourresultsturnedouttobe,itwould bedifficulttoarguewedidnotexamineawideenoughbreathofstimulus programstogivethemafairchancetoshowwhattheycando. In theory, the effectiveness of stimulus programs can be curtailed by “crowd out”. Crowd out theory suggests that whatever their stimulus effects, government deficits have the undesirable result of simultaneously reducingprivatespending,becausefundsnormallyborrowedbyconsumers andbusinessesmustbeusedtofundthedeficit.Reducedprivateborrowing inturncausesareductioninconsumerandbusinessspending,offsettingthe deficit’sstimuluseffects. In testing to show crowd out effects, a deficit variable is added to each Keynesian consumption, investment or GDP model. This allows simulta- neoustestingofbothKeynesianstimulusandcrowdouteffects.Eachmodel shows stimulus and crowd out effects separately, and allows readers to directly calculate net effects of stimulus programs, for example, the effects of reductions in federal taxes on consumption spending, controlling for many other factors that affect consumer spending. Everybody acknowl- edges the possibility that crowd out, “if it occurs”, can adversely affect stimulus programs. Rarely do people actually test to see if it does occur. Thisbook’suniquecontributionistoexhaustivelytesttodetermineifitdoes occur,andifso,howseriousaproblemitis. As alternatives to Keynesian models, we could have tested dynamic stochastic general equilibrium (DSGE) models, but these are models that typically contain assumptions about human behavior like perfect foresight andintertemporalutilitymaximization,thataredesignedtoinferfromthese assumedbehavioralcharacteristicsthatstimulusprogramsdon’tworkinthe longrun.Similarly,wecouldhavepickeddifferentcombinationsoffiveor sixvariablesthoughtappropriateandtestedVARmodels.Theproblemhere isthatsinceVARstypicallyarenotrecognizabletheoreticalconstructs,itis hard to know what your results mean. By comparison, we know what a Keynesiantheoreticalconstructmeans,andifweslipadeficitvariableintoit and then test, the test will either show the variable statistically significant (crowd out matters) or not (crowd out doesn’t matter), controlling for all theotherKeynesianinfluences.Inshort,wewillhaveausefulresult,froma fairtest,scientificallyarrivedat. When examining how consumption or investment spending varies as deficits rise or fall, we control for the effect of business cycle variation on both government deficits and on private spending. This was necessary to EXECUTIVESUMMARY ix unambiguouslyidentifycrowdout’seffects.Adecliningeconomyalonecan causeagrowingdeficitandsimultaneouslydecliningconsumerandbusiness spending,butthatisabusinesscycleeffect,notacrowdouteffectinwhich the deficit causes the decline in private spending. Some argue it is only businesscycleeffects,notcrowdout,whichcausethenegativerelationship betweendeficitsandprivatespending.Theyarguethatwithoutthestimulus programs, the observed decline in private spending associated with the deficit would have just been worse. The difference between this and the crowd out explanation has enormous political and economic implications forgovernment’sroleintheeconomy. Methodologically, extensive tests for endogeneity, stationarity and heteroskedasticity were undertaken. Testing was done in first differences, eliminating most non-stationarity and reducing multicollinearity problems byabouthalf.Modelsexplained90–95%oftheyearlychangesofconsump- tion and investment during the 50-year period tested. Four different, though overlapping, time periods were tested. Findings were essentially the same for the 1950s and 1960s as for the 2001–10 decade, and for decadesinbetween.Deficitresultswerealsorobustformoderatechangesin the structure of the models tested. They were also generally robust to different regression techniques (OLS, strong and weak instrument 2SLS), and use of different strong 2SLS instruments. Hence, we feel our findings will be difficult to refute in reasonably well-constructed future models of howtheKeynesiansystemworks. Ourfindingsoverwhelminglyindicatethatasgovernmentdeficitsgrow, creating observable stimulus effects, consumer and business spending declines due to crowd out, fully cancelling the stimulus effects (or worse). Theoffsettingdeclineinprivatespendingappearsdueto“crowdout”,that is,tryingtofinancebothincreaseddeficitsandtraditionalprivateborrowing levelsfromarelativelyunchangingsizedpoolofloanablefunds. This finding that stimulus programs do not work held in virtually all circumstances tested. The specific type of tax cut or government spending deficitdidnotmatter,nordiditmatterifwetestedinrecessionsornormal economic times. Nor did it matter what particular decades since 1960 we tested,and,generally,itdidnotmatterifweusedoneregressiontechnique (OLS)versusanother(2SLS)todoouranalysis(thoughasamatterofgood practice, where 2SLS is needed, it should be used). With rare exceptions, usually due to statistical problems like multicollinearity, none of these variations in the models we tested resulted in a net positive effect for tax x EXECUTIVESUMMARY cut or spending increase stimulus programs. In virtually all cases, results indicatedcrowdoutfully,ormorethanfully,offsetstimuluseffects. Examination of the 1981–83 recession period indicates the pool of loanable funds drops even faster in recessions than business and consumer loandemand.Hence,newdeficitfinancingdemandsonthepoolofloanable fundsinrecessions,ifanything,causeevenbiggercrowdoutproblemsthan innormaltimes.Thedataexaminedsupportthisconclusion. Themodelsfromwhichweobtainedtheseresultsalsoexplainextremely well the behavior of consumption and investment during the 2007–09 economic crisis. Our econometric findings suggest that deficit-financed stimulus programs such as the 2009 Obama stimulus program have a substantial negative effect on the GDP, raising unemployment 2.26– 2.94% during the period they are in force. Deficits have this undesirable result because to fund them, funds normally borrowed by consumers and businesses are used. Reduced borrowing by consumers and businesses in turn causes a reduction in their spending, offsetting the deficit’s stimulus effects. Worse, “lumpiness” in borrowing tends to result in private spending reductionsevengreaterthanthestimulus’positiveeffects,leadingstimulus programstohaveanetnegativeimpactontheeconomy.Bylumpinesswe meanthefollowing:consumerswhoneedtoborrow$10,000tobuyanew car, but find that their bank can only lend them $9000 (because they lent theother$1000tothegovernmenttofinancea$1000stimulusprogram), willnotbuythecaratall.Thiscausesprivatespendingtofall$10,000from expectedlevels,afargreaterdropthanthestimuluscanoffset. Chapter 16 provides a more detailed summary of findings and conclusions. P REFACE Ileftacademiclifein1972,nottoreturnuntilaquartercenturylater.When I returned, one of the most hotly contested issues of my youth, “Do Keynesian-type stimulus programs work?” was still unresolved. I was sur- prisedbecausewhenIleftacademia,workineconomicsseemedmoreand more dominated by the new, econometrically based scientific method, rather than the older philosophical approach, i.e., mainly theoretical deductions derived from “self evident” truths about human and business behavior.Ifeltitwouldonlybeamatteroftimebeforescienceprovidedan answertothestimulusquestion.Thatdidnotoccur. Myresearchinterestsinlarge-scaleeconometricmodelingledmetotry to develop and test a Keynesian-type model of the macroeconomy. For aboutsixmonths,IkepttryingtobuildandtestsimpleKeynesianCrossand IS-LM models,and then extend the worktomorecomplexmodelsofthe sametype,butwithnosuccess.Inempiricaltestaftertest,Ikeptcomingup withthewrongsignonthegovernmentrevenuesvariable:Iwasconsistently getting positive signs, when Keynesian stimulus theory said I should be gettingnegativesigns.Worse,Iwashavingnearlyasbadaproblemwithmy governmentspendingresults.Inmoresophisticatedmodels,testresultsfor governmentspendingwerealsogivingmethewrongsign:negativeinstead ofthepositivesignKeynesiantheoryleadsustoexpect. What to do? One thought was just scrap my Keynesian model testing programandmoveontotestingsomeothertheory.Thisisclearlywhatmany ofmycolleagues had doneduring the 1980sand 1990s whenI wasout of macroeconomics.Whatlarge-scalemodelsremainedwerenowDSGE-based. xi
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