Laura Tyson’s Confused Case for a Second Stimulus

I was a bit critical of Laura Tyson's New York Times article on “Why We Need a Second Stimulus.” Apparently I wasn’t nearly critical enough.

The Nation and National Public Radio are advising President Obama to “stop listening to infrastructure-phobic advisers like Larry Summers and start taking counsel from Laura Tyson, a member of his Economic Recovery Advisory Board who argues that $1 trillion in infrastructure investment is needed over the next five years.”

At The Atlantic, senior editor (and Boston Globe columnist) Joshua Green thinks Laura Tyson’s article “underscored what a loss it is for the Obama administration that it couldn't manage to find a place for her on its economic team.” Mr. Green can’t imagine why a Berkeley professor who wants to add an extra trillion to federal spending wouldn’t be the ideal budget director.

In the article that so impressed Mr. Green, Tyson wrote, “The primary cause of the [current] labor market crisis is a collapse in private demand... By late 2009, in response to unprecedented fiscal and monetary stimulus, household and business spending began to recover. But by the second quarter of this year, economic growth had slowed to 1.6 percent.”

Combining “fiscal and monetary stimulus” in a single phrase is a clumsy way to conceal the irrelevance of   “fiscal stimulus” (debt-financed federal spending) to GDP growth in 2009. Fiscal stimulus means the Treasury sells more bonds. Monetary stimulus means the Fed buys more bonds. To discuss those transactions as if they had the same effect is just another mysterious Keynesian incantation.  

Tyson claims there is “too little appreciation for how stimulus spending has helped stabilize the economy and how more of the right kind of government spending could boost job creation and economic growth.” She wants much more spending on unemployment benefits (a paradoxical definition of a jobs program) and on aid to state and local governments (where unemployment rates are relatively low). 

To argue for more borrowing and spending, however, Tyson cannot credit monetary policy for helping the recovery. Because she explicitly advocates much more spending on “unemployment benefits and aid to state governments” (not just “infrastructure”), Tyson has to demonstrate that changes in federal spending (not Fed policy) explain why the economy appeared to be recovering in late 2009 but faltering by the second quarter of 2010. It is not enough to allude to simulations from Mark Zandi's famously incorrect forecasting model, as the CEA and CBO have done. Tyson needs to show us a fact or two. She didn’t even try. She even got the size of Obama’s stimulus bill wrong, citing last year's antiquated $787 billion figure that the Congressional Budget Office (CBO) has revised twice since January.

In reality, the 2009 stimulus bill was mostly about extending unemployment benefits, expanding Medicaid, dispensing small checks (refundable tax credits) and other schemes to rob Peter and pay Paul. Such transfer payments add nothing to GDP; they just discourage work. The increase in federal nondefense purchases (such as "shovel-ready" projects) contributed only two-tenths of one percent (0.2) to the change in GDP in 2009. That was no larger than in 2008 when the Recovery Act did not exist. And even that trivial sum is merely an accounting gain rather than a net economic gain, because federal borrowing is no free lunch. The reason Keynesian accounting is no substitute for economics is that governments can only spend what Danny DeVito called "OPM" (other peoples’ money). To claim that such spending is a net addition to “aggregate demand” is to ignore those other people — namely, current and future taxpayers.

The timing of Obama's so-called stimulus spending has been totally inconsistent with Tyson’s description of how the economy supposedly responded in the past and present, and why she expects growth to slow by a percentage point or two next year unless the feds spend more on multi-year jobless benefits and deficit-sharing with the states. In its latest whitewash, the CBO “now estimates that the total impact over the 2009–2019 period will amount to $814 billion. Close to half of that impact is estimated to occur in fiscal year 2010, and about 70 percent of ARRA’s budgetary impact will have been realized by the close of that fiscal year.” With half of the spending in fiscal 2010 and 30 percent in 2011 and beyond, that means just 20 percent of the $814 billion ($163 billion) had been spent by the end of October 2009. Yet it was in late 2009 when Tyson claims the stimulus had the most impact. 

Tyson worries that “by next year, the [fiscal] stimulus will end.”  That’s wrong too. The CBO estimates that 30 percent of the spending ($244 billion) will occur in fiscal 2011 (January to October) and beyond to 2019.

Unfortunately, Ms. Tyson’s reference to the second quarter’s GDP is entirely unrelated to her diagnosis of the problem as being “a collapse in private demand.” GDP does not measure private demand because it subtracts imports. Yet spending on imports is just as much a part of “demand” as is spending on domestic goods and services. Real gross domestic purchases increased at a 4.9 percent annual rate in the second quarter, up from 3.9 percent in the first. Neither figure suggests any paucity of private spending.

The second quarter surge in imports (which largely accounts for the wide gap between domestic purchases and GDP) looks like a statistical fluke. “Real” imports appeared to rise so much mainly because import prices supposedly fell at a 9.5 percent annual rate (which means a 2.38 percent rise in the quarter, multiplied by four to get the annual rate). By contrast, import prices rose at a 14.6 percent annual rate in the first quarter and at a 24.8 percent rate in the fourth quarter of 2009. Those figures say more about the folly of converting smallish price changes into annual rates than they do about the real economy. Besides, imports fell 2.1 percent in July and exports rose 1.8%, so the questionable second quarter trade figures did not indicate a lasting trend.

Tyson did not bother to figure out how large the first stimulus bill was, or when the borrowed loot was spent. She did not bother to look up the negligible contribution of federal spending to recent changes in GDP, and she confused GDP with domestic demand. 

The press kept telling us that Tyson was almost certain to replace Peter Orszag as OMB director, and then to replace Christina Romer as head of the Council of Economic Advisers. Yet such plums keep slipping from her fingers, to the dismay of her fans at The Nation, NPR and The Atlantic. This is rare evidence of good judgment from the Obama White House.