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CBO Fiscal Policy Multipliers

Yes, the ARRA Is Working: CBO Agrees

The fact that the ARRA was not big enough to put the unemployment rate on a downward trajectory is unfortunate. But now CBO joins in with its assessment that it is indeed working.

Menzie Chinn writes:

Econbrowser: CBO's Assessment of ARRA's Impact on Q3 Output and Employment: From CBO's just released Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output as of September 2009 :

...Economic output and employment in the spring and summer of 2009 were lower than CBO had projected at the beginning of the year. But in CBO's judgment, that outcome reflects greater-than-projected weakness in the underlying economy rather than lower-than-expected effects of ARRA.

In other words, the continued deterioration of the economy through the first few months after the passage of ARRA was not due to the stimulus package; rather underlying conditions had deteriorated, and the economy would have been in a worse state in the absence of the package.... For GDP, the... CEA report's model based approach indicates 3.1 and 3.6 ppts increment (SAAR) in Q2 and Q3, implying 1.66% higher GDP. The midpoint of the CBO range is 2.2 ppts. What about employment? CEA estimated 1.16 million cumulative jobs, by Q3. CBO estimates a range of 0.6-1.6, with midpoint at 1.1 million....

The report also includes a tactfully worded assessment of fully intertemporally-optimizing general equilibrium models, and their usefulness for real world analyses of monetary and fiscal policies in the short run.

Although some analysts favor the rigor of that approach to modeling behavior, other analysts view the assumptions underlying households' and businesses' decisionmaking in those models to be unrealistic and leading to unrealistic predictions. In particular, this type of model generally assumes that people are fully rational and forward-looking, basing their current decisions on a full lifetime plan. The forward-looking assumption implies that people expect to eventually pay for any increased government spending or reduced revenues in the form of future tax increases and that they incorporate those expected payments -- even if far in the future -- into their current spending plans. Thus, they are assumed to reduce their consumption when government spending rises, because their lifetime income has fallen by the amount of the eventual taxes. For the same reason, cash transfer payments and tax refunds have little or no effect on current consumption in such models. People in the models generally also have full access to credit markets, so they can borrow to maintain their consumption when faced with a temporary loss of income. This class of models does not typically incorporate involuntary unemployment: People can work as many hours as they choose at the wage rate determined by the market. Finally, in these models, monetary policy usually follows a fixed rule by which increased output or inflation implies higher real interest rates. [Emphases added]

This is a very clear exposition of CBO's analysis. Those who understood this post will find it very useful. Those unpersuaded by models should look elsewhere for succor.