## Department of "Huh?!" Greg Mankiw Is Not Making Any Sense...

The $787 billion ARRA was about 2/3 spending increases and 1/3 tax cuts. Jared Bernstein and Christie Romer estimated that with a spending multiplier of 1.57 and a tax multiplier of 0.99 that the ARRA would boost production over its lifetime by$787 x 2/3 x 1.57 + $787 x 1/3 x 0.99 =$1,083 billion.

Now comes Greg Mankiw to say that they overestimated the impact of the ARRA because their multipliers were wrong: that he prefers a tax multiplier of 3 (from Romer and Romer) and a spending multiplier of 1.4 (from Valerie Ramey) and that as a result the right estimate was that the ARRA would boost production over its lifetime by $787 x 2/3 x 1.4 +$787 x 1/3 x 3 = $1,521 billion. But, Greg,$1,521 > $1,083... Mankiw: Crisis Economics: In an economic assessment... released in January 2009, President Obama's advisors concluded that, if they did nothing, the unemployment rate would reach 9%.... So they developed their medicine: an ambitious plan to stimulate the economy.... Today, however, the unemployment rate is nearly 10%. Clearly, things have not gone as the president's advisors expected.... To the question of why their patient — the U.S. economy — did not respond as expected, the Obama team's answer is that the patient was sicker at the beginning of 2009 than they had originally thought, not that they administered the wrong medicine.... There is no way to decisively prove or disprove the Obama administration's argument. All we can do is consider its premises.... Extreme and sustained unemployment during a recession, Keynesians argue, results from a decline in overall (or aggregate) demand in the economy. When the economy is knocked off balance by serious economic shocks, the government can help restore normalcy by increasing demand through government spending. And because the influx of government spending drives businesses to hire and consumers to spend, its impact is multiplied.... To Obama-administration economists, as well as to many others, the recession that followed the financial crisis of 2008 seemed like a classic case of decline in aggregate demand. Because of the credit crisis, people were not able to obtain loans — for homes, cars, business equipment, or any of the countless other transactions that rely on credit in today's economy. And because people were unable to obtain loans, these sales and purchases couldn't take place, resulting in a significant drop in demand across the economy.... [T]he [Bernstein-Romer] multiplier for direct spending — would be 1.57, while the tax-cut multiplier would be 0.99. In other words, every dollar spent by the government would yield$1.57 in aggregate demand, while every dollar in reduced taxes would yield only 99 cents in increased demand. And because 1.57 is larger than 0.99, the Obama team concluded it was better to increase spending than to cut taxes. Obama and his advisors arrived at these numbers through a standard macroeconometric mode....

When we talk about the impact of government purchases on aggregate demand, and therefore on job creation, we must take into account an enormous number of "general equilibrium effects" — that is, the indirect effects that occur as one economic variable influences another, which in turn influences yet another, and so on. Such effects can be modeled and analyzed to some extent.... These general equilibrium effects are tremendously important to the economy — sometimes in positive ways, sometimes in negative. The positive effects are those that underlie the conventional Keynesian fiscal-policy multipliers: Higher government spending leads to higher incomes for some people, which causes higher consumption, and therefore higher incomes yet again.... Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today.... [E]ven if recipients of stimulus funding filled out their government reports reliably and correctly, the data they provided would not accurately describe the effects of the stimulus on job creation. Nor would data about job creation by itself actually resolve the underlying question about the administration's economic-recovery effort: whether it was right to pursue a spending-heavy stimulus plan, instead of one focused more on tax cuts.

Addressing this question requires not only data about the past year or two, but also analysis of some key assumptions at the core of the administration's approach to fiscal policy.... [Obama's] first assumption overlooks an important difference between spending and tax cuts in the context of economic stimulus. When the government is seeking to revive its sick patient — the economy — time is of the essence.... The administration's second assumption, meanwhile, is a matter of academic theories about the sizes of the relevant economic multipliers.... [T]he Obama administration's economic team consulted these standard models in deciding that spending would be significantly more effective than tax cuts. But a great deal of recent economic evidence calls that conclusion into question.... The Romers' conclusion... was that the tax multiplier was 3.... Some excellent work on this topic [of the spending multiplier] has come from Valerie Ramey of the University of California, San Diego. Ramey finds a government-spending multiplier of about 1.4....

[T]he fiscal-policy decisions of the past year and a half have not been implausible or inexplicable — but they have also not been empirically shown to work. The data point to other approaches. It may seem unfair to criticize government economists working under great pressure in the midst of a crisis. After all, they are not in fact doctors treating patients. They work for politicians, who must take into account not just economic theory and data but also voter attitudes and political realities. Economic policy is not just applied economics. But economists are social scientists, not politicians. And whether they work for the government or have the luxury of merely observing the scene from an ivory tower, the integrity of the profession and the importance of the work involved demand that they be subjected to critical judgment; they must be compelled always to submit their assumptions, data, models, and conclusions to careful scrutiny. The foremost job of economists is not to make the lives of politicians easier, but to think through problems, to examine all the available information about the problems' causes and potential treatments, and to propose the solutions most likely to work...