economics

July 27, 2010

Economists dispute effect of US stimulus By Robin Harding in Washington

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Published: July 26 2010 17:21 | Last updated: July 26 2010 17:21

Thomas Jefferson, no fan of deficit spending, has a clearer view of the US fiscal stimulus than any living politician. From his memorial by the Tidal Basin in Washington he can watch a $12.4m stimulus project to fix a seawall and stop him sinking into the water.

The site is cluttered with machinery and rolls of steel mesh. It employs about 20 workers. That makes it hard to deny that the stimulus is doing something – but Republican critics point to a 9.5 per cent unemployment rate to argue that it has failed. Democratic prospects in elections this autumn and any push for more spending rest on proving otherwise.
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That is difficult. At one Congressional hearing, Mark Zandi, chief economist at Moody’s Analytics, said each dollar spent on infrastructure was creating $1.57 in gross domestic product within a year, and that without the stimulus there would be 2m fewer jobs today.

He was followed by John Taylor, an economist at Stanford University, who said government spending “had little to do with the turnaround in economic activity”. Mr Taylor estimated the effect of the stimulus at about 70 cents of GDP per dollar spent.

The trouble is that economists cannot try the recession again – this time without government-built seawalls – to see what would happen. Instead, they must rely on models and historic data to judge how bad the recession would have been without a fiscal boost. In some models, stimulus works well, while in others it cannot work at all, which is why economists get such different results.

The highest estimates of stimulus effects – as much as $2 of GDP per dollar spent – come from large macroeconomic models run by the Federal Reserve and firms such as Moody’s Analytics. These models describe every sector of the economy and are where the Obama administration gets its stimulus numbers.

Some academic economists criticise large macro models for relying on ad hoc number-crunching rather than theory. Robert Barro of Harvard University argues that they find big effects for stimulus because they assume that higher government spending causes higher output, whereas it might be the other way around. Gus Faucher, director of macroeconomics for Economy.com, responds that the assumption is reasonable if the spending comes before the output rise.

Mr Barro’s own work finds that an extra dollar of defence spending increases GDP by only 40-50 cents in the short term. But critics say that estimate is not relevant because it relies on numbers from the second world war, when rationing kept private spending down.

Mr Taylor says large macro models have “less emphasis on expectations” than the “New Keynesian” models he uses. Many of these models, which are common in academia, assume that people anticipate future taxes to pay for the stimulus. That limits any rise in their spending.

New Keynesian models have also come in for criticism because most of them do not include a financial sector and so struggle to explain the recession at all.

“Until folks like Taylor can explain how we got into the recession then it is hard to be convinced by their conclusions on stimulus,” says Mr Faucher.

Many New Keynesian modellers estimate the effect of stimulus at between 50 cents and $1 per dollar spent in normal times. But the same researchers find numbers as high as $3.90 when interest rates are zero, as in 2009 and today, and the central bank cannot cut them to stimulate the economy.

“In an economy with an output multiplier for government purchases of just under 1 in normal times, the multiplier rises to 1.7 when monetary policy becomes passive with a zero nominal interest rate,” wrote Robert Hall, president of the American Economic Association, in a paper.

That is something close to a consensus among economists – albeit with high-profile dissenters such as Mr Barro and Mr Taylor – and suggests that the stimulus did have a large influence. Without more direct evidence, however, proponents of more spending will struggle to overcome fears about adding to the national debt.

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Wage freezes, staff cuts and expanding class sizes

In the academic year that finished last month, introductory courses in psychology at the University of Illinois at Chicago had 300 students per lecture. When the new semester begins next month, the same class will have 450 students, writes Hal Weitzman.

The congested psychology classes are a striking example of how Illinois’ budget woes are having a tangible effect on the state’s residents. Gary Raney, head of UIC’s psychology department, said the school had to offer two rather than three classes as part of efforts to bridge the lack of funding from the cash-strapped state.

As a public institution, the university depends on the state for its funding. However, not only did education account for a large share of the $1.4bn (€1bn, £900m) in cuts that the state made in its last financial year, but Illinois is also behind on paying its bills: it still owes the University of Illinois $279m of the $743m it was due to have handed over for the financial year that ended last month, on top of the $45m it owes for the current year.

Students are suffering, says Prof Raney. Salary freezes mean he is losing academic staff to other institutions, while he cannot replace those who retire. As well as expanding class sizes, he has been forced to cancel three courses for next semester.

“We have about 55 students for every member of faculty, compared to 25 in the broader college of liberal arts and sciences,” he says. “How much attention can we actually give to individual students?”

Prof Raney says UIC receives a lot of money from external grants but, as staff numbers dwindle and teaching workloads increase, the university’s research status is suffering, putting outside funding at risk. “We’re trapped in a vicious cycle,” he says.

Prof Raney has little confidence the state will get to grips with its financial situation, and he worries about how UIC will handle the pressure. “We physically can’t increase class sizes any further,” he says. “Our classes are now as big as the largest teaching space in the university.”

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