Evaluating fiscal stimulus measures

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<p><strong>Evaluating fiscal stimulus measures</strong></p>
<p><br />
<em>Romesh Vaitilingam interviews Jonathan Parker for Vox</em></p>
<p><em>January 2009 <br />
<br />
Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/3002]<br />
</em></p>
<p><strong>Romesh Vaitilingam: </strong>Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Jonathan Parker of Northwestern University. Jonathan and I met at the American Economic Association's annual meetings in San Francisco in January of 2009, where we spoke about the effectiveness of fiscal stimulus measures. I began by asking him about his research on the impact of the 2001 and 2008 tax rebates in the United States.</p>
<p><strong>Jonathan A. Parker: </strong>Well, let me start with 2001 since that was one that the research is now - the dust is settled on and we understand what happened. In 2001 the United States entered a recession just as President Bush was taking office. Part of his election campaign was based on a tax reform package, and so it was relatively simple and quick for the Congress and the Administration to agree on a reform package that included sending out economic stimulus payments, rebate checks as they were called in 2001, to about 66 million American households; about two thirds of US taxpayers. These were in an amounts of three or six hundred dollars and they were sent out rather quickly as the economy went into a slowdown. As fiscal policy goes, you always want to be ahead of the game: acting before the economy enters a serious recession in the hopes that you actually mitigate or stop a potential recession.<br />
Usually when you look at fiscal policy responses that a government takes; it takes them in response to a slowing economy. It's difficult to know what the effect of the fiscal policy was, and what the actual evolution of the economy was. It's possible that a fiscal policy goes into effect in a recession. Recessions all end; maybe the fiscal policy was not the cause of the end of the recession.<br />
In this case in 2001 in the United States, they couldn't mail out 66 million checks all at the same time. They staggered them over a 10 week period and they keyed them to a social security number; a particular digit of the social security number of the tax payer. This digit is effectively randomly assigned: it was viewed as a fair way to mail them out.<br />
From a scientific perspective of evaluating the efficacy of a policy, it was very interesting: because we could now compare people treated by government with fiscal spending stimuli at different times, and see if the people who received their checks early reacted differently from the people who received their checks late in the experiment, if you will.<br />
What we found, this is joint work with Nick Selaylus and David Johnson that I wrote up following this policy, was that the rebate checks generated about a third of the amount mailed out of spending within a couple of months of receipt of the check on average. Low income, low asset households tended to spend more than high income, high asset people and that there was with more statistical uncertainty, it wasn't as obvious&nbsp;&nbsp; there was another third spent over the next three months.<br />
That was a pretty big bang for the buck that when you add up the amount of money sent out and those spending responses actually did help to end the recession of 2001 in the United States. A significant boost to consumption, demand; the recession was mild, short and it was deemed a success.<br />
In 2008, basically the Bush Administration and Congress tried the same thing to much less effect in the sense that now we've entered a rather protracted or deeper slowdown. The checks went out in May and June primarily in the United States, and while the collapse of consumer demand has been much greater since then, we're still not exactly sure how effective the stimulus payments were.<br />
I have a couple of studies going on this at the moment, one of which has some preliminary evidence. The preliminary evidence pertains to the five weeks following the receipt of the check for an initial set of households. We can compare their spending responses to the spending responses of households who say they'll get a check later, but we don't have that data in yet.<br />
What we find is that household spending of the households that got checks early jumped by three percent relative to those who will get their checks later. We suggest or we think that there's been a substantial kick from these economic stimulus payments of 2008 in the United States, also. Looking forward, it's a little hard to know.<br />
I would say that it's a good policy to send out rebate checks if you're ahead of the game, and if you're talking about a small demand slow down that you'd like to correct. The key is, of course, that the policy maker needs to know what demand slowdowns should be corrected and what shouldn't. People vary greatly in whether they believe there are any that should or whether all should be. That's not something we can directly answer with our research. We can tell policy makers how effective they'll be.<br />
However, in response to a protracted downturn with clear causes like declining house prices, where one thinks that perhaps house prices ought to decline given the fundamental problems with the financing and underwriting standards that have been revealed: that ought to be a natural economic process which should occur and will occur and actually, naturally should lead to some demand reduction.<br />
If you went to smooth that out, just sending people money may not be the best way to do that. It might be perhaps better to do things like extend unemployment insurance benefits or work directly on helping people find new jobs, retrain, or sectoral allocation that has to occur in response to the real economic shock we've actually seen happen.</p>
<p><br />
<strong>Romesh: </strong>So what do we know about the different impact of tax rebates, which is what your recent research has been looking at, and say, tax cuts where people don't see immediate money in their pocket, but they know they will be making more at the end of the year? And perhaps then of course, the other side of the coin&nbsp;&nbsp; increased public spending: talk about spending more on infrastructure.</p>
<p><br />
<strong>Jonathan: </strong>Well, with any tax change you have to think about, well how does the government balance its budget ultimately? If you cut taxes today you either have to have higher taxes in the future or you have to have lower government spending in the future: it's got to come from somewhere.<br />
The rebate checks as one time changes; the 2008 policy was a one time change. The 2001 policy in the United States was actually a first installment of a long run change that was moved forward. It certainly makes sense to move forward a long run change that you have to put money in people's pockets more quickly, especially if times are hard, so they can access the money and spend it if they want to. If they don't want to, they don't have to. If they do spend it, then you've probably done a good thing. You've given them their money earlier in a tough economic time and helped them out. Plus, you've probably helped to stabilize the economy: That seems like a win, win situation.<br />
The questions as to whether you want to do a long-term tax cut or persistent change is really a question, I think, of long term policy. Where surely, we all like lower tax rates, but you have to fund a certain amount of government spending, and you want to do a certain amount of redistribution or insurance for people also through the public sphere.</p>
<p><br />
<strong>Romesh: </strong>Jonathan, there's been talk recently about the threat of deflation and the fact that in an environment where the prices are falling, who might respond to getting a tax rebate or a tax cut by not spending it or holding on and waiting for lower prices? Do we know anything about that?</p>
<p><br />
<strong>Jonathan: </strong>Well, that's always a possibility: my view that good policy should just have absolutely no problem with that. If we're in a situation where prices are falling, I guess the concern here is hitting the nominal interest rate zero floor which we've now seen actually crossed, because the interest rates on treasury bills in the United States has actually been negative on a couple of days recently. <br />
That's a fantastic thing in some sense because now we say, &quot;well, the government has this large debt and it's actually not having to pay interest on that large debt&quot;. Which means that in the future you are looking at having to raise tax revenue to cover those interest payments: now you don't have to do that.<br />
So that's a very good thing for the fiscal authority: the fiscal side of the budget. In fact, the government can exploit that quite a bit. If it's true that Treasury debt is essentially free to float, then they should work around and float Treasury debt freely.<br />
Another issue is that with a very, very low inflation rate it's simple for the government to use newly printed money to purchase Treasury bills and Treasury debt and retire a bunch of the government debt.<br />
Now, either that will generate inflation, in which case we're not in a zero inflation environment. We'd like to be back in a two or two percent inflation environment, perhaps. Or the government has simply retired a bunch of the government debt for free in a non-distortionary manner, and can now give people lower taxes or rebates that will generate inflation, in which case we're not in a zero inflation environment. We'd like to be back in a two or two percent inflation environment, perhaps. Or the government has simply retired a bunch of the government debt for free in a non-distortionary manner, and can now give people lower taxes or rebates for free because we don't have to.<br />
The government has solved some of its budget problem by putting money out there and retiring a bunch of the government debt. If we can retire the government debt for free, that seems like a wonderful thing. I don't see this zero interest rate bond as a real concern. It's simple to buy Treasury debt and retire national debt and promise people lower taxes in the future.</p>
<p><br />
<strong>Romesh: </strong>What about the spending side of things? Can we come back to that: the talk of shovel ready projects for infrastructure?</p>
<p><br />
<strong>Jonathan: </strong>Yeah, certainly. A lot of the alternatives to sending out money and putting it in people's pockets is to have the government do the spending. If the government can figure out useful and highly productive infrastructure projects to do, that it's a wonderful thing. We obviously need roads and bridges, infrastructure and defense spending, and the like. These things can often be durable in the sense that you spend now when you need to do the spending, and they last for many years. You'd like to do the spending at times, in fact, when there are resources in the economy they aren't very expensive. So there's a lot of home construction that isn't happening now, and people who are skilled in construction potentially could be doing infrastructure projects reasonably and expensively for the government, and then the government doesn't have to do them later when it's more expensive. That all seems like a good thing. The difficulty in using that sort of strategy for fiscal policy or fiscal stabilization, is that it takes time to plan and figure out what are really the valuable infrastructure projects to do.<br />
By the time you do a careful job of planning and setting things up and getting the projects rolling, the economy may well have turned around and be doing well. Then you're doing fiscal stimulus exactly when you're already on the upside of a recession which is really, typically a pretty booming time in an economy.<br />
The advantage of a tax rebate or tax change is that they can be done much more quickly; they can hit the economy much more quickly and be a little more appropriate for the stabilization goal. The infrastructure is a problem the government faces in a long term sense. If they have it ready to go it certainly makes sense to use it as a stabilization tool.<br />
But because it tends to work much more lagged. It takes just time to build a road and it takes time to set it up and contract it. You try to do a lot of spending all at once; you often get problems of corruption and misallocation of resources. That wasteful and again leads to higher tax burden in the future, all other things being equal.</p>
<p><br />
<strong>Romesh: </strong>We're now in a position where the different countries are taking different approaches to this fiscal stimulus issue. The US seems to be very much &quot;let's go for it&quot;, and the Obama administration will follow through on that. The UK certainly, and some of the European continental countries are a bit more reluctant.<br />
What's your take on how that debate is going? How should economists' analysis say inform that debate, do you think?</p>
<p><br />
<strong>Jonathan: </strong>Well, I think that the differences in the way that the real estate shock has propagated across countries ought to play a big role in that. In the United States there was clearly a housing market overbuilding, if you will, and a collapse of the financial structure that was supporting that. That adjustment is going to have to take time to play out. The financial sector of the US is wrecked: it might be a little strong but not too strong, whereas other countries' financial structures are in much greater shape. They are not looking at the problems to the extent that the United States is. They probably ought to be having a more restrained or modest impact.<br />
Some of the spillovers to these countries are purely from US demand. That's something that really spending in their own country I don't think is going to do a lot of helping with.</p>
<p><br />
<strong>Romesh: </strong>I'd really like to know what lessons we can really learn from the experience of Japan, because people are looking back at that as the most recent experience of a very prolonged stagnation and a failure to tackle effectively with policy.</p>
<p><br />
<strong>Jonathan: </strong>People have been looking both back at the Japanese case and also at the United States' experience of the Great Depression. What I think is coming clear is that we really don't understand these events - especially Japan - as well as we should. We saw what happened, we saw the responses and we see a lot of it didn't work, especially in Japan's case.<br />
We assume all of those things either caused the further problems or we don't know what the original problems were, and these weren't the solutions. It still remains a large mystery why Japan was doing so well and then doing so poorly.<br />
Everybody has their own ... there are a lot of people who that think they have an answer: Well, what's unusual is that Japan did so well, they were destined not to do well. What was funny was the boom, not the bust and of course they have all of these issues and problems.<br />
You can always point to issues and problems. You can point to issues and problems in the best run companies in the world. When they do poorly, you say: &quot;Oh, well this is why - it's these problems.&quot; When they are doing well, you look at the good things and you say they're doing well because of these things. Often both of those, the good and the bad strategies exist in both companies. Ex-post rationalization really doesn't help us here. I think we've done too much of that and too little careful investigation of what worked and what didn't work in different instances.</p>
<p><br />
<strong>Romesh: </strong>Let's close, Jonathan, with the long run issues. When are we going to be able to evaluate the impact of these fiscal stimulus packages, and what are the potential dangers?</p>
<p><br />
<strong>Jonathan: </strong>The big potential danger I think that everyone is nervous about is that it goes too far. The United States has a whole lot of strengths in the economy that the government is temporarily, one hopes, and not overly turning its back on. When companies in the United States fail, they get reallocated, reorganized: the productive bits get pulled out, the unproductive pieces get shut down, the workers can go and work elsewhere. We have social insurance programs, we have job retraining, and we have labor mobility around the country: these things all help labor markets function and the economy function reasonably well.<br />
When the government steps in and backs up banks, auto companies and so on and so forth, suddenly that's sand in the gears of that reallocation and movement forward. There's arguments for doing that when you are in a recession: that is put this process on hold for a moment; and use auto companies and financial companies as jobs programs. Well, that ought to be pretty temporary, and it ought to be as limited as you can possibly make it. We don't want to end up like Venezuela but having paid for all the capital.</p>
<p><br />
<strong>Romesh: </strong>And that in the long run, scientific issues: being able to evaluate these packages. You're evaluating 2001 and 2008 pretty close to when they were introduced. Are you going to be able to evaluate these packages quite so soon?</p>
<p><br />
<strong>Jonathan: </strong>The difficulty in evaluating something like the Treasury programs to bail out the automakers or the various reorganization of banks, and the discounting of all the commercial paper they've done, is that it's very hard to know what the counterfactual would be. There's no real variation across banks or across companies here, and so we can't understand what the counterfactual is. After this is done, in some sense this is the problem when we went to study Japan, the dust will settle, people will pick their favorite reasons, and there will ten reasons and one data point. It's going to be a little difficult to disentangle afterwards, but hopefully we will get some information out of this. People will find some clever sources of variation. We'll be in a situation to hopefully avoid it in the future.<br />
My own take is one of the big things that we need to rework bankruptcy law. The idea that something is too big to fail is really an argument that says that it's too big to somehow let equity and debt holders in that company take a large loss. That is basically because in the bankruptcy proceeding they will hold up the reorganization and release of the business model to the new owners, until they can extract every last penny.<br />
Perhaps the new legislation or one of the post crisis financial architecture keys is to make any firm that's viewed as too big to fail or even close to it subject to a very different and rapid bankruptcy law in which equity holders are rapidly wiped out if need be, and they don't really get a say, and debt holders even potentially rapidly wiped out without a say.<br />
Then the firm can close: go into bankruptcy on Friday, and open on Monday under new ownership without debt payments that are needed. If you have such a law in place I would guess that the very high leverage ratios that we've seen in the past wouldn't be undertaken by banks. If they did, then we'd just get up and running right away without involving a lot of public money.</p>
<p><strong>Romesh: </strong>Jonathan Parker, thank you very much.</p>
<p><strong>Jonathan:</strong> Thank you.</p>

Topics:  Macroeconomic policy Taxation

Tags:  fiscal stimulus, income tax rebates, household spending

International Programs Professor of Management, Sloan School of Management, MIT

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