John Taylor, inventor of the Taylor Rule and about as sound an economist as you will find anywhere today, has given an interview to Barron’s. And in that interview he points out the obvious, that the stimulus left things worse than they were before. The interesting part is that he doesn’t really understand why and the reason for that is that he does not think in terms of Say’s Law. Here is the relevant part of the interview:
Barron’s: What’s the best case you can make on behalf of those who defend the recent fiscal stimulus?
Taylor: The case that has been made for the discretionary fiscal stimulus is based on quite conventional Keynesian theory. It is basically that, if the government gives people a lot of extra money on a one-time basis, they will spend it. Not all of it, but most of it. Similarly, when the federal government gives money to states and localities as part of the temporary fiscal stimulus, it will be spent in such a way as to boost gross domestic product. And that will greatly help when economic activity is otherwise either contracting or stagnant.
My own view is that the theory is flawed, and the evidence that the fiscal stimulus achieved the desired result is practically nonexistent. The surge in federal spending only increased the burden of the already burdensome federal debt.
Barron’s: Start with the evidence.
Taylor: The attempt to stimulate consumer spending in 2009, or the earlier attempt under President Bush in ‘08, showed the expected rise in consumer income as government payments were made, but little or no response from consumer spending. Inconveniently for the advocates, consumer spending actually declined in some of the calendar quarters when it was supposed to have been stimulated. If you use statistical analysis to take into account the factors that would have brought increases or decreases in consumer spending, you find virtually no boost to spending from the stimulus.
As for the money sent to states and localities, economist John Cogan and I found that the funds were either put into financial assets or used to reduce borrowing. The hoped-for increase in infrastructure spending was negligible.
What is also inconvenient for the advocates: According to the national income and product accounts, state-and-local government purchases were lower every quarter in 2009 and 2010 than in 2008.
Barron’s: And you would expect these results from the standpoint of economic theory?
And it is precisely here that Taylor wanders off into simply making it up. Real incomes are falling. Employment numbers are down. The number of people on Food Stamps is at an all time high. But the only thing Taylor has to explain this refusal to spend their extra money is because they will instead choose to pay down debt. The interview continues:
Taylor: Let’s start with consumer spending. It’s basic economic theory that most people look beyond the very short-term. To expect them to rush out and consume more when the government cuts them an extra check on a temporary basis is not realistic. Instead, they will bank most of the extra money or use most of it to pay down debt. There are exceptions, of course. Some people will feel so pinched, they will need to spend the money. But the data show that the exceptions don’t dominate the story.
What he needs, as does everyone, is an understanding of where demand at the aggregate level comes from. And where it comes from, as my classical economists used to say, was from the creation of value adding supply. If there is no increase in real (ie saleable) output, there will be, can be, no increase in aggregate demand.
The national accounts show increases in GDP because all expenditures by governments go straight in as production, just as if real value added had been created. But expenditure can only be of what has been bought. The difference between measured production and measured demand is called “saving” in the national accounts, but it is calculated as a residual from the other data. No actual independent calculation is made. So it appears that there has been an increase in saving when all there has been is a major reduction in productive output available for others to buy.
Taylor remains wedded to the belief that aggregate demand is an actual independent element of the macroeconomy. It isn’t and so long as he thinks in those terms, he will not, in my view, be able to finally understand why a fiscal stimulus cannot work even though he perfectly well understands that it does not.