Recap: "Stimulus SmackDown: Can Deficit Spending Save the Economy?"

Posted on March 5, 2009


It wasn’t Ali-Frazier or even Hagler-Hearns, but the live debate hosted by University of California-Davis Institute of Government Affairs last night between Michele Boldrin of the CATO Institute and Washington Univeristy and J. Bradford DeLong of UC-Berkeley – “Stimulus SmackDown: Can Deficit Spending Save the Economy?” – proved entertaining nonetheless. As you might conjecture based on their institutional affiliations, DeLong argued in support of the recent U.S. economic stimulus bill while Boldrin vociferously argued against it.

Here’s a recap of the action:

Bradford DeLong

DeLong is a self-professed economic historian, and specifically denies that he is a macroeconomist. (That seemed to be a theme throughout the evening…) His approach to the economic stimulus package is a simple one, and one heard frequently throughout political circles – the patient is bleeding, therefore we need to apply a bandage. While that bandage will not heal the severed artery, we should focus on triage first and long-term solutions later.

Today’s economic environment now reaches far beyond a housing bubble – it’s clearly spilled over into other parts of the economy, so focusing solutions more broadly to include infrastructure projects, health care reform, and monetary allocations to individual states is an approach consistent with our economic challenges. It’s okay to increase the deficit now to achieve a surplus later. We should be spending more and taxing less in the short term to pull us out of today’s emergency.

DeLong argued that empirical studies show that when one industry gets motivated and decides to spend, it can turn an entire economy. In this case, the stimulus plan is a decision by society to spend and that “the government’s money is as good as anyone’s. It is a reasonable and intelligent thing to take this action on our own behalf.” That said, DeLong acquiesced that an economic stimulus package does not equate to long term economic growth, but continued to emphasize is argument on triage first, operation later.

DeLong supports the “Ackerlof’s approach” to taming the economy. (George Ackerlof won the 2001 Nobel Prize in Economics for his contributions to psychology in the marketplace and has recently written a new book – “Animal Spirits.”) DeLong also argued that the Swedish Banking Model deployed in the 1990’s is sound approach that should be considered in the United States.

His presentation was short and to the point – do something now and deal with the consequences once the economy is recovering. We are facing significant economic problems now, and something needs to be done immediately to stem the tide of ongoing negative economic trends.

Michele Boldrin

Boldrin is a general equilibrium economist, which means that he focuses on the microeconomic side of supply and demand – equilibrium models starting from individuals and firms, then aggregating into macroeconomic analysis (whereas macroeconomics tend to take an “top-down” aggregated approach to economics.) As Boldrin put it, macroeconomists “suffer from the aggregate.”

He likened the approach of economic stimulus to that of rock-climbing – rushing to decisions serves to detriment of the participant. The notion that “We have to do something!” will ultimately weaken the economy even further. “Even the Bush tax cuts – $400? They avoided the real economic problem.” The real problem lies in the financial markets and overall structural dynamics of the economy.

Boldrin focused two primary arguments against the stimulus package in its current form. First, he cited empirical evidence that show increases in public spending do not have a multiplier effect on the economy. That is, when government spends, the economy feels only the net effects of the primary spending – there is not downstream multiplier effect. In fact, he maintained that the Keynesian multiplier for government spending was perhaps less than 1. Several prominent economists share this perspective, including Robert Barro and Bob Hall and Susan Woodward. Of course, other leading economists such as Valerie Ramey and Christina and David Romer contest that the government multiplier is greater than 1. Shocking -economists don’t agree on something. (Christina Romer is the Chair of Obama’s Council of Economic Advisors, perhaps for good reason based on her research findings.)

Boldrin also showed correlation empirics from several of the G7 countries – France, Germany, Canada, Italy, and Japan – which all indicate that there is no correlation between public spending and Gross National Product for any of these countries. He also clearly stated that his issue is not with the general concept of government spending, but whether it is useful for economic stimulus. He cautioned the Obama administration on shrouding political aims under the guise of economic stimulus. Quick spending does not help the acute.

For example, what about increased health care spending that is included in the stimulus package? This is an industry currently with rising employment according to the January 2009 U.S. Bureau of Labor Statistics, so two outcomes will be evident from these spending increases. First, we’ll end up paying higher wages to the current labor market in the health care industry. Second the “hammer and nail guy” in Las Vegas will not benefit from the stimulus because he won’t become a nurse by year’s end. Yes, there are provisions for creating a health IT system, but relative to the other allocations in the stimulus plan, they account for a small part of the overall allocation to the health care stimulus line items.

In a related argument, Boldrin argued that focusing the economic stimulus on spurring demand for durable goods such as automobiles and housing (which generally require credit, and in turn, require fixing the credit market) will only increase employment in the production of that good in those industries – it does not create overall employment. (This is the general equilibrium economist showcasing his traits.) If we focus on stimulating demand in the industries hardest hit by the recession, we are going to be pushing for the purchase of SUVs and houses in Nevada. Isn’t that how we got here in the first place? (DeLong believes the labor is more flexible than Boldrin, even using the example of the person redoing his bathroom who was a janitor just two months ago. Labor mobility is a hotly debated topic among labor economists.)

The problem with increased spending now is that history shows that we do not decrease the spending later. There is never guarantee that these government programs will be cut later. “Pay-as-you-go” as is proposed is not the same as cutting spending and taxes in the longer term. “Pay-as-you-go” can simply mean increased taxes in the longer term to pay for these social programs now inserted into annual government expenditures.

Boldrin often took the debate away from the straight “Yea or Nay” on the economic stimulus package and focused his attention on the state of the U.S. financial system, again examining the effects of public spending on economic growth, illustrating the cases of Japan in the 1990s and Chile in the 1980s. Japan took the approach of fiscal spending for many years and created a “zombie state” in banking. Japan’s long-term economic growth struggles throughout the 1990s are well-documented. Alternately, the solutions of the Chilean banking crisis in the early 1980s focused on cleansing the banks and swiftly as possible. Boldrin supported taking the latter approach, and said that we need to purge the leadership of the banking sector – “keeping the same guys is a bad idea.” When credit crunch creates the problem, you need to start with the banks first.

With regard to the Swedish model introduced by DeLong, Boldrin agreed because Sweden exercised fiscal constraint in lowering taxes and spending – not the basis on the U.S. economic stimulus package.

Selected Audience Questions

“If there is true slack in the labor market (unused capacity), and we assume that the social cost of the infrastructure and other social programs included in the stimulus package equals long-term social benefit, doesn’t that mean that building a bridge or school now means getting that public works project at a bargain because spending more now means less spending later?”

DeLong : Agreed.

Boldrin: Yes, but we must mandate that when government costs rise now, they must be cut down the road and there is evidence in our economic and political history that these cuts do not occur.

Macroeconomics suffers from too many assumptions – flexible prices, labor and capital mobility, the efficient market hypothesis, rational expectations theory, perfect information, perfect competition, and many others. Isn’t basing policy decision on macroeconomic theory a flawed approach given the complexity of our economic environment?

Both DeLong and Boldrin agreed with this point. DeLong went on to say that the most relevant lectures he attended were that of Charles Kindleberger, who wrote “Manias, Panics, and Crashes,” which is consistent with his support of Ackerlof’s plan for the economy.

Boldrin went on to say that the New Keynesians (such as DeLong, Obama, and Christina Romer) suffer from the same problem. There is too much “master of the universe” – that Greenspan or Bernanke or the government can move some levers and we’ll all become rich. Economics is too complex to assume singular actions can move the economy. There are technology shocks, demand shocks, energy shocks, changes in productivity, and other exogenous effects that are constantly affecting the economy.

When did the Great Depression end and why?

DeLong used this question to further support the need for emergency spending. He stated that the Great Depression ended briefly in 1937 when the United States started to show signs of recovery in 1935 and 1936. Roosevelt ended many of the public works programs such as the WPA and the economy slipped back into negative territory – Delong felt that FDR released government intervention to soon. Then World War II arose and the increased war-time spending further bolstered the economy through even more government spending, and eventually pulled us back to stability in the mid-1940s. Using this logic, it’s very clear that government spending pulled the United States out of the Great Depression.

Final Takeaways

I attended the “Smackdown” expecting to side with Bradford DeLong based on his blog entries over recent weeks about the overall meltdown of the economy. I must admit, he’s done a good job hiding his Keynesian tendencies…

I was left with a statement from Boldrin that ultimately strengthened my viewpoint against the vastness of the stimulus package (Admittedly, I went into the event biased against the broad provisions included in the bill such as the health care and other social provisions…):

“What happens when we come back in six months with 12% unemployment and are having the same debate? Will the response be – ‘We have to do something!’?”


[The entire debate was videotaped and should be available at in the next day or so.]