Did Government Overspending Prevent Economic Armageddon?

December 31st, 2010
in Op Ed

By Steven Hansen

In Personal Transfer Payments and GDP, my colleague John Lounsbury points out that USA government's Great Recession spending caused an increase above trendline in the social safety net (such as unemployment compensation and food stamps).  John points out that the cost to taxpayers was nearly the same as the increase in GDP - and concludes:

........that the increase in personal transfer payments was effective in softening the impact of the recession and has, so far in the recovery, put the economy on a better footing, at least as measured by GDP, than would otherwise have occurred.  However, this has come at a price.  The national debt has been increased by essentially the same amount as the “extra” personal transfer payments, or $569 billion, over the three years 2008-2010.When John overviewed his analysis, he pointed out that he had to assume that there were "no externalities that would have influenced GDP differently without the transfer payments".  In short, John is saying there is no way to prove with certainty what are the economic effects of government spending.

Follow up:

John is correct - we will never know.  Economics is a dark science because we are unable to experiment using two different solutions during same predicament.  Truth in economics is illusive, "facts" are data points in search of opinion.

Would the real economy have been just the difference caused by the excess transfer of payments?  Here are two opposing arguments:

1) If you did not have the excess transfer, would have some (most or a few?) of the beneficiaries of these payments scrambled harder to make some real money which would have caused real GDP growth; or

2) If you did not have the excess transfer, would it have triggered a deeper chain reaction in the economy causing an even larger economic contraction.

My imaginary nemesis Nobel Laureate Paul Krugman would argue case #2 - and I have sympathy for this argument.  Once an economic trend sets in, it tends to overshoot destroying otherwise healthy enterprises.  There is also a basis for Professor Krugman's statement that the stimulus was too small.  The problem with this "too small" argument is that the original stimulus designed by Congress was not a real stimulus - aside from tax cuts and unemployment benefits, it was little more than pork barrel politics or dogmatic spending initiatives.

Could Professor Krugman be implying that the stimulus was too small based on its ingredients?

Would the "recovery" portion of the Great Recession been stronger without the excess transfer of payments?  There are valid arguments that softening the decline would also soften the recovery as it particularly played around with money spending curves.   Maybe the USA economy would be in the same place today without this excess above trendline spending - and have a stronger growth factor?

I am not arguing that payments under this Personal Transfer Payments safety net were wrong.  The debate is the economic effect of a government providing money to individuals.   Understanding this dynamic allows expansion of our control over the economy.

I wish all a great and prosperous New Year.

Economic News this Week:

Econintersect economic forecast for January 2010 was released this week pointing to a slightly improving economy.   This week the Weekly Leading Index (WLI) from ECRI improved from  0.8% to 2.2% implying the business conditions six months from now will be roughly the same as today.

Initial unemployment claims in this week's release were down significantly.  This was a significant one week drop likely an anomaly of reporting during the holiday season.  This is why Econintersect follows the 4 week moving average to smooth out the weekly gyrations.  Using unemployment claims data as a reference, the December 2010 employment growth would be in the range of 150,000.

No data released this week was inconsistent with Econintersect’s November forecast of slow growth.   The table below itemizes the major events and analysis this week (click here for interactive table).

Bankruptcy Filed this Week: None

Bank Failures this Week: None


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1 comment

  1. admin (Member) Email says :


    Let me first thank you for your comment, and I would like to wish you a great year.

    I would like to point out that:

    1) The article did not suggest there should not have been transfer of payments and specifically stated "I am not arguing that payments under this Personal Transfer Payments safety net were wrong."

    2) The article was arguing that we do not know what is the economic effect of a government providing money to individuals. Understanding this dynamic allows expansion of our control over the economy." If you have a pile of money, one should argue about optimizing its use.

    3) There are more than two sets of historical possibilities - the two opposing points stated in the article were both questioned if either point was correct either fully or in part.

    The issue i raise with your comment is that history is not proof unless somehow we are able to identify and quantify all the dynamics in play. As an example, we know that in the distant past, excess government transfers have gone straight to the economy with multipliers well above 1.0 times of the amount transferred. In the excess transfer beginning in 2009, the multiplier may not have quite reached 1.0.

    Why? I don't know, and i have not read anyone who has made a case. And even if they made a case - they cannot prove why it was so. They would have to create a model based on certain assumptions. There is no way to test these assumptions.

    History can only be a "scientific" guide if we identify and quantify all dynamics in play. It is impossible to realistically compare the 1930's to the 2000's as we have a completely different set of dynamics today. It is also problematic when we compare even country to country as each has different dynamics - and different gearing. For example, believing an economic approach which worked in the USA would work in New Zealand might get you into trouble.

    Arguing economic "fact" is a little like arguing about the best religion. Biology is a science. Geology is almost a science. Economics does not rise to a science. Economic "fact" has been mined in uncontrolled situations where we cannot define the conditions which lead to that outcome.

    I am interested in the link to Alan Harvey argument against Rogoff. It is interesting because Rogoff is one of the few economists who continuously has bothered to do complete historical comparisons - the rest seem to only have cherry-pick historical "facts" which support their positions.

    I am not one who believes we have already found the best solution. We need to continue to explore. But more importantly, we need to figure out a way to test several solutions. The USA is lucky in that was as there are 50 different states - and can test bed solutions under more controlled and comparable situations. i have yet to meet a scientist who proves any theory without running controlled experiments.

    Thanks again for commenting. Any author should be flattered (as I am) when someone takes the time to develop a well reasoned comment inspired by his writing.

    Steven Hansen

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