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Monday, March 5, 2012

More Debates about the Stimulus Debate

In a blog post yesterday Paul Krugman repeats a claim made by Christina Romer (in footnote 18 of a speech at Hamilton College last November) which he says answers “in devastating fashion” the empirical paper by John Cogan and me which shows that stimulus (ARRA) grants led to lower net borrowing by state and local governments. But Romer’s claim actually provides no such answer or rebuttal.

Romer argues that state balanced budget laws would have prevented states from increasing their borrowing by any significant amount in the counterfactual event that ARRA did not exist. Her argument does not apply to our paper for two reasons. First, state and local governments can increase and decrease their borrowing by considerable sums for infrastructure projects (schools, roads, light rail, etc.) within their balanced budget laws. Second, net borrowing (which is what Cogan and I examined) is the difference between the net increase in liabilities and the net acquisition of financial assets. As ARRA funds came in, state and local government increased their net acquisition of financial assets, and thereby reduced net borrowing compared to what they would have done in the absence of ARRA. Neither state balanced budget laws nor conditions in municipal bond markets, would, in the absence of ARRA, prevent the state and local government sector from increasing net borrowing simply by buying fewer financial assets.

So the point I made at the Harvard debate with Larry Summers stands: While state and local governments received substantial grants under the 2009 stimulus, a statistical analysis by John Cogan and me shows that they did not use these grants to increase their purchases of goods and services as many had predicted. Instead they reduced net borrowing and increased transfer payments. Even with balanced budget laws, state and local governments can borrow for infrastructure, and they borrowed less on a net basis during the stimulus period, while they put additional funds into financial assets.

Krugman’s post also refers to Mark Thoma’s comments on my recent blog post summarizing my opening remarks at the Harvard debate. Thoma criticizes me for focusing on what actually happened to the stimulus funds rather than just simulating existing models. But I think it is essential to look at what actually happened. While this may seem to leave open the theoretical possibility that some other hypothetical better-designed stimulus would have worked, the fact that the actual program was designed the same way as the one that did not work 30 years ago raises serious questions about the feasibility of some such hypothetical stimulus.

Both Thoma and Krugman were led to make these comments after reading John Cochrane’s post on the Harvard debate in which he raises good questions about observed state-by-state employment correlations.

Finally, last November I responded to several other misleading statements made about my research by Christina Romer in her Hamilton College speech.