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Obama, the GFC and the role of stimulus in post-meltdown economics

Amidst the noise, hype, trepidation and even fear that has surrounded the ascendancy of Donald Trump to the office of the 45th Presidency of the United States, there have also been retrospectives of the Obama era. These have, understandably, tended toward social policy, but in many respects, the significance of the Obama legacy is economic, in large part because Obama’s first term as President coincided with the Grand Fiscal Conundrum of 2008-09.

Here, FWPA’s Statistics and Economics Manager, Jim Houghton, charts the course of the last eight years, touching upon US economics and responses to the GFC. He compares the US and Australian experiences and records that without significant stimulus packages, neither economy would be tracking in a positive direction.

Global Financial Crisis – Policy Responses

The annual Report of the Council of Economic Advisers Jan 2017 takes the opportunity to review the effectiveness of the economic stimulus package initiated by President Obama at the beginning of his Presidential first term in 2008.

From its peak, the unemployment rate recovered to its pre-recession average in mid-2015 and continued to fall, standing at 4.6 percent as of November 2016. Overall, CEA estimates that the Recovery Act saved or created about 6 million job-years (where a job-year is the equivalent of one full-time job for one year) through 2012. Refer Figure 1.1.

fig1

This rebound occurred much more quickly than in most other advanced economies, many of which also experienced systemic financial crises in 2007-08. For example, Japan, which recovered relatively quickly, has seen growth level off in recent years, and while the euro area economy has improved noticeably over the last two years, the area is on the verge of missing nearly an entire decade of growth, as it still has not attained 2008 levels of income per capita (Figure 1-4).

fig2

CEA estimates raised the level of GDP by between 2 and 2.5 percent in FY 2010 and part of FY 2011.

To review the Economic Report of the President 2017 go to: https://www.gpo.gov/fdsys/browse/collection.action?collectionCode=ERP&browsePath=2017&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=0

In Australia by comparison our economic progress has been positive during this period in terms of GDP growth and unemployment. However, there has been a degree of partisan contention as to whether the economic outcome was the result of government stimulus measures or other factors.

A Treasury submission to a 2009 Senate enquiry (Economics Reference Committee  – Government’s economic stimulus initiatives) summarised the impact as:

fig3

Source: P4 Treasury Briefing Paper for the Senate Inquiry into the Economic Stimulus Package 2 October 2009

To view the full proceedings of the senate Inquiry go to: http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Completed_inquiries/2008-10/eco_stimulus_09/index

Andrew Leigh has done some further work to look at the impact of the stimulus on consumption during the period in a paper entitled “How much did the 2009 Australian Fiscal Stimulus Boost Demand? Evidence from Household Reported Spending Effects”, The BE Journal of Macroeconomics:Vol 12 Issue 1 paper 2012. 

He suggests that one of the reasons for the success of the stimulus program was the higher marginal propensity to consume exhibited by Australian consumers compared to other jurisdictions. This may reflect the structure of the consumer package which was effectively a “bonus” payment in Australia compared to tax rebate in the US.

fig4

He also takes the opportunity to compare household expenditure and the household stimulus payments.

fig5

Although it is impossible  to  precisely  separate  the  impact  of  fiscal  policy   from other temporal shocks (eg. fluctuations in consumer sentiment), the uptick in  household  final  consumption  expenditure  is  $9 billion  after  the  $8.8  billion  of   household  payments  in  the  December  2008  quarter,  and  $4  billion  after  the  $12   billion  of  household  stimulus  in  June  2009  quarter.

To review the full report go to: http://andrewleigh.org/pdf/fiscalstimulus.pdf

A more detailed review was undertaken by Chris Barrett, Australia and the Great Recession, 2014.

Barrett uses a number of approaches to determine the timing of stimulus expenditure then convert that “raw cashflow” into a quarterly impact on GDP as follows:

fig6

He then subtracts these growth impacts from the observed changes in GDP to arrive at – real GDP level with and without stimulus.

fig7

This chart shows the  level  of GDP, and the estimated impact  of stimulus. We can deduce the  GDP  growth  impact  from  the  slope  of  the  different  lines.  The  quarter-on-quarter  slopes  of  the   “without  stimulus”  line  are  the  ones  to  look  at.  They  show  a  slightly  deeper  downturn  in  the   December quarter 2008 (-1.2% versus actual -0.9%), basically no growth in the March 2009 quarter  (0.1%  versus  actual  0.9%),  and  then  a  second  and  much  larger  fall  in  the  June  quarter  of  2009  (- 1.4% versus actual +0.4%). 

Barrett, also takes the opportunity to consider some of the statements by strong opponents of the stimulus package, In particular the claims by Prof. Tony Makin, that the federal public investment actually contributed negatively to total expenditure over the critical December 2008 and March 2009 quarters. 

Elements of Prof. Makin’s work has been published by Federal Treasury as an external paper in November, 2016. The more recent paper is consistent with previously expressed views of which Barrett specifically comments: 

“Makin’s comments regarding Federal expenditure are correct, but is also an unusual criticism to make of stimulus for two reasons:

  1. There was no substantial public investment spending announced until the Nation Building and Jobs Plan in early February 2009; and
  2. The vast majority of the public investment spending was transmitted through the States, so we wouldn’t expect it to show up in the federal spending line.

And in fact, when we consider the effect of the investment spending both in terms of the intended timing and the transmission mechanism, the December quarter 2010 national accounts show that total public gross fixed capital formation contributed 1.2 percentage points to growth of 1.7 percent over the last three quarters of 2009 – the largest contribution of any category.

Makin also argues the cash payments were ineffective in boosting household consumption. He points to a weak result for consumption in the December quarter of 2008 (since revised to an actual negative). This also is a curious criticism, given the Economic Security Strategy (ESS) bonuses were not paid until mid-December, when that quarter was virtually over.” (page 10)

Barrett also reviews and rebuts a number of other criticisms leveled at the stimulus package including:

  • Fiscal stimulus was too large (page 12)
  • Cash Payments were ineffective (page 15)
  • Permanent Tax Cuts were preferable (page 15)
  • Spending would force up interest rates and harm growth (page 17)
  • Forecasts were unrealistic (page 19)
  • No cost benefit analysis undertaken (page 20)

The report also includes an extensive review of why the stimulus appears to have been successful in Australia when compared with other jurisdictions.

Some of the factors considered were the speed of the policy roll out. With elements of the package supporting consumption through cash payments and investment through public infrastructure spending and private investment incentives. The package also included a phasedown over the same period the recovery was expected to take hold. (page 25)

However, Barrett somewhat optimistically comments that a critical part of the package was a firm plan regarding fiscal consolidation. At the time this certainly provided the markets and ratings agencies with a consistent fiscal policy outlook. Subsequent events have confirmed the political challenges associated with fiscal consolation.

In considering why Australia performed better than many other countries Barrett gives credit to the starting position the government was in when the GFC hit. This included the strong fiscal position plus factors such as good financial regulation, flexible exchange rates, flexible labour markets, and an independent central bank (page 28)

To review the full report go to: https://www.wilsoncenter.org/sites/default/files/Australia%20and%20the%20Great%20Recession.pdf

To review Prof Tony Makin, The Effectiveness of Fiscal Policy: A review, External Paper November 2016; Treasury External Paper go to: http://research.treasury.gov.au/external-paper/the-effectiveness-of-federal-fiscal-policy-a-review/

 

 

Posted Date: January 25, 2017

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