Thursday, March 26, 2009

Rosy Projections Inspire False Confidence

Christina Romer, the Chair of the President’s Council of Economic Advisers, and Jared Bernstein, Chief Economist of the Office of the Vice President, provided estimates of the simulative effects of increased government spending in the United States in a recent paper. They claim that President Obama’s recent $700+ billion stimulus package, which will incur mountains of debt to expand government spending to compensate for declining consumer spending, will increase real GDP by 1.6 times the amount spent by the government. Based on research by Cogan, Cwik, Taylor, and Wieland of the National Bureau of Economic Research, “new Keynesian” macroeconomic models that are empirically estimated and tested depict a vastly different outcome.

The “new Keynesian” models incorporate rational expectations by individuals and firms and some degree of price rigidity in their framework, thereby enabling changes in behavior over time in response to policy decisions. Additionally, Romer and Bernstein assume that the current historically low interest rate environment persists for the entire duration of their simulation which is inconsistent with assumptions of forward-looking households and rational inflation expectations. The stimulus package, unlike those of other nations that have focused largely on infrastructure investments, contains significant tax rebates, transfer payments, and state and local government support. It is questionable if this type of “stimulus” will result in additional purchases or simply finance previously planned spending and debt retirement. Regardless, the “new Keynesian” models predict that after a very marginal impact in the first year, the government spending multipliers are less than one as consumption and investment are crowded out and people adapt their expectations to incorporate increased taxation, higher interest rates, and the likelihood of inflationary pressures. Such a result suggests that additional government spending is actually destructive to GDP growth as opposed to expansionary. Additionally, the NBER’s models estimate an increase in employment of 0.5 million people as a result of the stimulus package which is much less than the 3.5 million projection of the Obama administration and less than the average number of jobs lost in just one month in 2009.

It seems that Obama, in an effort to support his wealth redistribution agenda, has embraced the rosy projections of economic models that are based on unrealistic assumptions and fail to be validated by other commonly accepted models. Under the guise of impending economic disaster, the administration will continue to use fear to enable it to push its ideologies on an unsuspecting and fearful populace. In the end, the rich and the poor will end up paying for his reckless spending and dangerous policies.