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Why Did the American Investment and Recovery Act (ARRA) Fail -- Or Did It?

Conference Paper · April 2012

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WHY DID THE AMERICAN RECOVERY AND REINVESTMENT ACT (ARRA) FAIL— OR DID IT?

L. Jan Reid, Coast Economic Consulting, Santa Cruz, California, USA

ABSTRACT
The United States Congress approved the American Recovery and Reinvestment Act (ARRA) on February
13, 2009. U.S. President Barack Obama signed the bill into law on February 17, 2009. ARRA was passed
in response to widespread fears that the United States was in danger of slipping into a 1930s-style
economic depression. After ARRA was enacted, related economic debate centered on tax reductions
versus direct federal-government spending. Old arguments resurfaced about the effectiveness of the “New
Deal” programs instituted by U.S. President Franklin Roosevelt; the 1936-1938 recession; and the
theoretical views of both Keynesian and neoclassical economists.

Since ARRA was passed, a number of economists have criticized the effectiveness of the stimulus program.
Criticisms have ranged from arguments that “the stimulus was too small to be effective” to assertions of
ARRA’s failure to address the shortage of qualified workers in the labor force.

I briefly review some of these arguments and conduct empirical tests to determine their validity.

Keywords: ARRA, Stimulus, Recession, Recovery, GDP, Debt/GDP Ratio, Macroeconomics, President
Obama, Unemployment.

1. INTRODUCTION
The American Recovery and Reinvestment Act of 2009, abbreviated ARRA (Pub.L. 111-5) and commonly
referred to as “the Stimulus” or “The Recovery Act,” is an economic-stimulus package enacted by the 111th
United States Congress in February 2009 and signed into law on February 17, 2009, by President Barack
Obama.

In response to the late-2000s recession, the primary objectives for ARRA were to save existing jobs and to
create new jobs almost immediately. Secondary objectives were to provide temporary relief programs for
those most impacted by the recession; and to invest in infrastructure, education, health, and “green” energy.
The approximate cost of the economic stimulus package was estimated to be $787 billion at the time of
passage. The Act included direct spending on infrastructure, education, health, and energy; federal tax
incentives; and expansion of unemployment benefits and other social-welfare provisions. The Act also
included many items not directly related to immediate economic recovery, such as long-term spending
projects (e.g., a study of the effectiveness of medical treatments); and other items specifically included by
Congress (e.g., a limitation on executive compensation in federally aided banks, added by Senator Chris
Dodd and Representative Barney Frank).

The rationale for ARRA was derived from Keynesian macroeconomic theory, which argues that during
recessions, government should offset the decrease in private spending with an increase in public spending
in order to save jobs and to stop further economic deterioration.

In a report prepared for President Obama’s administration, Christina Romer and Jared Bernstein made a
number of predictions about the effect of ARRA on the United States’ economy. (Romer and Bernstein,
2009) At the time, Romer was President Obama’s nominee for the Council of Economic Advisors, and
Bernstein worked for Vice President-elect Joe Biden. An analysis of these predictions forms the basis of my
paper. My analysis of the Romer and Bernstein predictions indicates that ARRA failed to meet many (if not
all) of its initial goals. I discuss the Romer and Bernstein ARRA goals in Section 3 below.

Did the American Investment and Recovery Act (ARRA) Fail?


2. LITERATURE REVIEW
Economic criticism of the stimulus package included the following objections:

• The stimulus was too small to be effective. (Krugman, 2009)


• The stimulus should be limited to a monetary stimulus, not a fiscal stimulus. In essence, this
means that the stimulus should be restricted to actions by the Federal Reserve Board (FRB).
(Lucas, 2008)
• ARRA failed to address the shortage of qualified workers in the labor force, particularly in
manufacturing. (Silvia and Brown, 2012)
• The Federal Reserve Board should target a path for nominal Gross Domestic Product (GDP).
(Romer, 2012)
• While state and local governments received substantial grants under ARRA, they did not use
these grants to increase their purchases of goods and services as many had predicted. Instead,
they reduced borrowing and increased transfer payments. (Cogan and Taylor, 2011)
• The stimulus failed because of the effect of policy uncertainty. (Baker, Bloom, and Davis; 2011)

I discuss each of these criticisms in Section 5 below.

3. ARRA Goals
As mentioned previously, Romer and Bernstein made a number of predictions concerning the effect of the
ARRA stimulus. Only GDP growth was accurately predicted by Romer and Bernstein. In Table 1, I
summarize these predictions and compare them to actual economic results. I discuss some of these
predictions below.

TABLE 1
ARRA PREDICTIONS

PREDICTION RESULTS

3.675 million jobs will be created by the end of Seasonally adjusted civilian employment
2010. (Romer and Bernstein, p. 4) decreased from 143.328 million jobs in Decem-
ber 2008 to 139.220 million jobs in December
2010, a loss of over 4.108 million jobs. (Federal
Reserve Bank of St. Louis [FRED], Series
CE160V)

More than 90 percent of the jobs will be created Private nonfarm employment decreased from
in the private sector. (Romer and Bernstein, 111.803 million jobs in 2008 to 107.693 million
p. 2) jobs in 2010, a loss of 4.110 million jobs.
(FRED, Series NPPTTL)

ARRA will cost approximately $775 billion. The Congressional Budget Office estimated that
(Romer and Bernstein, p. 3) ARRA would increase the federal deficit by $787
billion over the 2009-2019 period. (CBO, 2009)
As of February 24, 2012, $746.9 billion has been
paid out. (Recovery.gov)

Did the American Investment and Recovery Act (ARRA) Fail?


PREDICTION RESULTS

Gross Domestic Product (GDP) will increase by In 2005 chained dollars, real GDP increased
3.7% by the end of 2010. (Romer and from $12.663 trillion to $13.216 trillion, an
Bernstein, p. 4) increase of 4.37%. (FRED, Series GDPC96)

The civilian unemployment rate will be 7.0% at The seasonally adjusted civilian unemployment
the end of 2010. (Romer and Bernstein, p. 4) rate was 9.4% at the end of 2010. (FRED,
Series UNRATE)

State fiscal relief is fiscal relief given to the state By the end of 2010, federal government
governments by the federal government. One seasonally adjusted consumption expenditures
dollar of state fiscal relief is assumed to result in and gross investment (in 2005 dollars) increased
$0.60 in higher state and local government from 2,509.588 billion to 2,552.14 billion, a
purchases and $0.30 in lower state and local difference of 42.552 billion. (FRED, Series
government taxes (largely due to preventing GCEC96)
state and local tax increases). (Romer and
Bernstein, p. 5) State tax receipts decreased from $784.709
billion in 2008 to $704.555 billion in 2010, a
Total state fiscal relief was $53.6 billion. decrease of $80.154 billion. (FRED, Series
(Ed.gov, March 7, 2009) Thus, Romer and USTOTLTAX)
Bernstein predicted that state government
purchases would increase by $32.16 billion and
state-government taxes would decrease by
$16.08 billion.

A fiscal stimulus of 1% of GDP will result in a I note that federal-government consumption and
1.57% change in output by the end of 2010. investment rose by 42.552 billion (0.34% of
GDP) and real GDP increased by 4.37%.
(FRED)

Did the American Investment and Recovery Act (ARRA) Fail?


3.1 REAL GDP
As mentioned previously, ARRA was successful in significantly increasing Real GDP (RGDP) over the
period 2009-2010. In Figure 1, I give the annual change in RGDP for each quarter from 2007-2011.

FIGURE 1: ANNUAL PERCENT CHANGE IN REAL GDP (2007-2011)


6

-2

-4

-6
I II III IV I II III IV I II III IV I II III IV I II III IV
2007 2008 2009 2010 2011

3.2 PRIVATE-SECTOR JOBS


Although jobs were created predominantly in the private sector, annual increases in overall employment did
not begin until 2011. During the year 2011, total employment rose from 139.22 million to 140.79 million, a
gain of 1.57 million jobs. (FRED, Series CE160V) During the same period, non-agricultural federal
government employment decreased from 20.745 million to 20.652 million, a decline of 93,000 jobs. (FRED,
Series LNU02032188) Thus, private-sector employment rose by 1.66 million jobs, while federal government
employment fell by 93,000 jobs.

I note that Timothy Conley and Bill Dupor have estimated that ARRA created or saved 450 thousand
government-sector jobs (all levels of government), and destroyed or forestalled the creation of one million
private-sector jobs. (Conley and Dupor, 2011, p. 1) However, an analysis of the Conley and Dupor
estimates is beyond the scope of this paper.

3.3 CIVILIAN UNEMPLOYMENT


The civilian unemployment rate rose from 7.3% in 2008 to a high of 10.0% in October, 2009. By the end of
2010, the unemployment rate had fallen to 9.4%. Since that time, the unemployment rate has fallen to 8.3%
in January, 2012. This compares favorably to the 1981-1983 recession during U.S. President Ronald
Reagan’s first term in office. During that period, the unemployment rate rose from 7.2% in April 1981 to
10.8% in December 1982. The Reagan recession was characterized by ten consecutive months of double-
digit unemployment, from September 1982 to June 1983. (FRED, Series UNRATE)

Did the American Investment and Recovery Act (ARRA) Fail?


3.4 STATE FISCAL RELIEF
As mentioned previously, state tax receipts decreased from $784.709 billion in 2008 to $704.555 billion in
2010, a decrease of $80.154 billion. By the end of 2010, federal government seasonally adjusted
consumption expenditures and gross investment (in 2005 dollars) increased from $2,509.588 billion to
$2,552.14 billion, a difference of $42.552 billion; and state tax receipts decreased from $784.709 billion in
2008 to $704.555 billion in 2010, a decrease of $80.154 billion. Thus, the increase in federal government
consumption, the decrease in state tax receipts, and the multiplier between fiscal relief and state
government consumption and fiscal relief and state government tax increases seems to be consistent with
the goals established by Romer and Bernstein.

Romer and Bernstein predicted a multiplier of 0.60 between state fiscal relief and state-government
consumption, compared to the actual linear multiplier of 0.79. Romer and Bernstein also predicted a
multiplier of 0.30 between state fiscal relief and state government tax reductions, compared to the actual
linear multiplier of 1.50. However, most of the reduction in state government tax receipts was because
RGDP declined and unemployment rose for much of the two-year period.

Cogan and Taylor have argued that “While state and local governments received substantial grants under
ARRA, they did not use these grants to increase their purchases of goods and services as many had
predicted. Instead they reduced borrowing and increased transfer payments.” (Cogan and Taylor, p. 1)
Cogan and Taylor estimate that the multiplier between ARRA grants and state-government purchases was
0.0967, and that the multiplier between ARRA grants and total receipts minus ARRA grants was only 0.113.

Christine Romer effectively rebutted Cogan and Taylor by arguing that: (Romer 2011, p. 37)

Cogan and Taylor’s analysis shows the importance of specifying the counterfactual. Most
states have balanced budget requirements. The requirements leave some room for deficit
financing of current spending for a year or two, by running down rainy-day funds or the use
of various accounting devices, especially if the deficit is the result of a downturn that was not
expected when the budget was passed. But states didn’t have the option of continuing the
pace of borrowing they had done in the 2008 and 2009 fiscal years. Absent the Recovery
Act, states would have been forced to contract spending greatly. Therefore, relative to the
plausible baseline, state spending was substantially higher following the receipt of the
Recovery Act funds.

3.5 FISCAL STIMULUS GDP MULTIPLIER


Romer and Bernstein predicted that “A fiscal stimulus of 1% of GDP will result in a 1.57% change in output
by the end of 2010.” (Romer and Bernstein, p. 12) The fiscal stimulus was $786.9 billion. RGDP at the end
of 2008 was $13.216 trillion: the fiscal stimulus was 5.95% of nominal GDP. RGDP increased by 4.37% by
the end of 2010. Thus, the simple linear multiplier was approximately 0.73.

The U.S. President’s Council of Economic Advisors (CEA) estimates that ARRA increased RGDP by an
average of 2.13% for the period Q2 2009 to Q4 2010. (CEA, 2011, p. 7) Over the same period, the cost of
the fiscal stimulus averaged $85.36 billion, or 0.65% of 2008 GDP per quarter. Thus, it can be inferred that
the CEA estimates an average multiplier of 3.28.

4. THE LAG BETWEEN THE FISCAL STIMULUS AND RGDP GROWTH


In this section, I address two questions concerning the ARRA stimulus program and the economic recovery:

1. Was the 2009-2010 economic recovery weaker than past economic recoveries?
2. Did the unemployment rate fail to recover as quickly as did RGDP?

Did the American Investment and Recovery Act (ARRA) Fail?


4.1 GDP, RECESSIONS, AND RECOVERIES
In the United States, the unofficial beginning and ending dates of national recessions have been defined by
a private nonprofit research organization, the National Bureau of Economic Research (NBER). The NBER
defines a recession as "a significant decline in economic activity spread across the economy, lasting more
than a few months, normally visible in real gross domestic product (GDP), real income, employment,
industrial production, and wholesale-retail sales." According to the NBER, the U.S. economy was in a
recession from December 2007 to June 2009. The recession lasted 18 months, which makes it the longest
recession in the United States since World War II. Previously, the longest U.S. postwar recessions were
those of 1973-75 and 1981-82, each of which lasted 16 months.

Most economists believe that once a recession ends, the economy tends to grow at a rate that is above the
long-term trend for GDP growth. This boom in growth tends to occur because confidence in the economy
has been at least partially restored. Companies fear the long-term consequences of missing out on
increases in demand, and they begin to increase investment and employment, which in turn increase
consumption. It was generally assumed that the recovery from the recession of 2008-2009 was weak and
characterized by abnormally slow growth. However, available data does not support the view that the 2009-
2010 economic recovery has been anemic or significantly different from the previous five recoveries

I define “recovery rate” as the economic growth rate in the first year after the end of a recession, and “long-
term growth rate” as the annual average growth rate for the period 1947-2011. The U.S. economy had a
recovery rate of 3.30% following the 2007-2009 recession, compared to a long-term growth rate of 3.17%.
As shown in Table 2 below, the economy grew at an average rate of 3.30% from Q3 2009 to Q2 2010,
compared to a long-term average recovery rate of 5.79%. Table 2 gives the annual increase in RGDP for
the first year following the end of a recession. However, there is a significant difference between pre-1980
and post-1980 recoveries. The average growth rate for recoveries prior to 1980 was 7.11%. The economic
growth rate for recoveries in the 1980-2001 period was 3.81%. The average growth rate in the current
recovery is actually higher than the growth rates in three of the previous four recoveries.

TABLE 2
RGDP GROWTH RATES
DURING THE FIRST YEAR AFTER THE END OF A RECESSION

RECESSION BEGIN END RATE

1948 1948 Q4 1949 Q3 10.36%

1953 1953 Q3 1954 Q2 6.68%

1957 1957 Q3 1958 Q1 7.50%

1960 1960 Q2 1961 Q1 7.52%

1970 1970 Q1 1970 Q4 4.45%

1973 1973 Q4 1975 Q1 6.16%

1980 1980 Q1 1980 Q2 2.94%

1981 1981 Q3 1982 Q4 7.74%

Did the American Investment and Recovery Act (ARRA) Fail?


1990 1990 Q3 1991 Q1 2.61%

2001 2001 Q2 2001 Q4 1.94%

2008 2008 Q1 2009 Q2 3.30%

AVERAGE (1948-2001 Recessions) 5.79%

4.2 The UNEMPLOYMENT RATE


Table 3 gives the decrease in the civilian unemployment rate for the first year following the end of a
recession. The civilian unemployment rate declined by only 0.1% following the 2007-2009 recession,
compared to an average post-recession decline of 0.86%. Again, this decline is consistent with the average
of post-1980 recoveries. The average unemployment decline for recoveries prior to 1980 was 1.42%,
compared to an average unemployment decline of 0.38% for recoveries in 1980-2001. The average decline
in unemployment in the current recovery is greater than or equal to the decline in three of the previous four
recoveries.

TABLE 3
DECREASE IN THE CIVILIAN UNEMPLOYMENT RATE
IN THE FIRST YEAR AFTER THE END OF A RECESSION

RECESSION BEGIN END CHANGE

1948 1948 Q4 1949 Q3 −2.2%

1953 1953 Q3 1954 Q2 −1.4%

1957 1957 Q3 1958 Q1 −1.1%

1960 1960 Q2 1961 Q1 −1.3%

1970 1970 Q1 1970 Q4 −0.1%

1973 1973 Q4 1975 Q1 -1.0%

1980 1980 Q1 1980 Q2 −0.1%

1981 1981 Q3 1982 Q4 −2.5%

1990 1990 Q3 1991 Q1 0.8%

2001 2001 Q2 2001 Q4 0.3%

2008 2008 Q1 2009 Q2 −0.1%

AVERAGE (1948-2001 Recessions) −0.86%

Did the American Investment and Recovery Act (ARRA) Fail?


The decline in unemployment is consistent with the increase in RGDP during the recoveries. In Table 4, I
compare the increase of RGDP with the decline in unemployment during each of the recovery periods.
There have been four U.S. recessions in which economic growth was less than 4% during the recovery
period: 1980, 1990, 2001, and 2008. Of these four periods, the most recent recovery period has the highest
rate of economic growth and the greatest decline in unemployment rate. The unemployment rate increased
during the two recovery periods that had the lowest percent increases in economic growth (1990 and 2001).

TABLE 4

GDP AND THE DECLINE IN THE UNEMPLOYMENT RATE


IN THE FIRST YEAR AFTER THE END OF A RECESSION

CHANGE IN
RECESSION BEGIN END RGDP UNEMPLOYMENT
RATE

1948 1948 Q4 1949 Q3 10.36% -2.2%

1953 1953 Q3 1954 Q2 6.88% -1.4%

1957 1957 Q3 1958 Q1 7.50% -1.1%

1960 1960 Q2 1961 Q1 7.52% -1.3%

1970 1970 Q1 1970 Q4 4.45% -0.1%

1973 1973 Q4 1975 Q1 6.16% -1.0%

1980 1980 Q1 1980 Q2 2.94% -0.1%

1981 1981 Q3 1982 Q4 7.74% -2.5%

1990 1990 Q3 1991 Q1 2.61% 0.8%

2001 2001 Q2 2001 Q4 1.94% 0.3%

2008 2008 Q1 2009 Q2 3.30% -0.1%

AVERAGE (1948-2001 Recessions) 3.17% −0.86%

4.3 THE FEDERAL RESERVE BOARD


Since 1981, recessions in the United States have been characterized by longer recovery periods. For
example, the unemployment rate declined from 9.7% to 9.1% in 2010, and from 9.1% to 8.3% in 2011.
There are several possible explanations for the increase in the recovery periods since 1981. There were a
number of changes in the U.S. economy beginning in 1981. The post-1980 recessions have been more
severe than previous recessions. For example, the unemployment rate reached 11.4% in 1983, and 10.6%
in 2010, compared to a high of 7% during the 1948-1949 recession. It will simply take longer for an
economy to recover from a more severe recession. The Federal Reserve Board (FRB) will tend to dampen
the recovery by attempting to control inflation while maximizing employment.

Did the American Investment and Recovery Act (ARRA) Fail?


The FRB takes a much more active role in manipulating the economy than it did prior to 1980. The increase
in FRB activity is attributable to the 1979 appointment by U.S. President Jimmy Carter of Paul Volcker as
Chair of the FRB.

Gary Stern has explained that: (Stern, 2009)

For four decades, when the world has faced financial crisis, ethical quandary or managerial
impasse, it has turned to Paul Volcker.

He’s best known, of course, as the Fed chair who—in that clichéd but vivid phrase—“broke
the back” of inflation in the early 1980s by restricting growth in the money supply and
allowing the fed funds rate to rise as high as 20 percent. He faced enormous criticism for
doing so. As the economy slowed and unemployment rose, building contractors shipped
2x4s to his office and farmers protested on tractors in front of the Fed; one powerful
congressman demanded his impeachment.

But Volcker was steadfast, and his strategy worked. Inflation dropped from over 13 percent
in 1979 to under 2 percent in 1986, and the economy sprang back to health—thereby
establishing the Fed’s credibility as a guardian of price stability and economic growth.

The increase in FRB credibility meant that the FRB engaged in more frequent interest-rate manipulations
since 1980. This has resulted in fewer, but more severe, recessions. The FRB is not perfect, and will
sometimes raise or lower interest rates unnecessarily. Since macroeconomic mistakes (e.g., unnecessarily
changing interest rates) are inevitable, the FRB’s mistakes have tended to increase the severity of
recessions.

4.4 CURRENCY REGIMES


In the early 1970s, a floating-currency regime was proposed by the U.S. Treasury. The floating-currency
regime replaced the fixed-currency regime established by the Bretton Woods Gold Standard agreement.
Floating currency has tended to increase currency volatility and to make recessions more severe. Economic
recovery became more difficult, because policy makers often had to deal with trade barriers caused by
significant increases or decreases in currency valuations.

4.5 LABOR SHORTAGES


The recovery periods were also impacted by labor shortages that have occurred since the early 1980s,
particularly shortages that result from skills mismatches after the introduction of new technologies in
manufacturing. According to Silvia and Brown: (Silvia and Brown, p. 1)

The best example of how technology changes the demand for skilled labor can be seen in
the manufacturing sector (see Washington Post: U.S. manufacturing sees shortage of
skilled factory workers, 2/19/2012). Output in the manufacturing sector has continued to
expand since the 1980s while employment within the sector continues to decline. The main
reason for this inverse relationship is that the technology adoption that began in the early
1980s significantly altered the required skill levels of workers in manufacturing. In other
words, manufacturing become more computer aided and less labor intensive. The side
effect of this new capital-labor mix is that the skills of manufacturing workers need to be
higher in order to operate and maintain the new technologically advanced equipment. In
today’s globally competitive manufacturing sector, advanced production technologies have
allowed the U.S. to remain competitive by reducing costs to meet foreign competition.

Did the American Investment and Recovery Act (ARRA) Fail?


The Beveridge curve is a graphical representation of the relationship between unemployment and the job
vacancy rate (the number of unfilled jobs expressed as a proportion of the labor force). This curve typically
shows job vacancies on the vertical axis and unemployment on the horizontal axis. The hyperbolic curve
(named for William Beveridge) slopes downward, as a higher rate of unemployment normally occurs with a
lower rate of vacancies. If the curve moves outward over time, then a given level of vacancies would be
associated with higher and higher levels of unemployment, implying decreasing efficiency in the labor
market. Inefficient labor markets are due to mismatches between available jobs and the unemployed, and to
an immobile labor force. The curve has been rising over the past year, which indicates that the skills gap is
widening.

If the Beveridge curve rises during a recovery period, the recovery period will be slower and weaker
compared to a recovery period in a more efficient labor market.

5. HYPOTHESIS TESTS
In this section, I report the results of the following hypothesis tests:

1. Was the stimulus too small to be effective?


2. Would the stimulus have been more effective if it had been restricted to a monetary
stimulus?
3. Was fiscal relief to state and local governments an economically efficient use of
taxpayer funds?
I tested these three hypotheses using the Fair Model developed by Dr. Ray Fair of Yale University. On
March 1, 2009, Dr. Ray Fair used his Multicountry Econometric Model (MCD Model) to estimate key
economic variables with and without the stimulus for the period Q1 2009 through Q4 2012. A complete
description of the model is provided in Fair (2004). The effect of the stimulus on the federal government
deficit has been recently estimated by Seidman and Lewis (2009).

5.1 WAS THE STIMULUS TOO SMALL?


As mentioned previously, Paul Krugman has criticized the ARRA stimulus for being too small to be effective.
Although Krugman is critical of the size of ARRA, he has not recommended an optimal stimulus size.
Additional stimulus is constrained by its effect on inflation and by the increasing difficult of selling U.S.
Treasury bonds in the world market.

As spending increases, inflationary pressures rise. At some point, RGDP will actually be negative as a
result of the stimulus spending, because the increase in RGDP is less than the increase in the inflation rate.
The availability of capital is also a constraining factor. As the deficit rises, U.S. Treasury bonds become
more risky and are less attractive in the world market.

I make the following assumptions:

1. The stimulus size is constrained by a Government Debt to GDP (Debt/GDP) ratio of


1.20 (120%). As explained below, this is an extremely liberal assumption.
2. Additional stimulus spending is divided equally between transfer payments to
households (TRGHQ) and federal-government purchases of goods (COG).
3. There will be no changes to federal-government tax policy over the forecast period.
4. Additional stimulus spending will occur during the period Q2 2009 through Q4 2011

Did the American Investment and Recovery Act (ARRA) Fail?


The current U.S. Debt/GDP ratio is slightly greater than 100%, a level exceeded only during World War II.
Jennifer DePaul has explained that “Other countries whose debt exceeds its GDP include: Greece (143%)
Italy (120 %) Ireland (114 %) and Japan (229%).” (DePaul, 2011) Even during the Great Depression of
1929-1933, the U.S. Debt/GDP ratio never exceeded 100%.

In Table 5, I show the estimated change in key economic variables from Q2 2009 to the four quarters of
2012, when stimulus spending will have increased by $10 billion per quarter for eleven consecutive quarters.
This amounts to an increase of less than 14% over the actual stimulus.

As shown in Table 5, additional stimulus spending would have had a minor effect on economic output and
employment. However, the Debt/GDP ratio would quickly have become unsustainable. By Q3 2012, the
additional stimulus spending would have begun to harm the economy, as GDP and employment would have
begun to fall, and the unemployment rate would have begun to rise relative to the actual unemployment rate.

Therefore, I reject Krugman’s argument that the stimulus spending was too small to be effective. In many
respects, ARRA was an effective stimulus program. Although the recovery was not as strong as the 1983
recovery, it was stronger than three of the previous four recoveries, and achieved GDP growth that was
higher than the long-term average growth rate.

TABLE 5
ECONOMIC EFFECT OF A $110 BILLION INCREASE
IN STIMULUS SPENDING

INCREASE IN CHANGE IN CHANGE IN


REAL GDP UNEMPLOYMENT JOBS DEBT/GDP
PERIOD ($ BILLION) RATE (%) (THOUSANDS) RATIO

2009 Q2 5.31 −0.03 56 0.91

2009 Q3 9.05 −0.08 131 0.94

2009 Q4 11.28 −0.12 199 0.96

2010 Q1 12.26 −0.15 257 0.99

2010 Q2 12.44 −0.17 294 1.01

2010 Q3 12.14 −0.18 318 1.04

2010 Q4 11.65 −0.17 322 1.07

2011 Q1 11.07 −0.17 327 1.08

2011 Q2 10.59 −0.16 320 1.09

2011 Q3 10.14 −0.15 313 1.12

2011 Q4 9.76 −0.14 310 1.14

2012 Q1 4.05 −0.10 248 NA

2012 Q2 0.00 −0.05 167 NA

2012 Q3 2.33 0.00 91 NA

Did the American Investment and Recovery Act (ARRA) Fail?


INCREASE IN CHANGE IN CHANGE IN
REAL GDP UNEMPLOYMENT JOBS DEBT/GDP
PERIOD ($ BILLION) RATE (%) (THOUSANDS) RATIO

2012 Q4 -3.42 0.04 32 NA

5.2 WOULD A MONETARY STIMULUS HAVE BEEN MORE EFFECTIVE THAN A FISCAL STIMULUS?
Robert Lucas Jr. has recommended that the stimulus be limited to a monetary stimulus run by the FRB.
Lucas has pointed out that in 2008 the “Fed has put more than $600 billion of new reserves into the private
sector, using them to discount -- lend against -- a wide variety of securities held by a variety of financial
institutions.” (Lucas, 2008) Lucas argues that the advantages of this type of stimulus are “It entails no new
government enterprises, no government equity positions in private enterprises, no price fixing or other
controls on the operation of individual businesses, and no government role in the allocation of capital across
different activities.”

Although Lucas is correct about the advantages of this type of stimulus, a broad monetary stimulus program
suffers from the lack of targeting in capital allocation. Would General Motors have been saved under the
Lucas Plan? Lucas, unlike some other economists, sees the lack of government targeting as an economic
advantage.

I have tested Lucas’ proposal by assuming that the FRB create $600 billion in new reserves during the
second quarter of 2009 and that the federal government refrain from enacting ARRA. Lucas’ proposal is
analogous to increasing bank borrowing (variable BO) from the FRB by $600 billion. I note that a variant of
Lucas' proposal was tried in 2008 with little success. Bank borrowing for the FRB rose from $48 billion in
2007 Q4 to $559 billion in 2008 Q4.

As shown in Table 6, the Lucas Plan would have resulted in high unemployment and fourteen quarters of
sub-optimal economic growth when compared to ARRA. The civilian unemployment rate would been over
10% for two full years, reaching a high of 10.98% by the end of 2010. The economy would not have begun
to recover relative to the ARRA until the end of 2012. Total employment would have been significantly less
than under ARRA. Under the Lucas Plan, more jobs would have been lost than under ARRA for every
quarter from 2009 Q2 until 2011 Q2.

Therefore, I find that the economy would have been significantly worse off if the stimulus had been limited to
a monetary stimulus and no fiscal stimulus.

Did the American Investment and Recovery Act (ARRA) Fail?


TABLE 6
ECONOMIC EFFECT OF A $600 BILLION INCREASE IN RESERVES
AND NO FISCAL STIMULUS

CHANGE IN CHANGE IN CHANGE IN


REAL GDP UNEMPLOYMENT JOBS
PERIOD ($ BILLION) RATE (%) (THOUSANDS)

2009 Q2 0.35 0.00 4

2009 Q3 -24.39 0.00 -254

2009 Q4 -52.88 0.15 -709

2010 Q1 -77.22 0.44 -1,261

2010 Q2 -94.13 0.77 -1,792

2010 Q3 -24.39 1.07 -2,255

2010 Q4 -104.51 1.33 -2,447

2011 Q1 -96.97 1.41 -2,455

2011 Q2 -80.95 1.36 -2,268

2011 Q3 -64.61 1.19 -2,007

2011 Q4 -50.53 0.99 -1,705

2012 Q1 -33.35 0.76 -1,329

2012 Q2 -18.69 0.50 -976

2012 Q3 -8.01 0.27 -677

2012 Q4 -1.02 -0.07 -429

5.3 STATE FISCAL RELIEF


John Cogan and John Taylor have argued that: (Cogan and Taylor, p. 1)

Using a new data set, we find that the American Recovery and Reinvestment Act (ARRA) of
2009 increased federal government purchases as a share of GDP by only .19 percent and
infrastructure by only .05 percent at its peak in the third quarter of 2010. While state and
local governments received substantial grants under ARRA, they did not use these grant to
increase their purchases of goods and services as many had predicted. Instead they
reduced borrowing and increased transfer payments. A review of research on similar
stimulus programs in the 1970s reveals similar behavior on the part of state and local
governments, which raises questions about the design and feasibility of such programs in
the federal system of the United States.

Did the American Investment and Recovery Act (ARRA) Fail?


Government consumption and investment includes the purchase of both consumption goods (e.g., school
lunches) and capital goods such as streets, highways, and buildings. Transfer payments, such as state
fiscal relief, are not part of government consumption and investment. Despite the fact that over $750 billion
has been spent on the ARRA program, there has been a decline in real federal government consumption
and investment (C&I). Table 7 provides a comparison of the growth of C&I during various U.S. Presidential
administrations.

TABLE 6
ANNUAL GROWTH OF FEDERAL GOVERNMENT
CONSUMPTION AND INVESTMENT

ANNUAL
President Term CHANGE
IN REAL C&I
Barack Obama 2009-2012 -0.54%

George W. Bush 2001-2009 2.27%

William Clinton 1993-2001 1.31%

George H. Bush 1989-1993 1.53%

Ronald Reagan 1981-1989 3.57%

Jimmy Carter 1977-1981 1.94%

Average 1.68%

Cogan and Taylor (p. 18) have estimated that if there had been no state fiscal relief, state and local
governments would have:

• Decreased net borrowing by $224 billion;


• Decreased other expenditures such as transfer payments by $124 billion; and
• Increased purchases by $102 billion

Cogan and Taylor conclude that their results “are quite similar to those of Gramlich (1979) in his studies of
comparable countercyclical stimulus programs more than three decades ago. Experience from the 1977
stimulus package and from the 2009 stimulus package shows that grants to state and local governments do
not necessarily result in increases in government purchases.” (Cogan and Taylor, p. 25)

I tested whether or not ARRA funds could have been more efficiently spent if state fiscal relief were not part
of the ARRA program. I have simulated a modified ARRA program in which there is no fiscal relief to state
and local government. Instead, approximately $245 billion is transferred from nominal federal government
transfer payments to state and local governments (TRGS) to real federal government purchases of goods
(COG).

Did the American Investment and Recovery Act (ARRA) Fail?


As shown in Table 7, the ARRA program would have had a bigger effect on employment and economic
growth if funds had been transferred from fiscal relief to federal government consumption. GDP would have
been higher, the unemployment rate would have been lower, and total employment would have risen by
1.22 million jobs by the end of 2010. Fiscal relief to state and local governments ended in 2011 Q3. The
economy would have been slightly worse off in 2012 if there had been no fiscal relief to state and local
governments.

TABLE 7
ECONOMIC EFFECT OF A TRANSFER OF $245 BILLION FROM FISCAL
RELIEF TO STATE AND LOCAL GOVERNMENTS TO
FEDERAL GOVERNMENT CONSUMPTION

CHANGE IN CHANGE IN CHANGE IN


REAL GDP UNEMPLOYMENT JOBS
PERIOD ($ BILLION) RATE (%) (THOUSANDS)

2009 Q2 21.76 -0.19 302

2009 Q3 30.85 -0.31 518

2009 Q4 37.53 -0.43 715

2010 Q1 42.93 -0.53 912

2010 Q2 46.70 -0.61 1,071

2010 Q3 47.71 -0.66 1,195

2010 Q4 44.28 -0.65 1,216

2011 Q1 28.42 -0.55 1,099

2011 Q2 19.00 -0.41 913

2011 Q3 10.54 -0.27 710

2011 Q4 -3.16 -0.11 460

2012 Q1 -9.95 0.04 216

2012 Q2 -12.01 0.15 38

2012 Q3 -11.54 0.21 -72

2012 Q4 -10.09 0.23 -127

6. CONCLUSION
My empirical results indicate that ARRA stimulus spending was effective in increasing economic growth and
in reducing unemployment. I found that additional stimulus spending would have been counterproductive,
and that a solely monetary stimulus would have caused a major increase in unemployment. I also found
that fiscal relief to state and local governments is economically inefficient and results in major job losses and
a significant reduction to overall economic growth.

Did the American Investment and Recovery Act (ARRA) Fail?


7. REFERENCES
Baker, Scott R., Bloom, Nicholas, and Davis, Steven; “Measuring Economic Policy Uncertainty,” September
12, 2011.

Cogan, John F. and Taylor, John B., “What the Government Purchases Multiplier Actually Multiplied in the
2009 Stimulus Package,” December, 2011.

Congressional Budget Office (CBO), “Summary Of Estimated Cost Of The Conference Agreement For H.R.
1, The American Recovery And Reinvestment Act Of 2009, As Posted On The Web Site Of The House
Committee On Rules,” February 13, 2009.

Conley, Timothy and Dupor Bill; “The American Recovery and Reinvestment Act: Public Sector Jobs Saved,
Private Sector Jobs Forestalled,” May 17, 2011.

Council of Economic Advisors, “The Economic Impact Of the American Recovery and Reinvestment Act Of
2009: Seventh Quarterly Report,” July 1, 2011.

DePaul, Jennifer, “New Debt Ratio Signals Out-of-Control Spending,” The Fiscal Times, August 5, 2011.
http://www.thefiscaltimes.com

Ed.gov, http://www2.ed.gov/policy/gen/leg/recovery/ factsheet/ stabilization-fund.html, United States


Department of Education, 2009.

Fair, Ray C. Estimating How the Macroeconomy Works. (Harvard University Press, 2004)

Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/

Krugman, Paul, "Failure to Rise”, New York Times, February 13, 2009, page A31.

Lucas, Robert E. Jr., “Bernanke is the Best Stimulus Right Now,” December 23, 2008; Wall Street Journal,
www.wsj.com.

Recovery.gov, http://www.recovery.gov/pages/default.aspx

Romer, Christine, “What Do We Know About the Effects of Fiscal Policy? Separating Evidence From
Ideology,” Speech at Hamilton College, November 7, 2011,
http://emlab.berkeley.edu/~cromer/Written%20Version%20of%20Effects%20of%20Fiscal%20Policy.pdf

Romer, Christine, “Christine Romer: “We Need a Regime Change at the Fed,” February 20, 2012; Macro
and Other Market Musings, http://macromarketmusings.blogspot.com/2012/02/christina-romer-we-need-
regime-change.html.

Romer, Christina and Bernstein J., “The Job Impact of the American Recovery and Reinvestment Plan”,
January 10, 2009.

Seidman, Lawrence and Lewis, Kenneth. “Does Fiscal Stimulus Cause Too Much Debt”, Business
Economist, October 2009, pp. 201-205.

Silva, John E. and Brown, Michael A., “Is The Skills Disconnect In The Labor Force New?.” Wells Fargo
Securities, February 27, 2012.

Stern, Gary, “Interview with Paul A. Volcker,” July 15, 2009, The Federal Reserve Bank of Minneapolis,
http://research.mpls.frb.fed.us/publications_papers/pub_display.cfm?id=4292.

Did the American Investment and Recovery Act (ARRA) Fail?


8. AUTHOR PROFILE

L. Jan Reid earned his M.S. at the University of California, Santa Cruz, in 1998. L. Jan Reid is President of
Coast Economic Consulting, a firm specializing in litigation, risk management, and regulatory economics.
Jan is an active participant in regulatory proceedings at the California Public Utilities Commission (CPUC) in
the United States. He has regularly testified before the CPUC and has conducted numerous workshops and
seminars on cost of capital and risk management.

ACKNOWLEDGMENTS
I am extremely grateful to economist Ron Knecht, Member of the Board of Regents of the Nevada System of
Higher Education, for providing valuable information on contemporary and historical views of conservative
economists; to Dr. Roy Fair of Yale University for access to his macroeconomic model; and to Gina L.
Serman Reid of Coast Economic Consulting for reviewing the manuscript and making many useful
suggestions.

Did the American Investment and Recovery Act (ARRA) Fail?

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