Why Obama’s Economic Stimulus Package Has Failed 1

Any President of the United States who flushes close to $1 trillion of taxpayers’ hard-earned wealth down the toilet during the first hundred days of his administration surely must expect tough political sledding for the remainder of a single term administration. The capture of the governorships of Virginia and New Jersey were the first  Republican Party green shoots from  this significant  presidential economic failure.  Martha Coakley croaking on her way to the Senate in the People’s Republic of Massachusetts is the writing on the wall both for the President and for the Democratic majority in the United States Congress.

Obama’s stimulus package has failed lamentably on its own clearly-stated terms: “You ask what is my aim?  My aim is to stem the rate of unemployment by late 2009 nation-wide at no more than 8 per cent and to bring it down quickly thereafter to a rate enjoyed during the mid-2000s.  This package will achieve that goal.”  Well, with unemployment stalled at 10 per cent, and threatening to rise during the first half of 2010, with the United States and the United Kingdom – the two big Keynesian spenders among the G20 nations – the last to stagger out of recession, and with the United States now confronting  its worst debt crisis since the end of World War II, major planks in the president’s economic policy platform are riddled with dry rot.

Choices matter in the competitive environment of Presidential politics. Bad choices have serious consequences. And President Obama made terrible choices in his selection of Larry Summers and Christina Romer as economic policy advisors.  As if in a 1960s time-warp, Obama chose two out-of-date hydraulic Keynesians to prepare and to promote his rescue package for an ailing US economy. Predictably, the hydraulic Keynesian policies that they have promoted, and continue to promote,  in the teeth of adverse evidence,  have failed and will continue to fail to produce economic recovery, indeed will slow down the natural recovery of an unimpeded, still resilient market economy.

For the most part, I do not share the enthusiasm for New Keynesian rational expectations that many of the best economists in this country now endorse.  However, New Keynesianism is infinitely superior to the hydraulic Keynesianism promoted inter alia  by Alvin Hansen, John Hicks, Paul Samuelson, James Tobin and Robert Solow.  So for the sake of argument, I am going to put myself into New Keynesian shoes and speculate how much better would be Obama’s future political prospects had he chosen leading New Keynesians and not worn-out old Keynesians to be his policy advisors.  Specifically, I have in mind the two most brilliant New Keynesians in the United States, namely, Gregory Mankiw and David Romer.

Well here would have been their warnings to the President had he flirted in their presence with old-fashioned Keynesian nostrums:

“new Keynesian economists do not necessarily believe that active government policy is desirable.  Because the theories developed in this book emphasize market imperfections, they usually imply that the unfettered market reaches inefficient equilibria.  Thus these models show that government intervention can potentially improve the allocation of resources.  Yet whether the government should intervene in practice is a more difficult question that entails political as well as economic judgments.  Many of the traditional arguments against active stabilization policy such as the long and variable lags with which policy works, may remain even if one is persuaded by new Keynesian economics.”  G. Mankiw and D. Romer, New Keynesian Economics Volume 1, 1991, 3


“Of course, there are also disadvantages to the Keynesian approach to modeling.  Without microeconomic foundations, welfare analysis is not possible.  More importantly, specifying aggregate relationships directly may cause us to overlook important effects.  For example, stating directly that consumption depends on current disposable income neglects the possibility that temporary and permanent income movements may have different effects; similarly, it neglects the possibility of Ricardian equivalence.  When consumption behavior is derived from microeconomic foundations, in contrast, these possibilities are immediately apparent.  Finally, aggregate relationships may change when the structure of the economy or the nature of policy changes.  Thus, working with aggregate relationships rather than microeconomic assumptions may lead us astray in assessing the likely consequences of changes in policy.  This is the basis of the Lucas critique of traditional macroeconomic models…”  D. Romer, Advanced Macroeconomics, 1996, 196-197.

These are far from ringing endorsements of hydraulic Keynesianism. For the non-economist, the passages may well seem to be opaque. I shall make use of my writing skills in the next two columns, however, to make their meaning crystal  clear in a  careful New Keynesian critique of Obama’s economic stimulus policies.

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4 Responses to “Why Obama’s Economic Stimulus Package Has Failed 1”

  1. zombiehero213 Says:

    “flushes close to $1 trillion of taxpayers’ hard-earned wealth down the toilet”
    I’m not sure what the number is, but how much “stimulus” came from the Fed? It’s not fair to the stimulus crowd to say they only flushed $1 trillion because I’m sure the Fed contributed more than a trillion of it’s own. It’s that stimulus as well?

    I’ve only read this post and the one with Delong but heck, makes me want to go to GMU.

  2. charlesrowley Says:

    You make a great point. However, the stimulus injected by the Fed just possibly may be returned. You may think that it is flushed; I may think that it is flushed. But we cannot yet be sure. The stimulus flushed through the federal budget definitely is flushed. So it is wise to err on the side of caution.

    As for coming to GMU, why not give it a try? We are always on the look-out for likely applicants!

  3. zombiehero213 Says:

    “the stimulus injected by the Fed just possibly may be returned.”
    True, yet even looking through the Keynesian framework, it has already done it’s multiplier magic, right? Even if they aren’t “making loans” to people, all that liquidity has to have done something. If not, there is no case for the Fed to do anything, right?

  4. hussain Says:

    I will do an in depth research on all USA economic,financial,business,social,political and relevant matters first before I proceed to make any comments.The findings of my research will indicate all the indexes that will inevitably be able to provide the diagnosis about USA actual economy status.

    Numbers without solid interpretation could mislead anyone irrespectively as such be more realistic and not simply be more descriptive without any factors and figures proof.

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