Mar 25, 2010

In defense of the stimulus


Earlier this week, the Fraser Institute published a controversial report which argued that the government stimulus did not do much for economic growth in the last two quarters of 2009, suggesting that government spending on infrastructure was useless. While their analysis suffers from serious shortcomings, which I outlined in a previous blog post here, their research question merits further investigation. What role did stimulus spending play in the way the recession played out?

When the global recession hit in late 2008, economic output and employment fell so steeply in such a short period of time that policy-makers were seriously concerned about the possibility of the downturn growing into a global depression. The sense of urgency led to unprecedented levels of multilateral economic coordination, with stimulus spending rolled out worldwide and significant deficits incurred by nearly all governments.

A year and a half later, we seem to have dodged the bullet of a global depression. Many will agree that what likely saved us is the coordinated global stimulus packages. Others, however, argue that it was all much ado about nothing and the global economy would have bounced back without government spending. Who’s right?

It’s easy to write off the concerns about a deep and prolonged recession once the recovery has began. Unfortunately (or fortunately?), we cannot observe what the global economy would look like in the absence of the massive inflows of government spending, so this debate will not be resolved empirically.

It seems very likely that the governments’ willingness to step in and do what it takes to avert a potential disaster played an important role in boosting business and investor confidence. Without confidence about the future, and without much eased credit conditions and record low interest rate, business investment could have dried up for much longer. Business “investment intentions for 2010 remain modest and largely driven by the public sector,” observed Mark Carney (the governor of the Bank of Canada) in a speech to the Ottawa Economics Association on March 24. Yet, the role of stimulus spending on consumer and business confidence cannot be measured.

Other stimulus impacts are measurable and they provide strong evidence that the stimulus worked, both globally and in Canada. Institutional and government construction remained a beacon of light for the construction industry when commercial and residential construction plans were put on hold during the recession. In addition, the role of the public sector in keeping employment levels afloat cannot be denied. Most of the job creation that we’ve seen over the past six months comes from public sector employment, while the private sector is still shedding jobs. The automatic stabilizers of employment insurance and welfare helped stabilize household incomes to some extent, although they could have done a lot better if it was easier to qualify for these programs.

The federal stimulus package was far from perfect. As we’ve argued on this blog previously, the stimulus would have had a larger impact if it was bigger, less focused on tax cuts, and better targeted to projects with long-term payoffs for the country (think green infrastructure, universal early child care and education programs and poverty reduction initiatives). But without the stimulus, Canadians would have been a lot worse off.

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