The New Republic, July 31, 2009
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For weeks on end, Republicans have pounded home the message that economic stimulus has failed. (Charles Krauthammer: “[Obama] blew a hole in the budget that is a trillion dollars wide. There is nothing to show for it.”) Polls show that most people think the stimulus has done nothing to help so far. But today’s second quarter GDP data show that the stimulus has actually helped quite a bit.
The headline is that the economy shrank at a 1.0 percent rate, less than the 1.5 percent rate most economists expected. More importantly, the second quarter data looks great compared to the 6.4 percent rate of contraction in the first quarter of 2009 and the 5.4 percent rate of decline in the fourth quarter of 2008.
If you delve into the numbers, the effect of the stimulus is clear. The government sector directly added 1.1 percentage point to the growth rate in the second quarter. This was due partly to additional federal spending (much of it defense-related), but also due to a modest increase in state and local spending. In the prior two quarters, state and local government spending had been contracting, as state and local governments were forced to make cuts in response to budget deficits. The stimulus package allowed them to sustain existing programs and even expand them in some areas.
Even more important than the direct contribution of government spending was the indirect contribution that the stimulus made by keeping disposable income growing. Thanks to the Making Work Pay tax credit, the extension of unemployment benefits, and the special payment to Social Security beneficiaries, disposable income rose at a 4.6 percent annual rate in the quarter, even as wage income shrunk at more than a 5.0 percent rate.
This growth in income helped to sustain consumption. While consumption still fell at a 1.0 percent annual rate, the drop-off almost certainly would have been much more severe without the boost to income provided by the stimulus.
In total, the stimulus probably added 2.5 to 3.0 percentage points to the growth rate for the quarter. This is the difference between the mild decline that we saw and the disastrous plunge of the prior two quarters. And, assuming normal relationships between output and employment, as many as one million people have jobs today, who would not otherwise, because of the stimulus.
But, to say that the stimulus has made things better is not to say that it has made things good. We are looking at an unemployment rate that is virtually certain to cross 10 percent in the next few months and likely to remain above 10 percent into 2011, and possibly longer, without a further boost to the economy. While most of the stimulus has not yet been spent, we are already spending out the money at close to the maximum rate, and it is the rate of spending that matters.
To see this point, suppose a worker’s pay is increased by $500 a month. Mostly likely this worker will increase her monthly consumption in the fist few months after getting her raise. She may keep this raise for several years, but after her consumption originally increases, it remains fixed at the higher level as long as her pay stays at the new higher level.
In the same vein, the stimulus was already kicking an extra $30-$40 billion a month into the economy in the second quarter. There will be little additional boost from the stimulus in future quarters.
This is very bad news, because the economy has almost zero upward momentum. The continuing decline in jobs and hours, and falling real wages, will depress consumption. Investment is depressed by huge overcapacity. The same holds for housing, with the vacancy rate still at a record high. And, of course the stimulus was not large enough to fully stem off a massive round of budget cuts by state and local governments across the country.
The stimulus has eased the crisis, but voters will be expecting more, and it’s hard to see how they’ll get it without more government action to boost demand.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.