Economics 1490 THE WORLD ECONOMY GROWTH OR STAGNATION

Economics 1490 THE WORLD ECONOMY: GROWTH OR STAGNATION? with Professor Dale W. Jorgenson Lecture 9. FISCAL POLICY September 28, 2017 Harvard University Department of Economics Fall 2017

THE WORLD ECONOMY: GROWTH OR STAGNATION? A. Comparing Economies B. U. S. Crisis and Recovery C. European Slowdown D. Asian Economic Miracles E. Sustainability of Economic Growth F. World Economic Outlook

B. U. S. CRISIS AND RECOVERY 6. U. S. Financial Crisis 7. Monetary Policy 8. Financial Regulation 9. Fiscal Policy 10. Secular Stagnation

SUPPLEMENTARY READINGS ON FISCAL POLICY Congressional Budget Office (2015), “Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output in 2014, ” February 20. See: https: //www. cbo. gov/publication/49958 Council of Economic Advisers (2014), “The Economic Impact of the American Recovery and Reinvestment Act of 2009 Five Years Later: Final Report to the Congress, ” February. See: http: //www. whitehouse. gov/sites/default/files/docs/cea_arra_rep ort. pdf

TROUBLED ASSET RELIEF PROGRAM (TARP) • Enacted by the U. S. Congress on October 3, 2008, and signed into law by President George W. Bush the same day • Originally provided $700 billions for financial stability, but this was reduced to $475 billions by the Dodd-Frank legislation • Only $430 billions were actually disbursed • See: http: //www. treasury. gov/initiatives/financialstability/reports/Pages/TARP-Tracker. aspx

TOTAL TARP FUNDS OUTSTANDING

DISPOSITION OF TARP FUNDS TO DATE

OBAMA ECONOMIC TEAM

AMERICAN RECOVERY AND REINVESTMENT ACT • Estimated Macroeconomic Impact • Major Provisions of ARRA • Estimated Output Multipliers • Estimated Budgetary Costs

ESTIMATED MACROECONOMIC IMPACT OF THE AMERICAN RECOVERY AND REINVESTMENT ACT

ESTIMATED OUTPUT MULTIPLIERS

ESTIMATED OUTPUT MULTIPLIERS (cont’d)

ESTIMATES OF THE EFFECTS OF ARRA ON THE LEVEL OF GDP

GOVERNMENT SPENDING MULTIPLIER In this paper we argue that the government-spending multiplier can be much larger than one when the nominal interest rate does not respond to an increase in government spending. We develop this argument in a model in which the multiplier is quite modest if the nominal interest rate is governed by a Taylor rule. When such a rule is operative, the nominal interest rate rises in response to an expansionary fiscal policy shock that puts upward pressure on output and inflation. Christiano, Eichenbaum, and Rebelo, “When Is the Government Spending Multiplier Large? ” p. 79.

ZERO INTEREST RATE BOUND There is a natural scenario in which the nominal interest rate does not respond to an increase in government spending: when the zero lower bound on the nominal interest rate binds. We find that the multiplier is very large in economies in which the output cost of being in the zero-bound state is also large. In such economies it can be socially optimal to substantially raise government spending in response to shocks that make the zero lower bound on the nominal interest rate binding. Christiano, Eichenbaum, and Rebelo, “When Is the Government Spending Multiplier Large? ” p. 79.

GOVERNMENT SPENDING MULTIPLIERS IN A NEW KEYNESIAN MODEL

GOVERNMENT SPENDING MULTIPLIERS IN A NEW KEYNESIAN MODEL

NEW KEYNESIAN ANALYSIS OF THE ARRA: SUMMARY • Official Estimates by the Congressional Budget Office and the Council of Economic Advisers Are Based on Traditional Keynesian Multipliers. • The New Keynesian Model of Christiano, Eichenbaum, and Rebelo Generates Relatively Large Multipliers at the Zero Interest Rate Bound. • Although the Multiplier Is Large, Government Purchases of Goods and Services Are Small, So That the Impact of the ARRA Is Very Small.

WHY ARE GOVERNMENT PURCHASES SO SMALL? • Federal Government Purchases Are a Small Portion of the ARRA. • State and Local Purchases Were Slightly Reduced by the ARRA. • Most Federal Transfers to State and Local Governments Were Used to Reduce Government Borrowing (or Increase Government Net Lending)

EFFECT OF ARRA

EFFECT OF ARRA ON GOVERNMENT PURCHASES

ARRA FEDERAL TRANSFERS

EFFECT OF ARRA ON RECEIPTS

STATE AND LOCAL GOVERNMENT PURCHASES

CHANGE IN RECEIPTS AND PURCHASES

EXPENDITURES OTHER THAN PURCHASES

CHANGE IN RECEIPTS AND NON-PURCHASE EXPENDITURES

NET BORROWING

CHANGE IN RECEIPTS AND NET LENDING

TOTAL BUDGET CHANGES

THE ECONOMIC IMPACT OF THE ARRA: SUMMARY • The Economic Impact of Fiscal Policy Depends on the Size of Government Purchases of Goods and Services and the Magnitude of the Government Purchases Multiplier. • The Size of the Government Spending Multiplier Is Large at the Zero Interest Rate Bound (ZIRB). • The Change in Federal Government Purchases under ARRA Was Small and the Change in State and Local Government Purchases was Slightly Negative. • The Economic Impact of the ARRA Was Very Modest.

THERE’S NO SUCH THING AS SHOVEL-READY PROJECTS