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Government Spending Might Not Create Jobs Even during Recessions
By Bill Dupor & Rodrigo Guerrero, writing for the St. Louis Fed. Excerpts:
"The effectiveness of fiscal policy is often questioned because its
positive impact on employment and output may be dampened by secondary
effects that "crowd out" economic activity in the private sector. For
instance, if the expenditure is financed by borrowing, then this
borrowing might exert upward pressure on interest rates, which, in turn,
would cause a reduction in private investment. Similarly, a surge in
fiscal spending may bid up wages, thereby reducing the demand for labor
in the private sector.
Times of high unemployment usually see an uptick in calls for
increased government spending from politicians, pundits and economists.
These observers appeal to a logic for government intervention that might
not be valid during normal economic times; they argue that the
detrimental secondary effects of fiscal spending are not as prominent
when the economy is slack.
The simple thinking is that because the government's demand for goods
and services can be met with otherwise idle workers, additional public
spending need not bid up wages significantly or crowd out private
demand.
whether government spending is particularly effective at increasing
economic activity during times of high unemployment is an empirical
question. A large amount of research has been conducted on the effects
of government purchases on output (or gross domestic product) during
recessions; relatively less research has focused on these purchases'
employment effects. Understanding the employment effects of government
intervention during recessions is crucial—much of the brunt from
downturns, such as the 2007-2009 recession, is likely felt by people
losing their jobs.
Public Spending and Employment
A researcher ideally would like to see macroeconomic experiments with
government spending changing over time for reasons unrelated to
business cycle fluctuations and also to have these experiments occur
during both high- and low-unemployment times. These exogenous changes
would generate natural experiments akin to the controlled experiments
used to test, for example, the efficacy of new drugs.
Although truly exogenous large changes in government spending do not
exist in the U.S. (or probably anywhere else), we in the U.S. have
something close in the form of defense spending. Defense spending can be
used because changes in it are mostly determined by international
geopolitical factors rather than macroeconomic conditions. In our new
research, we employed a recently created data set containing more than
120 years' worth of data on government purchases; the data set was
introduced in a series of papers by economists Michael Owyang, Valerie
Ramey and Sarah Zubairy. These data appear in the upper panel of the figure.
They include episodes of large variation in government spending during
both low-unemployment times, such as World War I and the Korean War, and
high-unemployment times, such as World War II.
The spending data also include a time series of "defense news
shocks." Using historical documents, such as Business Week magazine,
Ramey constructed a time series of changes in the values of future
military spending. These data appear in the lower panel of the figure.
Note, for example, the large upward spikes near the start of World War
II and the downward spikes as that war neared its end. Since this series
is based on military purchases that were not motivated by business
cycle conditions, the data help to identify the exogenous component of
the government spending shocks. Moreover, it is important to use news
about military spending to tease out exogenous changes rather than
military spending itself because households and businesses may change
their behavior in response to new information even if the actual defense
spending is months to years away. For instance, a military contractor
might react to news about future government purchases by increasing its
workforce in anticipation of higher demand.
The upper panel of the figure
plots real (inflation-adjusted) per capita government spending between
1890 and 2010. The shaded bars indicate years when, according to our
measure, the labor market was slack, i.e., the unemployment rate was
greater than 6.5 percent. In addition to a general upward trend, there
are spikes in government spending. The most notable ones result from
World War I and World War II. The lower panel of the figure
plots the military news variable. At each quarter, it gives the change
in the present value of expected future defense spending as a fraction
of gross domestic product (GDP). For many periods, its values are zero,
which indicate periods where beliefs about future defense spending are
unchanged. Not surprisingly, there are major positive spikes around the
times of World War I and World War II.
Specifically, our research aims to answer the following two
questions: (1) By how much does national civilian employment change when
government spending increases? (2) Is this estimate dependent on the
unemployment level at the time in which the spending occurs?
We used the news about military spending to infer the quantitative
response of employment to exogenous changes in government spending.
Small Employment Effects
We found that, in the short and intermediate run, there are only
small employment effects of government spending in both high- and
low-unemployment times. We quantified the effects of government spending
over a four-year horizon following exogenous news about future U.S.
defense spending.
Following a policy change that begins when the unemployment rate is
high, if government spending increases by 1 percent of GDP, then total
employment increases by between 0 percent and 0.15 percent. Following a
policy change that begins when the unemployment rate is low, the same
government spending increase causes total employment to change by –0.4
percent and 0 percent.
Although the effect is larger during times of high unemployment, even
then, the employment effect of government spending is low.
In the longer run (e.g., seven or eight years), we also found almost
no effect on employment from government spending. The estimated effects
are not statistically different from zero. The main difference is that
in the long run we cannot reject the possibility that the effect of
public spending on employment is the same during times of high and low
unemployment. This is due to the fact that we lose precision in the
estimation at longer horizons.
Conclusion
The question of the efficacy of countercyclical fiscal policy during
downturns is far from settled. It is important that macroeconomists
continue to study the issue. As horse racing fans say, there is a lot of
money riding on it. For example, the total budget impact of the most
recent U.S. stimulus ($840 billion for the American Recovery and
Reinvestment Act of 2009) was larger than U.S. defense spending in Iraq
since 9/11.,
Endnotes
- Our paper largely follows the approach of a 2013 study by Michael Owyang, Valerie Ramey and Sarah Zubairy. [back to text]
- In answering these questions, we used two econometric adjustment
procedures. First, we estimated the dynamic effects using the local
projections method to allow the effect of spending to vary depending
upon whether the unemployment rate is high or low. Second, we used
instrumental variables with defense news shocks to correct for the
possibility that government spending is endogenous to local
business-cycle conditions. [back to text]
- These ranges are based on 90 percent confidence intervals. [back to text]
- According to a 2014 study by Amy Belasco, between the 9/11
attacks and the end of 2014, congressional appropriations for military
operations in Iraq totaled $815 billion. [back to text]
- Our findings suggest that the drop in unemployment since 2009
was probably not a result of the Recovery Act's spending component.
Understanding the reasons for the decline in unemployment is a topic
that warrants further exploration. [back to text]
References
Belasco, Amy. "The Cost of Iraq, Afghanistan, and Other Global War on
Terror Operations since 9/11." Congressional Research Service, Dec. 8,
2014.
Dupor, William; and Guerrero, Rodrigo. "Robust Inference about Fiscal Multipliers." Unfinished manuscript.
Fox, Justin. "The Comeback Keynes." Time, Vol. 172, No. 18, Nov. 3, 2008, p. 60.
Owyang, Michael; Ramey, Valerie; and Zubairy, Sarah. "Are Government
Spending Multipliers Greater During Periods of Slack? Evidence from 20th
Century Historical Data." American Economic Review, Vol. 103, No. 3,
2013, pp. 129-34.
Ramey, Valerie. "Identifying Government Spending Shocks: It's All in
the Timing." Quarterly Journal of Economics, Vol. 126, No. 1, 2011, pp.
1-50."
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