Why did the American Recovery and Reinvestment Act (ARRA) fail--or did it?

• Author: Reid, L. Jan

1. INTRODUCTION

   The American Recovery and Reinvestment Act of 2009, abbreviated ARRA (Pub.L. 111-5) and commonly referred to as "the Stimulus" or "The Recovery Act," is an economic-stimulus package enacted by the 111th United States Congress in February 2009 and signed into law on February 17, 2009, by President Barack Obama.

   In response to the late-2000s recession, the primary objectives for ARRA were to save existing jobs and to create new jobs almost immediately. Secondary objectives were to provide temporary relief programs for those most impacted by the recession; and to invest in infrastructure, education, health, and "green" energy. The approximate cost of the economic stimulus package was estimated to be $787 billion at the time of passage. The Act included direct spending on infrastructure, education, health, and energy; federal tax incentives; and expansion of unemployment benefits and other social-welfare provisions. The Act also included many items not directly related to immediate economic recovery, such as long-term spending projects (e.g., a study of the effectiveness of medical treatments); and other items specifically included by Congress (e.g., a limitation on executive compensation in federally aided banks, added by Senator Chris Dodd and Representative Barney Frank). The rationale for ARRA was derived from Keynesian macroeconomic theory, which argues that during recessions, government should offset the decrease in private spending with an increase in public spending in order to save jobs and to stop further economic deterioration. In a report prepared for President Obama's administration, Christina Romer and Jared Bernstein made a number of predictions about the effect of ARRA on the United States' economy. (Romer and Bernstein, 2009) At the time, Romer was President Obama's nominee for the Council of Economic Advisors, and Bernstein worked for Vice President-elect Joe Biden. An analysis of these predictions forms the basis of my paper. My analysis of the Romer and Bernstein predictions indicates that ARRA failed to meet many (if not all) of its initial goals. I discuss the Romer and Bernstein ARRA goals in Section 3 below.

2. LITERATURE REVIEW

   Economic criticism of the stimulus package included the following objections:

   * The stimulus was too small to be effective. (Krugman, 2009)

   * The stimulus should be limited to a monetary stimulus, not a fiscal stimulus. In essence, this means that the stimulus should be restricted to actions by the Federal Reserve Board (FRB). (Lucas, 2008)

   * ARRA failed to address the shortage of qualified workers in the labor force, particularly in manufacturing. (Silvia and Brown, 2012)

   * The Federal Reserve Board should target a path for nominal Gross Domestic Product (GDP). (Romer, 2012)

   * While state and local governments received substantial grants under ARRA, they did not use these grants to increase their purchases of goods and services as many had predicted. Instead, they reduced borrowing and increased transfer payments. (Cogan and Taylor, 2011)

   * The stimulus failed because of the effect of policy uncertainty. (Baker, Bloom, and Davis; 2011)

   I discuss each of these criticisms in Section 5 below.

3. ARRA Goals

   As mentioned previously, Romer and Bernstein made a number of predictions concerning the effect of the ARRA stimulus. Only GDP growth was accurately predicted by Romer and Bernstein. In Table 1, | summarize these predictions and compare them to actual economic results. | discuss some of these predictions below.

   3.1 REAL GDP

   As mentioned previously, ARRA was successful in significantly increasing Real GDP (RGDP) over the period 2009-2010. In Figure 1, I give the annual change in RGDP for each quarter from 2007-2011.

   3.2 PRIVATE-SECTOR JOBS

   Although jobs were created predominantly in the private sector, annual increases in overall employment did not begin until 2011. During the year 2011, total employment rose from 139.22 million to 140.79 million, a gain of 1.57 million jobs. (FRED, Series CE160V) During the same period, non-agricultural federal government employment decreased from 20.745 million to 20.652 million, a decline of 93,000 jobs. (FRED, Series LNU02032188) Thus, private-sector employment rose by 1.66 million jobs, while federal government employment fell by 93,000 jobs.

   I note that Timothy Conley and Bill Dupor have estimated that ARRA created or saved 450 thousand government-sector jobs (all levels of government), and destroyed or forestalled the creation of one million private-sector jobs. (Conley and Dupor, 2011, p. 1) However, an analysis of the Conley and Dupor estimates is beyond the scope of this paper.

   3.3 CIVILIAN UNEMPLOYMENT

   The civilian unemployment rate rose from 7.3% in 2008 to a high of 10.0% in October, 2009. By the end of 2010, the unemployment rate had fallen to 9.4%. Since that time, the unemployment rate has fallen to 8.3% in January, 2012. This compares favorably to the 1981-1983 recession during U.S. President Ronald Reagan's first term in office. During that period, the unemployment rate rose from 7.2% in April 1981 to 10.8% in December 1982. The Reagan recession was characterized by ten consecutive months of double-digit unemployment, from September 1982 to June 1983. (FRED, Series UNRATE)

   3.4 STATE FISCAL RELIEF

   As mentioned previously, state tax receipts decreased from $784.709 billion in 2008 to $704.555 billion in 2010, a decrease of $80.154 billion. By the end of 2010, federal government seasonally adjusted consumption expenditures and gross investment (in 2005 dollars) increased from $2,509.588 billion to $2,552.14 billion, a difference of $42.552 billion; and state tax receipts decreased from $784.709 billion in 2008 to $704.555 billion in 2010, a decrease of $80.154 billion. Thus, the increase in federal government consumption, the decrease in state tax receipts, and the multiplier between fiscal relief and state government consumption and fiscal relief and state government tax increases seems to be consistent with the goals established by Romer and Bernstein.

   Romer and Bernstein predicted a multiplier of 0.60 between state fiscal relief and state-government consumption, compared to the actual linear multiplier of 0.79. Romer and Bernstein also predicted a multiplier of 0.30 between state fiscal relief and state government tax reductions, compared to the actual linear multiplier of 1.50. However, most of the reduction in state government tax receipts was because RGDP declined and unemployment rose for much of the two-year period.

   Cogan and Taylor have argued that "While state and local governments received substantial grants under ARRA, they did not use these grants to increase their purchases of goods and services as many had predicted. Instead they reduced borrowing and increased transfer payments." (Cogan and Taylor, p. 1) Cogan and Taylor estimate that the multiplier between ARRA grants and state-government purchases was 0.0967, and that the multiplier between ARRA grants and total receipts minus ARRA grants was only 0.113.

   Christine Romer effectively rebutted Cogan and Taylor by arguing that: (Romer 2011, p. 37)

   Cogan and Taylor's analysis shows the importance of specifying the counterfactual. Most states have balanced budget requirements. The requirements leave some room for deficit financing of current spending for a year or two, by running down rainy-day funds or the use of various accounting devices, especially if the deficit is the result of a downturn that was not expected when the budget was passed. But states didn't have the option of continuing the pace of borrowing they had done in the 2008 and 2009 fiscal years. Absent the Recovery Act, states would have been forced to contract spending greatly. Therefore, relative to the plausible baseline, state spending was substantially higher following the receipt of the Recovery Act funds. 3.5...