Treasury’s non-modelling of the stimulus
Late last year I published an article with Agenda (the public policy journal of ANU) that critiqued the Treasury “modelling” (sic) of the Rudd government stimulus that followed the global financial crisis. It is an article that I started writing a long time ago, but sat in the “to do” pile for too long.
My main point was that the Treasury approach was hopelessly inadequate, a point that is abundantly clear to any economist who glances at their attempt, and has been readily admitted by some Treasury friends. As I wrote in the article:
“The biggest problem with the Treasury model is that because it misunderstands the issue of international crowding out, it drastically underestimates the impact on net exports. In addition, it entirely ignores the issues of domestic crowding out, monetary policy responses, and the costs of repaying the debt. While its estimate for the private savings response to the stimulus is at the low end of the range, this is the least of the problems.
“The ignorance of open-economy macroeconomics suggests that Treasury has neglected much of the advances made in macroeconomics over recent decades, and its strange assumptions on domestic crowding out and private savings response show that it has forgotten much of its own research. As Harvard economics professor Robert Barro said in 2009 when the US was debating its own stimulus policies, ‘The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936’ (Barro 2009).”
Of course, the media will continue to repeat the embarrassing Treasury results. One reason is that they simply don’t understand anything about the topic so they have no choice but to do what they are told by the government. But another reason is that there are few alternatives out there… so at the end of my article I provided an alternative set of numbers with the Treasury mistakes fixed:
“…the model suggests that the stimulus provided a 0.5 per cent increase in GDP in 2008/09. This benefit was entirely unwound by the end of 2009/10, and then in 2010/11 the stimulus was actually a drag on the economy, leaving GDP about $6 billion lower than the ‘no stimulus’ counter-factual. These outcomes can be compared with the estimates made by Treasury:
Table 2: Comparative estimates of stimulus benefits (annual GDP growth)
Treasury estimate Updated estimate 2008/09 1.0% 0.5% 2009/10 1.6% -0.5% 2010/11 -1.2% -0.4%
“Using the Treasury approach to estimating the employment impact, then the stimulus has resulted in the loss of over 30 000 jobs.”
One common statistic used when looking at fiscal policy is the “multiplier” which considers the link between government spending and GDP. If the multiplier is one, then every dollar of government spending increases GDP by one dollar. If the multiplier is negative, then the stimulus actually hurt the economy. The Treasury non-modelling simply assumed their multiplier and didn’t calculate a long-run multiplier at all. Once you fix their errors the outcome is not friendly to the government:
“Using the ‘central scenario’ above, the early benefit from the stimulus provides a positive multiplier of 0.5, but it then falls away sharply so that the multiplier by the end of 2011/12 is -0.1. Projecting forward, we can estimate a long-term multiplier of -1.5, which is close to the estimate provided by Guest and Makin (2011).
“This is also consistent with McKibbin and Stoeckel (2009), who find that the stimulus provides an immediate boost, but then becomes a net drag on the economy with a negative multiplier. In addition, these results are consistent with Barro’s estimate of a near-zero multiplier (Barro 2009), the US Congressional Budget Office estimates of a negative long-run multiplier (Elmendorf 2009), and Ergas and Robson’s finding that the Australian stimulus fails a cost–benefit analysis (Ergas and Robson 2009). It is also consistent with the anecdotal evidence from around the world that has shown no relationship between the size of the fiscal stimulus and economic growth (Ricardian Ambivalence 2012).”
And my conclusion:
“…by fixing some of the most egregious errors of the Treasury attempt, it can at least give a more accurate story about the stimulus. That story seems to be that there was some short-term benefit that was quickly unwound, leaving the Australian economy poorer for the experience.”