Did the Stimulus Do Its Job?

The rationale for the $787 billion stimulus legislation enacted in February 2009 is that government spending is necessary for juicing economic activity that would otherwise lie fallow. The idea comes from The General Theory of Employment, Interest and Money, the 1936 tome by Keynes that put macroeconomics on the map and launched a debate about the role of the state in managing the business cycle.

Economics being economics, definitive answers are forever lacking. We have only one run of history to analyze and so it's never clear what might have transpired if we tried x vs. y. Such is life in the dismal science, leaving mere mortals to argue over the scraps of evidence dispensed in the numbers. With that in mind, we offer the following statistical crumbs, fully aware that there are a billion or so other perspectives one might conjure from the sea of data.

Let's recognize that any stimulus plan worthy of the name should focus on raising consumption, which arguably leads to an expansion in the labor market. But first things first. For our purposes here, let's define consumption by three metrics:

1)personal consumption expenditures, a broad measure of consumer spending
2)retail sales, a somewhat more granular gauge of Joe Sixpack's spending habits
3)new orders for durable goods, which measures the business sector's consumption appetite.

Collectively, this trio represents a broad measure of the spending trend in the U.S. The following chart indexes these three metrics to 100 for November 2007, a month before the Great Recession began, according to NBER. It's clear from our chart below that the contraction in spending in the consumer and business sectors ended in January 2009. (Well, almost. Durable goods slipped again in March 2009, although the general trend for all three has otherwise been rising since the start of 2009.) We can debate if the consumption rebound has legs, but it's clear that the retreat hit bottom as this year opened. That brings us to the question: Was the bounce that began in January due to the fiscal stimulus? (Click to enlarge)

The answer is an emphatic "no," for reasons that require only a calendar and a news archive. The stimulus package was enacted in February, a month after the consumption rebound began. And as of October 30, only a fraction of the stimulus funds had been spent or "awarded"—roughly 20% of the total, according to Recovery.gov.

One can, of course, argue that the fiscal package has helped strengthen the recovery. But the recovery was arguably underway before the fiscal dollars hit the street.

If any aspect of government intervention deserves praise for ending the Great Recession, monetary policy is the leading candidate. The smoking guns are the explosion in the Federal Reserve's balance sheet and a Fed funds target rate of 0% to 0.25%.

But we should be cautious in congratulating the central bank. For one thing, the Fed's near-zero policy rate didn't arrive until September 2008, when the financial crisis metastasized into a far deeper problem. Some argue that had the Fed acted earlier, the worst of the fallout in late-2008 could have been avoided. Economist Scott Sumner, for instance, argues that the Fed "misdiagnosed" the economic challenge and thereby allowed the crisis to fester and build momentum.

Whether or not you agree with Sumner's thesis, there's still reason to wonder how much of the January 2009 bounce is due to monetary policy. Many economists argue that even under the best of circumstances, the influence of monetary policy has a 12-to-24-month lag. By that standard, an optimistic view of the Fed's influence on the January 2009 bounce means that policy choices in early 2008 are responsible for the revival. Yet that view is suspect, considering that the effective Fed funds rate was 4%-plus when 2008 opened. As late as September 1, 2008, the effective Fed funds was still roughly 2%. The Great Stimulus, in other words, arrived too late to influence the January bounce.

What about all the extracurricular quantitative easing engineered by the Fed? That too is debatable as a cause for the January 2009 revival depicted in our chart above. In the final months of 2008, most if not all of the Fed's monetary stimulus came from traditional policy adjustments, i.e., cutting interest rates, according to James Bullard, president of the St. Louis Fed.

What, then, accounts for the January 2009 bounce back? Perhaps the answer is simply that the natural forces of the business cycle brought on the revival. Have the liquidity injections by the Fed been worthless? No, not at all. Indeed, there are other measures of economic activity beyond the trio noted above. That includes the risk of deflation, which is almost surely lower these days thanks to central bank policy decisions in the fall of 2008. But deciding on how much is too much is certainly a valid topic. Alas, we'll never know for sure. We can't rerun economic history with an alternative policy.

What we do know is the consumption in U.S. stopped contracting in January 2009. A portion of the rebound, perhaps most of it, is due to the natural forces of the business cycle.