February 4, 2011

Stimulus Jump Started Economy

While the Republican party has tried, with some success, to define government spending as useless for economic growth (a new article of faith), economic analysis suggests a very different reality.

The economy has shown real strength in the last few months, with GDP of the U.S. fully recovered back to its previous high of 2007.

Normally, an economy after a major asset (housing) bubble and crash would still be significantly depressed at this point in time. In the Great Depression, both the stock market and housing crashed after a debt bubble, and the unwinding of the economy continued almost 4 years. With Roosevelt's recovery programs it took around 3 more years for national output to recover to 1929 levels, about 7 years in all.

This time the U.S. economy has recovered its previous, 2007-level output (GDP) much faster, returning to peak in around 3 years. In a manner somewhat similar to the Great Depression though, employment has lagged GDP and productivity has soared.

This unusually rapid GDP recovery happened while the stimulus money was spent.

Here's a graph of actual stimulus spending to date (2009 American Recovery and Reinvestment Act -- ARRA):

As you can see, stimulus spending continues at a significant though somewhat reduced rate. But while the rate of spending has decreased in the last few months, the economy has continued to pick up strength -- the recovery has become self-sustaining (for now).

Since the economy has continued to move upward, as shown by the latest improvement in economic indicators, such as the ISM index, we must conclude that the ARRA (the stimulus) led to the unusual economic recovery so soon after the bubble, and effectively created some self-sustaining growth.

In the Great Depression, the American economy did not recover so rapidly, but instead continued to sink for years longer.

It is interesting, and I will be thinking more on this, that in the Great Depression, U.S. GDP had recovered (to 1929 levels) by 1936-37, but unemployment at that time was still much higher than it had been before the Depression started -- roughly 15% vs 5% from before the Depression.

Once again, we have a great lag in employment recovery vs GDP recovery, just as in the Great Depression.

Thankfully though, even our broadest measures of unemployment combined with underemployment and discouraged workers are much better than in the Great Depression, by 8 to 10 or so percentage points, depending on what is counted.

We stopped the slide much sooner, and current employment is many millions higher than it would have been with no stimulus.

Whether this significant, early recovery from such a severe economic injury will sustain its strength remains to be seen, but it is plausible we have avoided a second Great Depression.

If the states and the federal government chart a middle way through deficit reduction -- such as by combining some judicious spending cuts (consider out-of-control U.S. defense procurement spending on new weapons) with some increased taxes on the wealthy, but still allowing for moderate deficits until the economy more fully recovers -- we will continue to mend slowly and time will eventually return our economy to better health.

In 1937, seeing the economic recovery and large Federal deficits, Roosevelt and Congress cut back on federal spending. The result of their austerity was a sharp new recession which drove unemployment up an additional 4 and 1/2 percentage points. The recovery by 1937 was not yet sufficiently self-sustaining to tolerate sharp government cutbacks.

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