The Economic Stimulus Act of 2008 and the American Economic Recovery and Reinvestment Act of 2009 where the latest big experiments the U.S. has undertaken with large-scale fiscal stimulus. Recall that the purpose of fiscal stimulus is to increase either AD or AS with some combination of government spending or tax cuts. John Taylor is a prominent critic of this type of stimulus. The reading below is not an article, but Congressional testimony Taylor gave to the Committee on Oversight and Government Reform. In it, he provides some arguments for why the ARRA was not effective in stimulating growth or reducing unemployment following the Great Recession. Read pages 1-6 then answer the following questions:

john taylor 2009-Stimulus-two-years-later.pdf (pages 1-6 posted below)

1. The ARRA of 2009 and the ESA of 2008 are described as "Keynesian" fiscal stimulus bills. Why?

2. What were the spending components of the ARRA, as described by Taylor? What percentage of the total spending in the ARRA went to each component? Is this information surprising to you in light of what you know about how the spending multiplier works?

3. This question is closely related to #2. Why where federal income transfers to the states ineffective as stimulus efforts?

The 2009 Stimulus Package: Two Years Later

John B. Taylor*

Testimony Before the

Committee on Oversight and Government Reform

Subcommittee on Regulatory Affairs, Stimulus Oversight and Government Spending

U.S. House of Representatives

February 16, 2011

Chairman Jordon, Ranking Member Kucinich, and other members of the Committee,

thank you for the opportunity to testify on the impact of the American Recovery and

Reinvestment Act (ARRA) of 2009, enacted two years ago this week.

My empirical research during the past two years shows that ARRA did not have a

significant impact in stimulating the economy.1 I do not think this finding should come as a

surprise. Earlier research on the discretionary countercyclical Economic Stimulus Act of 2008?

enacted three years ago this week?indicates that it too did little to stimulate the economy.2

Research on the discretionary countercyclical actions in the late 1960s and 1970s?the most

recent period of such large interventions prior to this past decade?also shows disappointing

results, including high unemployment, high inflation, high interest rates, and frequent recessions;

the poor results of the 1970s policies led top macroeconomists to write influential papers, such as

"After Keynesian Macroeconomics," which questioned the whole approach and to decry "that

countercyclical discretionary fiscal policy is neither desirable nor politically feasible." 3

My purpose here today is not to explain this recent revival of a failed approach to policy,

but rather to summarize the facts which once again raise doubts about its effectiveness. I take a

macroeconomic perspective, looking at the impact of ARRA on the major components of GDP,

such as government purchases and consumption expenditures. Changes in GDP are of course

directly related to employment growth, with faster growth of GDP creating more jobs. I make

use of a new data set developed by the Bureau of Economic Analysis (BEA) at the Department

of Commerce which traces the impact of ARRA on the economy through the National Income

and Product Accounts, the major source of data for macroeconomic analysis. I present and

analyze the data through a series of simple graphs, but the findings can be verified and supported

through statistical analysis.

* Mary and Robert Raymond Professor of Economics at Stanford University and George P. Shultz Senior

Fellow in Economics at Stanford University's Hoover Institution

1 Much of this research has been conducted jointly; see for example Cogan, Cwik, Taylor and Wieland

(2010), Cogan and Taylor (2010), Taylor (2010), and Taylor (2011)

2 Taylor (2009)

3 Examples of papers on temporary tax cuts and countercyclical grants to states are Blinder (1981) and

Gramlich (1979), respectively; the paper about after Keynesian macroeconomics is by Lucas and Sargent

(1978) and the quote is from Eichenbaum (1997)

2

The Major Macroeconomic Components of ARRA

The bar chart below summarizes the impact of ARRA on federal government sector

transactions during the two years or eight quarters since enactment.4 Three components of

ARRA are highlighted:

(1) Federal government purchases of goods and services (both government

consumption and government investment),

(2) Federal grants to states and local governments, and

(3) Temporary transfers and credits which increase the disposable personal

income of individuals and families.

For the purposes of assessing the impact of ARRA on the economy it is very important to

distinguish between these three categories and consider each in turn. 5

4 The data are from the BEA table "The Effect of the ARRA on Selected Federal Government Sector

Transactions" posted on the BEA webpage.

5 A small part of ARRA?not shown in the bar chart?was classified as going to the business sector in the

form of subsidies and tax benefits, for example for renewable energy or first time home buyers credits,

which I do not consider in this testimony. It should also be emphasized that ARRA is one of many other

fiscal interventions during the past two years, including the cash-for-clunkers program and an unusually

large increase in appropriated funds not officially counted as part of ARRA. See Anderson (2011) for

details.

Part B.

a) The Phillips curve is II: = it? + (m + z) amt -- Rewrite this relation as a relation between the deviation of the unemployment rate from the natural rate, ination, and expected ination. Now, suppose that the Phillips curve is given by: it, it? = 0.1 Zut, where Hf = nt_1 Assume ination in year t-l is zero. In year t, the central bank decides to keep the unemployed rate at 4% forever b) compute the rate of ination for years t, t+1, t+2, t+3 (please arrange in a table) 0) If half the workers have indexed their labor contracts, what is the new question for the Phillips curve? d) Based on your result in part (c), please compute new rates for years t, t+1, t+2, t+3 (please arrange in a table) e) How can you explain the effect of wage indexation on the relation between 11' and u? Question 2: Suppose that a monopolist can produce any level of output it wishes at a constant marginal (and average} cost of $5 per unit. Assume that the monopoly sells its goods in two different markets that are separated by some distance. The demand curve in the rst market is given by Q1 = 60 P1, and the demand curve in the second {casket is given by, Q2= 100 2P2, {a} (b)- {c} {d} If the monopolist can maintain the separation between the two markets, what level of output should he produced in each market, and what price will be charged in each market? What are total prots in this situation? How would your answer change with respect to the output sold in each market, price charged, and total prots, if transportation costs were zero and the rm was forced to follow a single-price policy? Suppose the rm adopted a w pricing policy where each market as a whole must pay an equal entiy fee for the right to boy from the monopolist (equal to the smallest consmuer surplus in the two markets). In addition the customers in each market must pay a price per unit sold equal to marginal cost. In this case what would be the entry fee, how much would he sold in the two markets, and what are total prots of the monopolist? Suppose the rm adopted a M pricing policy where each market as a whole must pay an equal entry fee for the right to buy from the monopolist (equal to the smallest consumer surplus in the two markets). In addition the customers in each market must pay a price per unit sold and the monopolist designs an \"optimal\" two part tari' where the price is set as to maximize its prots. In this case what would he the entiy fee, what would be the \"optima \" price charged, and how much would be sold in the two markets, and what are total prots of the monopolist