In “What you teach is what you think”, I berated Mishkin for calling the monetary policy action ‘bold’ at the end of 2008. In another “Policy and Practice” box in his Macroeconomics – Policy and Practice textbook (page 235), he deals with the fiscal stimulus package of 2009. Here´s how he tells the story:
In the fall of 2008, the US economy was in crisis. By the time the new Obama administration had taken office, the unemployment rate had risen from 4.7% just before the recession began in December 2007 to 7.6% in January 2009. To stimulate the economy, the Obama administration proposed a fiscal stimulus package that, when passed by Congress, included $288 billion in tax cuts for households and businesses and $499 biliion in increased federal spending, including transfer payments. As this analysis indicates, these tax cuts and spending increases were intended to increase planned expenditure, thereby raising the equilibrium output at any given interest rate [“zero” at the time] and so shifting the IS curve [or the aggregate demand curve] to the right.
Unfortunately, things didn´t work out as the Obama administration planned. Most of the government purchases did not kick in until after 2010, while the decline in autonomous consumption and investment were much larger than anticipated. The fiscal stimulus was more than offset by weak consumption and investment with the result that the planned expenditure ended up contracting rather than rising, and the IS curve did not shift to the right, as hoped. Despite the good intentions of the fiscal stimulus package, the unemployment rate ended up rising to over 10% in 2009. Without the fiscal stimulus, however, the IS curve would likely have shifted further to the left, resulting in even more unemployment.
It is from this sort of analysis that someone like Krugman confidently says that it wasn´t the case that fiscal stimulus didn´t work, it´s just that it wasn´t “big enough”. To students, Mishkin´s story leaves the impression that the contraction in consumption and investment spending was “just one of those things”.
He misses a great opportunity to hammer on students the power of monetary policy. He could say: “Things didn´t work out as planned because monetary policy was contracting, more than offsetting the rise in government spending”. In fact, he could have said, if monetary policy had been doing it´s ‘stabilizing job’, fiscal stimulus wouldn´t even have been needed. For all sorts of very plausible reasons, money demand was rising (velocity falling), but money supply growth was also falling. The combination of falling money and velocity can only result in one thing: a drop in aggregate spending (NGDP), in which case consumption and investment will fall, making fiscal stimulus go against very strong ‘headwinds’! In that case, there´s nowhere for unemployment to go but up!
The charts illustrate.
I believe a former central banker could have done much better. Maybe that´s too much to expect, given he would have to be pretty ‘courageous’ to say “we did it”.
It´s better to imply it was “just one of those things” or, as in the intro to chapter 12 (The Aggregate Demand and Supply model), say that “in 2007 and 2008, the US economy encountered a perfect storm.”