Stopping a Depression: Appendix
Consider this post an appendix for a forthcoming piece in Bloomberg. I share here additional graphs and notes about how the economy would have done in the absence of the increase in federal expenditure from January 2007 through January 2010. As I normally do, I will post the Excel version of my calculations under the "Data" tab.
Graph 1: Year-over-year growth in real GDP. Blue line is actual, red line is counterfactual in which federal spending is set to have no net impact on real GDP from 2007 to 2013, assuming fiscal multiplier of 1.
Graph 2: Level of real GDP, same actual and counterfactual.
Graph 3: Implied employment impact of the increase in federal spending, assuming fiscal multiplier of 1 and Okun's law parameter of 0.42. (That is, a 1 percent change in real GDP corresponds to a 0.42 percent change in the unemployment rate.)
Graph 4: Implied unemployment rate in the absence of that spending, same assumptions to construct counterfactual.
- I estimate the employment effects based on year-over-year change in GDP. This seemed to me far more consistent with the empirical behavior of the labor market than quarter-over-quarter change. It does not bias the results, anyway.
- The 0.42 estimate came straight from the data of year-over-year change in GDP and quarterly change in the unemployment rate, using a dataset from 1948 to 2013. It's still an open question for macroeconomic research whether this parameter has changed since 1948. Ball et al. find that it hasn't. Gordon finds that it has risen. In any case, this is a reasonable estimate.
- These are only estimates for the impact of increased federal expenditure. Tax receipts also fell significantly, both as a result of automatic stabilizers and discretionary fiscal policy. That means that these are all well below the true assessment of the aggregate impact of fiscal policy.
- My sense, from doing this number-crunching, is that fiscal and monetary policy actually did stop what would have been a second Great Depression. As in, an unemployment rate in the high teens, a drop of real GDP in the range of 15-20 percent from peak. The drop in private demand was that severe. Even when one makes reasonably conservative estimates, as I have throughout these calculations, it's hard to avoid the conclusion that fiscal stabilization, complemented by monetary accommodation, saved the United States from something truly and utterly disastrous.