Is There a Serious Conservative Argument Against the Stimulus?

I'm happy that Harvard University economist/blogger Greg Mankiw has decided that his blog is an appropriate place to respond to my "blogosphere commentary" (Intellectual Dishonesty (Gasp!) from a Conservative Economist) about his New York Times article today. His response, however leaves me even more doubtful that there is a serious conservative argument to be made against the broad outlines of Barack Obama's stimulus package.

My claim was that Mankiw willfully and intentionally misinterpreted this paper by Christina and David Romer about the macroeconomic effects of tax cuts. Mankiw's claim is that I naively and unintentionally misinterpreted it. Romer and Romer's distinction between between "exogenous" and "endogenous" tax cuts, Mankiw says, is merely an artifact of their research design, rather than a limitation of the potential applications of their findings to the recession.

The endogenous/exogenous distinction certainly is an element of the Romers' research design -- and a clever one at that. But this is not mutually exclusive with it also being a limitation on the applicability of the paper to a recessionary tax cut. In fact, I would argue that it is something approaching an express limitation: when Romer and Romer talk in their paper about countercyclical tax cuts, such as the ones now being contemplated as part of the stimulus package, they are decidedly lukewarm on them: "[P]olicymakers’ efforts to adjust taxes to offset anticipated changes in private economic activity have been largely unsuccessful", they write.

Granted, this type of tax cut is not the principal focus of the paper, so perhaps there is some room for interpretation. When I am writing to a large audience like that of the New York Times, my preference is to cite others' work more conservatively rather than more broadly, but in the digital age such courtesies are frequently ignored.

That notwithstanding, it is not like the paper is some founders' document or Dead Sea Scroll whose every fragment we must struggle to interpret. Christina Romer is a living, breathing economist -- very much so, in fact, since she's taking Mankiw's old job as the head of the President's Council of Economic Advisers. And when Romer had to estimate the multiplier associated with the sort of recessionary tax cut that Mankiw is talking about, as she did just yesterday (!) in the transition team's official position paper on the stimulus, she estimated a multiplier of $0.99 for every dollar of tax cuts rather than $3.00. So Mankiw is either suggesting that he knows Romer's work better than Romer does (even though he conceded in his New York Times editorial that the mechanism behind Romer's finding remains a "puzzle" to him), or he is in effect accusing Romer of being less than true to herself.

But there is another dead giveaway in the Romer paper suggesting that it is explicitly not intended to be applied as a one-size-fits-all fiscal policy solution. Romer and Romer identify not just one type of "exogenous" tax shock, but two. The first type is a spontaneous, 'just because' kind of tax cut "motivated by a desire to raise long-run growth". This is the type that Romer and Romer posit is associated with a large multiplier -- the large multiplier than Mankiw cites in the Times piece. The second type of "exogenous" tax shock is a tax increase motivated by a desire to pay off a budget deficit. Would this type of tax increase also be associated with a substantial reduction in growth? No, according to Romer and Romer. Instead they find that such a tax hike "do[es] not have the large output costs associated with other exogenous tax increases" and may in fact be beneficial to the economy!

So Romer and Romer identify two types of exogenous tax shocks, one associated with a larger-than-conventionally-assumed multiplier, and the other associated with a smaller-than-conventionally-assumed multiplier -- perhaps even one in which the sign is reversed. In considering a third type of tax cut, an "endogenous" tax cut designed to stimulate growth during a recession, what basis does Mankiw to assume that it will behave more like the former than the latter?

He doesn't have any, as far as I can tell. The more conservative reading of the Romer paper is that it is agnostic on a recessionary tax cut. The next-most conservative reading is that it is actively, if cautiously, skeptical about one. Mankiw's reading, on the other hand, does not appear to come from the text of the paper itself, nor from the other works and statements of Romer, some of which in fact contradict Mankiw's reading.

Perhaps, then, the context for Mankiw's interpretation lies outside the paper -- from work that other economists have done? Actually, this is a bit of a problem as well, because the reason the paper is a source of such wonderment is because it contradicts so much "conventional" (a.k.a. Keynesian) economic thinking.

This doesn't necessarily mean that it's wrong -- all great ideas must have their genesis somewhere.

But the analogy is that Mankiw uses in his blog entry, that of the clinical trial, seems to be the right one. This paper is the equivalent of a very early stage clinical trial -- it has not even been thoroughly peer-reviewed, much less its result replicated by other economists. Its mechanisms are conjectural and poorly understood. And frankly, it's a little counterintuitive -- a 300 percent multiplier on a tax cut is a very large multiplier indeed, large enough that it seems as though its impacts would have become manifest sometime and somewhere, by some tax-cutting prince in some supply-side neverland.

To extend the analogy: imagine that the patient -- the economy -- has cancer of the bladder. There is a safe, proven, therapy for cancer of the bladder -- the Government Purchases Therapy. This achieves solid but not spectacular results, preventing a recurrence about 70 percent of the time but sometimes with significant side-effects. And then there is an experimental therapy, the Mankiw Magic Tax Cut Therapy, which promises to restore the patient to full health within six weeks with no risk of a recurrence -- except that it has never been tested on rats, let alone humans, and it's a therapy for liver cancer, rather than bladder cancer. Which course of action are you going to take?

The objection to this, I suppose, is that if the tax cuts are experimental, they are also liable to be fairly benign, and would not contradict the "safe" remedy, which is government purchases. I think this is in fact a relatively thoughtful objection. If we can afford the tax cuts, they probably won't hurt us, and there's always the chance that they could help. What we don't want to do, however, is to take the tax cut therapy but simultaneously cut the government purchases therapy to half of its recommended dosage.