A recently released report by Christina Romer, chair of the
President's Council of Economic Advisers, and Jared Bernstein, the
Vice President's chief economist, is being widely cited by
Administration officials (including the President) and Members of
Congress as proof that the stimulus package currently being debated
in Congress--especially the spending portion--will actually
stimulate the economy.
The Romer-Bernstein report finds that the stimulus plan will
create about 3.7 million jobs and reduce the unemployment rate by
about two percentage points from where it would have been without
the stimulus by the fourth quarter of 2010. The report is
supposed to lend academic creditability to a plan based on
political considerations, but the estimates created are founded on
loose assumptions that lack academic rigor. The report should not
be relied upon as an accurate measure of the impact of the Obama
fiscal stimulus plan because it relies on rules of thumb and other
back-of-the envelope calculations rather than sound economic
Romer and Bernstein estimate how much government spending and
tax cuts will increase production, or gross domestic product (GDP).
To do so, they use what economists refer to as a multiplier. The
multiplier is the amount that a change in government spending or
tax cuts will increase GDP. For instance, a multiplier of one means
that a $1 increase in government spending results in a $1 increase
in GDP. A multiplier greater than one means that a spending
increase or tax cut has secondary effects that further boost GDP.
The secondary effects occur as the original money makes its way
though the economy and businesses hire more employees or increase
their pay, buy new inventory, or invest to expand operations.
The Romer and Bernstein multipliers for government spending and
tax cuts were estimated by the Federal Reserve's FRB/US model and a
leading private forecasting firm. They settle on a multiplier
of approximately 1.5 for government spending and about 0.99 for tax
cuts. This would suggest that for every dollar
the government spends, GDP increases $1.50, while every dollar in
lower government taxes increases GDP by just under a dollar. Romer
and Bernstein, however, are uncertain of the multipliers and note
as much in the report: "We confess to considerable uncertainty
about our choice of multipliers for this element of the package."
Romer and Bernstein are right to be uncertain of the multiplier
they use, especially the spending multiplier. Economists generally
estimate the size of the spending multiplier in their analyses by
looking at historically similar experiences. Romer and
Bernstein, however, rely on a model based on historical data that
is not comparable to current economic conditions, because an
increase in government spending as large as this one has never been
tried as a stimulus before. Rather than take the time to estimate a
more accurate multiplier, Romer and Bernstein use one estimated for
much lower levels of spending and assume it applies to the massive
spending program under analysis.
They then apply the spending multiplier to the proposed total
spending in the stimulus package. They ignore the fact that the
stimulus package contains spending on a variety of
items--everything from money for the National Endowment for the
Arts and new sod for national monuments to infrastructure spending.
Romer and Bernstein, therefore, assume that all spending affects
the economy equally.
A better back-of-the-envelope calculation would at least
consider estimated multipliers from a range of different models and
assumptions. Many economists have used a variety of methods and
assumptions to estimate the size of multipliers for government
spending and found them to be lower than those used by Romer and
Rule of Thumb
To estimate the number of jobs created by increased government
spending, Romer and Bernstein multiply the amount of government
spending in the stimulus plan by the multiplier discussed above.
The outcome is the increase in GDP resulting from the increased
spending. They then apply a "rule of thumb" that a 1 percent
increase in GDP results in the creation of 1 million jobs. They
do not justify this rule by citing any empirical or theoretical
The "rule of thumb" is misused because it assumes that increases
in GDP create jobs. In fact, the relationship is actually the other
way around. Production and work create GDP, so it is more accurate
to say that 1 million more jobs produce 1 percent more GDP.
Romer and Bernstein's analysis is based on loose assumptions
about the multiplier effects and inexact rules of thumb about job
creation. It is no wonder they are uncertain of the results of
It should be understood that all of the estimates presented in
this memo are subject to significant margins of error.... Our
estimates of economic relationships and rules of thumb are derived
from historical experience and so will not apply exactly in any
given episode. Furthermore, the uncertainty is surely higher than
normal now because the current recession is unusual both in its
fundamental causes and its severity.
Romer and Bernstein are admitting that their methods are likely
to lead to inaccurate results. The informal manner in which the
analysis was conducted should give pause to anyone using the
results of the report to support passage of the stimulus plan.
Not to Be Trusted
The Obama Administration and Members of Congress are relying on
a flawed report as evidence of the effectiveness of the stimulus
plan. The report should not be trusted. It is based on faulty
assumptions that even the authors admit create significant margins
of error. More rigorous research has shown that tax rate cuts will
create millions of jobs and cost less than the Obama plan.
Taxpayers deserve better information before their money is spent on
things that will not offer the return they were promised.
Curtis S. Dubay is a Senior Analyst
in Tax Policy in the Thomas A. Roe Institute for Economic Policy
Studies, Karen A. Campbell, Ph.D., is Policy Analyst in
Macroeconomics, and Paul L. Winfree is a Policy Analyst in the
Center for Data Analysis at The Heritage Foundation.