Holtz-Eakin Joins the Recovery Act Champions

Conservative Economist’s Own Methodology Demonstrates the Success of Stimulus

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Add conservative economist Douglas Holtz-Eakin to the ranks of experts whose work shows that the American Recovery and Reinvestment Act of 2009 operated exactly as intended, growing the economy and creating millions of jobs. It may seem surprising that Holtz-Eakin, the former Congressional Budget Office director, former chief economic advisor to Sen. John McCain’s 2008 presidential campaign, and current president of the conservative American Action Forum, would throw his support behind the stimulus bill. But that’s what he’s done—whether he likes it or not.

Why? Because the very methodology he repeatedly used to discredit the stimulus actually shows it was a remarkable success.

You see, for much of last summer, Holtz-Eakin had a favorite graph that he used whenever he got the chance. The graph purported to show that the American Recovery and Reinvestment Act was utterly ineffective at spurring economic growth. He loved this graph so much that he used it in no less than three different columns during the course of just two months, and even included it as part of his testimony before the Senate Finance Committee. (see chart)

Chart 1

Here’s what Dr. Holtz-Eakin believed this graph showed:

The chart … shows actual GDP during 2009. It also shows what would have happened if the trajectory at the start of 2009 had continued the entire year (labeled “Continued Decline”)—that is, the graphical version of “the economy was falling off a cliff.” The shaded area is the difference—the additional GDP from not continuing to decline—and totals $268 billion.

Stimulus tax cuts and spending in 2009 were roughly $260 billion. Thus, if one attributes all improvement in GDP to the stimulus—no role for the Fed, no role for mortgage relief programs, no role for worldwide economic improvement—then stimulus essentially broke even and provided no multiplier effects.

In other words, Holtz-Eakin argued that the dollar value difference between what would have happened to U.S. gross domestic product without the stimulus spending and what did happen was almost exactly equal to the cost of the stimulus itself—meaning the stimulus did not stimulate.

Of course, if an economy is really falling off a cliff, as it was in late 2008, one could be forgiven for pursuing policies that avoid such a disaster, even if they don’t produce any larger ripple effects. But guess what? Even Holtz-Eakin, using this same methodology, would be forced to admit that the Recovery Act did have larger ripple effects.

In July the Bureau of Economic Analysis updated its estimates of gross domestic product, the largest measure of our economy’s output, which showed that the Great Recession was much deeper even than we thought it was just a few months ago. What happens when we use Holtz-Eakin’s method for evaluating the Recovery Act but employ the latest data? It turns out that, according to Holtz-Eakin, the stimulus was a smashing success.

Chart 2

Using the most updated data, we can see that in 2009 there is actually about a $544 billion difference between what GDP would have been had it continued to contract as rapidly as it did during the fourth quarter of 2008 and what it actually was. As Holtz-Eakin points out, the total amount of fiscal stimulus during that year was $260 billion. This suggests the Recovery Act produced about $2.10 in economy activity for every $1.00 in spending or tax cuts. That’s a pretty good multiplier.

And if we apply the same methodology to the entire lifespan of the Recovery Act, not just to 2009, the multiplier becomes even more impressive. The total cost of the stimulus bill was about $800 billion, delivered over the course of two years. The difference between actual GDP through the first quarter of 2011 and what GDP would have been had it continued “falling off a cliff” is around $3.3 trillion—implying a multiplier of more than 4.

Of course, this whole analysis depends on the assumption that without the stimulus, the economy would have continued to decline at the same rate. We don’t know that for a fact, and that has always been the obvious weakness in Holtz-Eakin’s approach. It’s possible that the economic collapse could have slowed down all on its own. But it is also possible that the decline could have accelerated rapidly into a second Great Depression.

Indeed, the pace of decline was actually quickening before the Recovery Act was enacted. In the second quarter of 2008, the economy grew by an annualized rate of just 1.3 percent. In the following quarter it contracted by 3.7 percent, and then by a whopping 8.9 percent in the last quarter of 2008 as President George W. Bush prepared to hand over the White House reins to President Obama.

If instead of assuming the economy would have contracted in each successive quarter at the same rate as it had in the fourth quarter of 2008, we assume that it continued dropping but at an increasing rate, as it had been during the last three quarters of 2008, then the success of the stimulus is even more pronounced, with a multiplier surpassing 5.

The Recovery Act wasn’t the only government policy aimed at turning the economy around. The Federal Reserve played an important role, as did the Troubled Asset Relief Program and the rescue of the U.S. automobile industry. Nevertheless, independent analysts including the Congressional Budget Office, Moodys.com chief economist Mark Zandi, and Princeton economist Alan Blinder all find that the Recovery Act was successful at simulating growth and creating jobs. Now we can add Douglas Holtz-Eakin to that list, since his own method shows exactly the opposite of what he thought it did.

Far from proving the Recovery Act was inefficient and ineffective, it shows the progressive legislation did exactly what it was intended to do—spur additional economic activity and turn the economy around fairly, effectively, and efficiently for millions of American workers and their families.

Michael Linden is the Director for Tax and Budget Policy at American Progress.