The new director of the Congressional Budget Office, Douglas Elmendorf, may have been appointed by Congressional Democratic leaders, but his latest "Director's Blog" posting is unlikely to make Democrats pushing for stimulus bill passage very happy.
The CBO crunched the numbers on the initial Senate version of the stimulus bill and concluded that although there would be short term bursts in output and job creation, the benefits would fade relatively quickly. Worst of all, "CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net."
The reason for the longterm negative effect, says the CBO, jibes with a common conservative economist critique of debt-funded government spending: such fiscal policy supposedly "crowds out" private sector investment by soaking up all the available dollars.
In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to "crowd out" private investment -- thus reducing the stock of private capital and the long-term potential output of the economy.
So far, the CBO bombshell hasn't excited much commentary in the econoblogosphere, which is somewhat surprising, since this is precisely the kind of thing that gets economists all hot and bothered and shouting about multiplier effects. But we'll keep tracking that. In the meantime, here are a couple of things to think about while Republican senators no doubt go on the warpath.
First, a 0.1-0.3 percent net decline in GDP ten years from now is a pretty wild shot in the dark. Economists don't have that great a track record at predicting GDP numbers for the next quarter, much less that far out. More to the point, it's a minuscule amount. Just in the last fiscal quarter of 2008, a buildup in unsold inventory was responsible for a larger percentage of GDP growth.
Second, there is a clear short term burst in output and job creation -- the CBO's most optimistic forecast suggests the potential of 3.6 percent GDP growth and 3.9 million new jobs by the fourth quarter of 2010. If the primary goal is to reduce the pain caused by a contracting economy right now with only a very minor decline in output over the long term as a result, then you can make the case that it's a good deal.
Finally, a dose of pathetic irony. There is a way, says the CBO, to minimize the negative "crowding out" effect.
The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provisions -- such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislationâ€™s budgetary cost.
Of course, education funding is one of the elements of the bill that appeared to be getting the heave-ho on Thursday. So much for long term growth.