The stimulus is working

Shocker: Fiscal juicing stops economic free fall. Plus: Why more tax cuts would be the wrong medicine

Published July 31, 2009 4:59PM (EDT)

The Economic Policy Institute's (EPI) Josh Bivens declares that the stimulus plan is largely responsible for the significant slowdown in economic contraction measured in the second-quarter GDP numbers released today. (Found via Brad DeLong.) According to Bivens a "consensus" of macroeconomic forecasters gives the American Recovery and Reinvestment Act credit for 3 percentage points of annualized GDP growth in the second quarter, turning the economy's "performance from disastrous to merely bad."

Despite the overall contraction, the fingerprints of the American Recovery and Reinvestment Act could be seen in some aspect of today's report. Federal government spending grew at an 11 percent rate in the quarter, adding roughly 0.8 percent to overall GDP. State and local government spending grew at a 2.4 percent annual rate, the fastest growth since the middle of 2007. It is clear that the large amount of state aid contained in the ARRA made this growth possible.

Furthermore, real (inflation-adjusted) disposable personal income rose by 3.2 percent in the quarter, after rising by only 1 percent in the previous quarter. A large contribution to this increase was made by the Making Work Pay tax credit passed in conjunction with the ARRA, as this was the first full quarter that the credit was in effect. Inflation-adjusted transfer payments (including a one-time payment to Social Security recipients) rose at an annual rate of over 6 percent in the quarter as well.

The most disconcerting news in the new GDP report is that consumer spending declined more than expected in the second quarter, prompting Bloomberg News to declare in a headline that the GDP report indicated that the economy was "faltering" -- exactly the opposite take almost everyone else took from the numbers. But Bivens argues that the reason for the decline in consumer spending can be traced to the continued rise in the personal savings rate -- from 4 percent in the first quarter to 5.2 percent in the second quarter. And that explains why the Republican prescription for economic hard times -- more tax cuts -- is the wrong medicine. Cautious Americans would just continue to save the windfall.

This slippage between personal incomes and consumption spending caused by a rising savings rate makes plain that, instead of focusing on even more tax cuts, it was wise to make sure that much of the ARRA was devoted to direct public investment spending. The public investment spending in the ARRA, while not having a significant impact in the second quarter, will provide an even stronger boost to the economy in quarters to come.

The EPI is usually described as a left-wing, labor-oriented think tank, so it's not a huge surprise to see Bivens crediting Keynesian fiscal spending for boosting the economy, while downplaying the utility of tax cuts.  But if Bivens' overall analysis is correct, it suggests the  third quarter could be a bit more sunny than most economists have been anticipating.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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