Richard Posner picks up on Daniel Indiviglio’s post on stimulus and psychology. The stimulus made people feel better they say.
The [stimulus] program may, however, still have had an important positive effect on business and consumer psychology. Economists both left and right systematically neglect the psychological dimensions of a depression, properly emphasized by Keynes.
An exception, however is Daniel Indiviglio, who is not an academic economist, . . .
Maybe. I am not sure exactly what Posner means by psychology. I have never been optimistic about feelings as an economics model. Perhaps people spend more when they feel better but how do we get a consistent measure of feelings and even more to the point how does policy consistently effect them.
What I do think makes a difference is expectations. And, its pretty clear how the stimulus could have affected expectations. Most families got a slight reduction in taxes. If the administration nailed it just right then most of those families have simply incorporated that increase in disposable income into their expectations. Thus, they have altered their buying behavior in a very mild but lasting way.
More importantly, Wal-Mart knows that these consumers have more money. When it lays out its plans for the coming year its assuming a mild boost in consumer spending. This affects Wal-Marts choices, which it turn affects Wal-Mart’s suppliers choices.
These private expectations should be changing the evolution of the economy.
Vastly more important, however, are public expectations. I watched the brutal process by which the state of North Carolina incorporated the expectations of stimulus spending into its state budget. Expectations mean a lot in state budgeting because by law the state has to expect to break even.
Expectations of future stimulus checks meant less draconian budget cuts, fewer layoffs and milder tax increases.
That is, sans-stimulus things on the state government front were about to get much, much, much worse. Now they are only getting much worse. State budget implosions were the dog that didn’t bark as a result of stimulus. Virtually all states were headed for cataclysmic shortfalls that would have resulting in skyrocketing layoffs and much higher taxes.
If Barro or anyone else believes that tax hikes would have worsened this recession then they must believe that the stimulus lessened it.
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Monday ~ October 5th, 2009 at 9:50 am
Leigh Caldwell
Hmm. I agree that expectations definitely influence economic performance, and that the stimulus must have affected expectations (though this argument is a bit circular, because its effect on expectations is based mostly on the idea that it would definitely work – and if it hadn’t had that impact on expectations, would it have worked?).
Anyway…my main point is that we can indeed model feelings. Preferences are at least as complex as feelings, and we manage to model those with some success, using utility functions. Some thoughts about this in response to your article:
http://www.knowingandmaking.com/2009/10/can-feelings-be-modelled.html
Monday ~ October 5th, 2009 at 1:14 pm
Karl Smith
On the issue of stimulus working:
There is a bit of circularity there in the private sector. If businesses expect consumers to spend more over the next 18 months they will reduce labor reductions which will lower the probability of workers going unemployed which will in fact encourage spending.
However, the behavioral economics insight of just reducing withholdings should have provided the exogenous push to get such a virtuous cycle started.
On the public side, however, there is no circularity. State government is completely liquidity constrained. In cannot borrow to fund operations. Thus, an increase in state support will lead directly to either more state spending or lower state taxes.