John Taylor interview

Gene Epstein of Barrons.com interviewed Stanford economics professor John Taylor. Taylor believes that government economic policies should be constrained and predictable rather than ad hoc and discretionary. In particular, he is extremely leery of stimulus spending, and the looming possibility of QE3.

Barron's: What's the best case you can make on behalf of those who defend the recent fiscal stimulus?

Taylor: The case that has been made for the discretionary fiscal stimulus is based on quite conventional Keynesian theory. It is basically that, if the government gives people a lot of extra money on a one-time basis, they will spend it. Not all of it, but most of it. Similarly, when the federal government gives money to states and localities as part of the temporary fiscal stimulus, it will be spent in such a way as to boost gross domestic product. And that will greatly help when economic activity is otherwise either contracting or stagnant

My own view is that the theory is flawed, and the evidence that the fiscal stimulus achieved the desired result is practically nonexistent. The surge in federal spending only increased the burden of the already burdensome federal debt.

Start with the evidence.

The attempt to stimulate consumer spending in 2009, or the earlier attempt under President Bush in '08, showed the expected rise in consumer income as government payments were made, but little or no response from consumer spending. Inconveniently for the advocates, consumer spending actually declined in some of the calendar quarters when it was supposed to have been stimulated. If you use statistical analysis to take into account the factors that would have brought increases or decreases in consumer spending, you find virtually no boost to spending from the stimulus.

As for the money sent to states and localities, economist John Cogan and I found that the funds were either put into financial assets or used to reduce borrowing. The hoped-for increase in infrastructure spending was negligible.

What is also inconvenient for the advocates: According to the national income and product accounts, state-and-local government purchases were lower every quarter in 2009 and 2010 than in 2008.

And you would expect these results from the standpoint of economic theory?

Let's start with consumer spending. It's basic economic theory that most people look beyond the very short-term. To expect them to rush out and consume more when the government cuts them an extra check on a temporary basis is not realistic. Instead, they will bank most of the extra money or use most of it to pay down debt. There are exceptions, of course. Some people will feel so pinched, they will need to spend the money. But the data show that the exceptions don't dominate the story.

In short, the stimulus didn't stimulate and we shouldn't be surprised.