RDP 2014-02: Fiscal Policy and the Inflation Target Appendix A: Measurement of Recent Stimulus

For reasons given in Section 3, it is desirable to calibrate my stimulus rule, Equation (3), to recent behaviour. Estimates of recent stimulus legislation by the CBO, by Follette and Lutz and by Blinder and Zandi (2010) (through mid 2010) are similar. Notwithstanding this agreement, some issues of measurement and definition may be worth noting.

To avoid double-counting, I want to exclude measures that the standard FRB/US equations predict would have occurred anyway. The main component of the CBO estimates to which this applies is indexation of the alternative minimum tax (AMT), which I subtract from the published CBO totals to give the series plotted in Figures 2 and 3. Follette-Lutz and Blinder-Zandi make similar adjustments.

Although the FRB/US equations for transfers have a substantial cyclical effect, they do not explain all the recent increase, the shortfall being about 1½ per cent of GDP. Fortuitously, that roughly corresponds to increases in transfers that have been legislated in the three large bills. So restricting estimates of stimulus to the three large bills is a crude but simple approximation to the increase in transfers that is additional to the FRB/US equations.

The biggest difference between the CBO estimates and Follette-Lutz is the extension of ‘middle-class tax cuts’ that were scheduled to expire at the end of 2010. They are included within the CBO estimates, which are relative to a counterfactual of ‘existing legislation’, but excluded from Follette-Lutz, which is relative to a counterfactual of ‘existing policy’. In contrast, my implicit counterfactual is ‘predictions of FRB/US equations’, or what might be called ‘sustainable policy’, which calls for a large increase in taxes around this time in order to stabilise the debt. So the CBO estimates happen to provide a measure of stimulus in 2011 and 2012 that is closer to my purposes.

Less important, but high profile, are asset purchases such as the Troubled Asset Relief Program or TARP. I do not include this as systematic countercyclical policy largely because the net present value of asset purchases is highly uncertain and their multiplier is widely assumed to be quite low. So repetition of future TARP-like programs would have little effect on the cyclical behaviour of the economy.

There are other recent programs that might be considered to be countercyclical fiscal policy, including Cash for Clunkers, the homebuyers tax credit, and so on. But the total budgetary cost of these measures was small (Blinder and Zandi 2010, Table 10).