The first order of business for the Obama administration after getting elected was to enact a stimulus plan. At the time, Christina Romer was in charge of devising the stimulus plan and I had high hopes for her. Her research had shown that tax changes had a much bigger impact on the economy than spending changes and I expected her to put together a plan that reflected her research. Unfortunately, the stimulus plan that emerged was a hodgepodge of “temporary” tax changes – which had never proven effective in the past – transfer payments to individuals and states and some good old fashioned pork barrel spending mixed in. The results are pretty obvious to anyone who doesn’t have a political axe to grind.
Sweden took a different path (via the Spectator):
When Europe’s finance ministers meet for a group photo, it’s easy to spot the rebel — Anders Borg has a ponytail and earring. What actually marks him out, though, is how he responded to the crash. While most countries in Europe borrowed massively, Borg did not. Since becoming Sweden’s finance minister, his mission has been to pare back government. His ‘stimulus’ was a permanent tax cut. To critics, this was fiscal lunacy — the so-called ‘punk tax cutting’ agenda. Borg, on the other hand, thought lunacy meant repeating the economics of the 1970s and expecting a different result.
Three years on, it’s pretty clear who was right. ‘Look at Spain, Portugal or the UK, whose governments were arguing for large temporary stimulus,’ he says. ‘Well, we can see that very little of the stimulus went to the economy. But they are stuck with the debt.’ Tax-cutting Sweden, by contrast, had the fastest growth in Europe last year, when it also celebrated the abolition of its deficit. The recovery started just in time for the 2010 Swedish election, in which the Conservatives were re-elected for the first time in history.
Sweden’s GDP fell more than the US in the great recession (-5.0% vs -3.5%) but the bounce back was bigger too (+6.1% vs +3.0% in 2010). And Sweden has a balanced budget as the tax cuts basically paid for themselves.
One can’t help but wonder what might have happened to the US economy if Christina Romer had put together a plan that was true to her academic research. Where would the US economy be if we had cut spending and made permanent tax cuts? Obviously, there is no way to prove a counterfactual, but it probably isn’t coincidence that that formula proved equally effective in the 1920-21 depression here in the US. Oh, what could have been….