Bittlingmayer and Hazlett on the Stimulus

Josh Wright —  21 February 2009

George Bittlingmayer (University of Kansas) and my colleague Tom Hazlett look at the market response to the stimulus and find it none too enthusiastic:

President Barack Obama’s “stimulus” plan invokes the 1930s fiscal strategy put forward by British economist John Maynard Keynes, who saw capitalism as pretty much spent. Having exhausted their store of innovative ideas, investors curled up. Workers lost jobs, spent less, and sent still other workers walking. Budget deficits – government spending without taxes to “pay as you go” – would pull unemployed workers off the street and arrest the downward spiral. Investors’ “animal spirits” would be calmed, new capital risked, and economic vitality restored.  So the Obama theory – government spending is stimulus. If so, financial markets should feel the love. The U.S. budget is awash in red ink, and $800 billion more of it should easily move the needle on our economic prospects. Indeed it has – in the wrong direction. Financial markets don’t want more government debt or a scramble for “shovel-ready” spending projects. They want the skeletons in the banking sector’s closet exposed and expunged…

Yet, from Nov. 4, 2008 through Feb. 12, 2009, the DJI overall fell 18% — a larger drop than during the Sept-Oct plunge. In January, when the Obama plan, promising far greater deficits than the two much smaller “emergency stimulus” plans signed by Pres. George W. Bush in 2008, was unveiled, the market tanked – the worst January performance in 113 years.  More pointedly, key political victories for the Team Obama spending plan have not been viewed as buying opportunities on Wall Street. A string of negative market reactions began with the December 18 announcement of a stimulus bill of $700 billion (Dow down 2.5%), continued with the January 7 announcement that the actual plan would be “on the high side” (-2.7%) and continued with last week’s 61-36 Senate vote supporting the Administration’s fiscal plan. The White House victory and the new bank bail-out plan announced the following day by Treasury Secretary Geithner were met with a 5% wipe-out in the DJI, and a decline in Treasury bond yields, indicating a “flight to quality.”