Did Government Overspending Prevent Economic Armageddon?

In Personal Transfer Payments and GDP, my colleague John Lounsbury points out that USA government's Great Recession spending caused an increase above trendline in the social safety net (such as unemployment compensation and food stamps).

John points out that the cost to taxpayers was nearly the same as the increase in GDP - and concludes:

........that the increase in personal transfer payments was effective in softening the impact of the recession and has, so far in the recovery, put the economy on a better footing, at least as measured by GDP, than would otherwise have occurred. However, this has come at a price. The national debt has been increased by essentially the same amount as the “extra” personal transfer payments, or $569 billion, over the three years 2008-2010.

When John overviewed his analysis, he pointed out that he had to assume that there were "no externalities that would have influenced GDP differently without the transfer payments". In short, John is saying there is no way to prove with certainty what are the economic effects of government spending.

John is correct - we will never know. Economics is a dark science because we are unable to experiment using two different solutions during same predicament. Truth in economics is illusive, "facts" are data points in search of opinion.

Would the real economy have been just the difference caused by the excess transfer of payments? Here are two opposing arguments:

If you did not have the excess transfer, would have some (most or a few?) of the beneficiaries of these payments scrambled harder to make some real money which would have caused real GDP growth; or

If you did not have the excess transfer, would it have triggered a deeper chain reaction in the economy causing an even larger economic contraction.

My imaginary nemesis Nobel Laureate Paul Krugman would argue case #2 - and I have sympathy for this argument. Once an economic trend sets in, it tends to overshoot destroying otherwise healthy enterprises. There is also a basis for Professor Krugman's statement that the stimulus was too small. The problem with this "too small" argument is that the original stimulus designed by Congress was not a real stimulus - aside from tax cuts and unemployment benefits, it was little more than pork barrel politics or dogmatic spending initiatives.

Could Professor Krugman be implying that the stimulus was too small based on its ingredients?

Would the "recovery" portion of the Great Recession been stronger without the excess transfer of payments? There are valid arguments that softening the decline would also soften the recovery as it particularly played around with money spending curves. Maybe the USA economy would be in the same place today without this excess above trendline spending - and have a stronger growth factor?

I am not arguing that payments under this Personal Transfer Payments safety net were wrong. The debate is the economic effect of a government providing money to individuals. Understanding this dynamic allows expansion of our control over the economy.

I wish all a great and prosperous New Year.

Economic News this Week:

Econintersect economic forecast for January 2010 was released this week pointing to a slightly improving economy. This week the Weekly Leading Index (WLI) from ECRIimproved from 0.8% to 2.2% implying the business conditions six months from now will be roughly the same as today.

Initial unemployment claims in this week's release were down significantly. This was a significant one week drop likely an anomaly of reporting during the holiday season. This is why Econintersect follows the 4 week moving average to smooth out the weekly gyrations. Using unemployment claims data as a reference, the December 2010 employment growth would be in the range of 150,000.

No data released this week was inconsistent with Econintersect’s November forecast of slow growth. The table below itemizes the major events and analysis this week (click here for interactive table).

Bankruptcy Filed this Week: None

Bank Failures this Week: None

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.