QOTD: Small is beautiful

Quote of the Day:

Dean Baker points us to Feyrer and Sacerdote, who use cross-state variation in stimulus spending per capita to estimate the employment effects of the stimulus. They find a clear positive effect: states that got more money per person did better on jobs. And as Baker points out, the national effects must have been larger, since some money spent in New Jersey presumably creates jobs in New York and vice versa.

One thing I might point out, by the way, is that this is something of a “Well, duh” result. Of course more federal spending in a given state or county creates more jobs. And the burden of proof should always have been on stimulus critics to explain why this doesn’t mean that stimulus spending creates jobs at the national level too. In normal times you can argue that the positive job effect of higher spending is washed out by higher interest rates — that fiscal expansion will be offset by contraction on the part of the Fed. But with interest rates up against the zero lower bound, that argument doesn’t apply.

Anyway, there’s something else that’s interesting about the Feyrer-Sacerdote paper. In doing their analysis, they looked for “instruments” on stimulus spending. Instrumental variables is a statistical technique that you use to avoid having your results contaminated by reverse causation — say, if stimulus funds were directed to states with especially severe unemployment problems, you might find a spurious negative correlation between stimulus and unemployment. What you need to get around this is some variable that is correlated with stimulus but not affected by the job changes; in effect, you use this other variable to create a predicted stimulus level, then look at how employment is affected by the predicted level, not the actual level. If I’ve just lost you, never mind.

The point is that the best instrument Feyrer-Sacerdote found was population: low population states got a lot more stimulus per capita. As they say, this could be because they have a lot of roads per capita, or it could be because they’re rotten boroughs, with two senators even if they have no people. ...

And this has an interesting implication. If Feyrer and Sacerdote are right, people in the Dakotas, Nebraska and so on are congratulating themselves on their good employment performance, a result of their rock-ribbed self-reliance — when what actually happened is that they got themselves an outsized share of the very stimulus they denounce. - Paul Krugman