An excellent article on by John Taylor, entitled "An Empirical Analysis of the Revival of Fiscal Activism in the 2000s," in the JEL. His conclusion:
In sum, this empirical examination of the direct effects of the three countercyclical stimulus packages of the 2000s indicates that they did not have a positive effect on consumption and government purchases, and thus did not counter the decline in investment during the recessions as the basic Keynesian textbook model would suggest. Individuals and families largely saved the transfers and tax rebates. The federal government increased purchases, but by only an immaterial amount. State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures, and they shifted expenditures away from purchases towards transfers.
Some argue that the economy would have been worse off without these stimulus packages, but the results do not support that view. According to the empirical estimates of the impact of ARRA, if there had been no temporary stimulus payments to individuals or families, their total consumption would have been about the same. And if there had been no ARRA grants to sttes and localities, their total expenditures would have been about the same. The counterfactual simulations show that the ARRA-induced decline in state and local government purchases was larger than the increase in federal government purchases due to ARRA...
Others argue that the stimulus was too small, but the results do not lend support to that view either. Using the estimated equations, a counterfactual simulation of a larger stimulus package-- with the proportions going to state and local grants, federal purchases, and transfers to individuals the same as in ARRA-- would show little change in government purchases or consumption, as the temporary funds would be largely saved. Of course, the story would be different for a stimulus program designed more effectively to increase purchases, but it is not clear that such a program would be politically or operationally feasible.
More generally, the results from the 2000s experience raise considerable doubts about the efficacy of temporary discretionary countercyclical fiscal policy in practice. In this regard, the experience with the stimulus packages of the 2000s adds more weight to the position reached more than thirty years ago by Lucas and Sargent (1978) and Gramlich (1978, 1979).
Elsewhere, Taylor points out that these results are quite consistent with the permanent income hypothesis of Milton Friedman. Essentially, it pays to take rationality seriously.
What I'm thinking about is: does it make sense to say that a stimulus that consisted of direct government purchases, rather than of tax cuts and transfers, would have stimulated the economy more? How can we make sense of this?
The first thing to note is that direct government spending would still put money into the hands of the private sector, specifically, into the hands of workers, suppliers of materials, etc. To the extent that a transfers-and-tax-cuts stimulus transfers money to the private sector, a stimulus emphasizing new spending would have done the same.
The difference is that a boost to federal spending would mean that the private sector-- the workers and suppliers of materials with whom the government did business-- would have to do something in exchange for the money. For starters, assume that the government projects have no value in themselves. In that case, the private sector gets the same thing but has to jump through hoops to get it. Presumably they would do the same thing with the money-- save it. Worse, they might save more of it, because jumping through hoops for the money would have made them poorer.
Remember, ~90% of those who want to work are still employed. Considering how much job churn there is, and considering that the most energetic and resourceful people, who would be most useful on new federal spending projects, also tend to be those currently employed, it is a safe assumption that most of those who would work on stimulus-related public projects would be diverted from private sector jobs, not out of unemployment. So federal spending would depress other private sector activity in a way that tax cuts and transfers don't.
It's a different story if stimulus money were spent on projects with significant economic value. But here we get into the game of "picking winners," of which we've just seen the results in the Solyndra scandal. The truth is that allocating capital and labor to the most productive uses is a very difficult task, and the people, and maybe even more importantly the institutions and information networks, that are good at it, are high up in the commanding heights of the private sector. If there's no special reason why the private sector can't handle it, it's crazy to get the government involved. But there are such things as public goods, and if more spending on defense, or highways, contributed to the productivity of the private sector, stimulus might pay off.
I still like the idea of patent buyouts as stimulus. Patents are a second-best solution; it would be more efficient, in theory, to just pay the inventor and let anyone make the good, since the marginal cost of using a patent is zero. In a recession, let the government buy out lots of patents and release them into the public domain. That gets money out there and raises the productivity of the private economy in the long run.
But unless federal spending can provide a large boost to private sector productivity, its effects would be worse than the stimulus: equally ineffective in stimulating spending, but with extra distortionary effects on the economy. Taylor's piece is good news in a way though: it suggests at least that the stimulus didn't do much damage.