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Against Fiscal Stimulus
As the economy slows many people from Larry Summers to Martin Feldstein are calling for a fiscal stimulus. I am not convinced. Spending and tax decisions can rarely boost an economy.
First, the money for any new spending or tax cuts has got to come from somewhere, right? Thus there is usually substantial crowding out of any stimulus.
Second, by the time the new spending or tax cut gets through the political process the economy has moved on and the stimulus is no longer relevant except by accident.
Third, there just isn't that much discretionary spending to play with and even a large increase in spending, say tens of billions, is too small to make much of a difference in a 13 trillion dollar economy.
Fourth, in their desperation to "do something" politicians will often do something foolish. If a spending increase or tax cut isn't worthwhile on its own merits then it's highly unlikely to be worthwhile once we add in the benefits of "stimulus." Thus, it's one thing to argue for extending unemployment benefits as a matter of welfare it's quite another to think that an increase in unemployment benefits will so increase spending as to reduce unemployment! (The implicit view of Larry Summers.)
Economists may call for "temporary," "conditional," and "targeted" stimulus but they won't be the ones designing the plan. Spending increases and tax cuts are policies with long term consequences that we need to think about carefully.
Thus, I do not favor a fiscal "stimulus" package.
Posted by Alex Tabarrok on January 8, 2008 at 07:23 AM in Economics | Permalink
Comments
$400 X 150 million = 60 billion
(remember the $400 tax rebate as it was called)
This translates into about 1 million jobs. Probably saves government money considering unemployment insurance and retraining programs.
Posted by: huggy at Jan 8, 2008 9:56:53 AM
The money comes from the same place the 1 trillion dollars came from to have a housing bubble.
reinflate! reinflate! our dollar we depreciate!
go Fed! Go Fed!
Posted by: Huggy at Jan 8, 2008 10:02:16 AM
I got the amount wrong! It was a $300 rebate (some have a problem with using the term rebate). Sorry!
Posted by: huggy at Jan 8, 2008 10:44:56 AM
Alex,
I'm not sure I understand your third point. What about multiplier effects? Ten billion dollars may not be much of a "direct impact" but it will "indirectly" generate even more spending through out the economy.
Posted by: Student at Jan 8, 2008 11:22:01 AM
Student, multiplier effects, if they exist, come in only *after* crowding out. For example, suppose the government spends an extra $100. To spend more the government must borrow the $100 from the bond market which means reduced consumption and investment spending - let's say that private spending falls by $80 then the net increase in spending is only $20. Any multiplier is on the $20 not the $100.
Or to put it differently, the $80 reduction in private spending has a reverse multiplier effect, a division effect!, that cancels out much of the multiplier effect of the $100 increase in government spending.
Posted by: Alex Tabarrok at Jan 8, 2008 11:48:44 AM
Government stimulus spending on pet projects of politicians that the people wouldn't have voted for themselves, or their proxies wouldn't have voted for at a local level, reminds me of the Broken Window Fallacy.
How does one reconcile a belief in government stimulus packages with a belief in the Broken Window Fallacy?
Posted by: happyjuggler0 at Jan 8, 2008 12:10:06 PM
For example, suppose the government spends an extra $300 by giving a rebate to everyone with a job. This would go through the mechanisms mentioned above except the Federal Reserve is trying to lower short term interest rates. The Fed buys the bonds so that the full $300 goes out. This is inflationary. Recessions are deflationary.
Right now the Fed is pumping 20 billion or so in loans to banks every two weeks. The $300 dollars per person is needed to pay on these loans if we are to keep up the fiction that there isn't going to be a bail out.
Posted by: huggy3575 at Jan 8, 2008 12:45:23 PM
Alex, I have to agree with "Student" (and I like his or her screen name, too).
If capacity is full, then yes, there will be crowding out.
But when there are slack, unused resources, then there need not be any crowding out. If gov't spending creates demand that puts a person to work who otherwise would not be working, then that's a net increase in GDP. The case for government stimulus in recessions is that there are slack resources. If they are not put to work, then that output is foregone forever, and the economy is worse off.
At least that what all the neoclassical textbooks teach, and that seems to be what Marty Feldstein, Larry Summers et al believe (not to mention Keynes).
Posted by: A student of economics at Jan 8, 2008 1:39:03 PM
ASOE,
So basically you are saying that if glaziers aren't operating at full capacity, the government should break the windows of young people's homes so that glaziers can hire more people?
Posted by: happyjuggler0 at Jan 8, 2008 2:09:09 PM
Both Students - do you believe in multiplier effects? Could you explain multiplier effect on Robinson Crusoe economy? When I studied the economics I tried hard but could never come up with a good example. Ultimately I decided that the problem is not me but the multiplier thing....but I may still be wrong :)
Just a few thoughts on multiplier effect
- the conclusion is the less people save (the smaller the 'c'), the higher the multiplier. Ultimately, if people cease saving/investing, the production rises infinitely...?
- in recession SOME prices are wrong(=too high) - that's the reason for slack resources. I'm unsure how - considering Bastiat's effect - the fiscal stimulus is supposed to remedy this fact?
- the government may redirect some saving into consumption. However, how is this supposed to help during a recession? If you want higher consumption you must...invest first...?
- the fiscal stimulus will have mostly no effect on prices/slack resources, thus there might be a monetary stimulus. That will rise the amount of money (lower the 'real' prices) and put the slack resources to work...except that while before SOME prices were too high, after the monetary stimulus some prices are going to be too low... just wonder how would one expect the market to coordinate well when the government is deliberately inducing a lot of instability...
It seems to me that Bastiat's effect is better rooted in reality then multiplier effect.
Both Students.... recommended literature:
Henry Hazlitt: Failure of The New Economics (pretty long and boring, otherwise a good reason to cease taking Keynes seriously) and
M. Rothbard: Further Fallacies of the Keynsean system
Posted by: andy at Jan 8, 2008 3:09:17 PM
No one suggests that we might already be spending at "stimulus" rates?
What else is this debt and deficit stuff? Why is MORE debt and deficit suddenly a stimulus when current levels are not?
(I think there will be support for more spending though, because that seems to be the culture not just in government but in America at large.)
Posted by: odograph at Jan 8, 2008 3:40:23 PM
Alex--
I agree with your comments about economic stimulus packages in the short-term, but there is some value in long-term economic stimulus packages (i.e., infrastructure projects like the electrification of the New Deal or the Interstate highway system). As long as the economic stimulus involves putting people to work on projects with long-term value, I don't have any objections, even though they're not going to do much in the short-term.
Posted by: Matt Metcalf at Jan 8, 2008 3:46:43 PM
Matt--
What is our crazy ethanol effort?
(I really am looking for education here. I fear that "stimulus" is just "addition" to whatever we've got, which in my opinion is a not so perfect a "baseline.)
Posted by: odograph at Jan 8, 2008 6:35:07 PM
"Temporary" stimulus implemented "right now." Some economists have a child-like understanding of the political process.
Posted by: Mario Rizzo at Jan 8, 2008 7:20:58 PM
I think student of economics' reasoning should be qualified to some extent. There may still be some crowding out even when there is slack capacity. In most multi-equation macro models, as long as you are somewhere remotely near full employment, the interest rate will share a portion of the adjustment burden with output. If you're far from full employment and the interest rate is close to zero, fiscal stimulus is supposed to come into its own, but that approach didn't work any miracles in Japan in the 90s, so I have limited faith in its practical efficacy.
Thanks for taking us back to the debates of old, Alex. I love it when I can use my economics major for something :)
Posted by: steve at Jan 8, 2008 8:19:08 PM
Completely non-sequitur, but will the eminent personages arguing for a fiscal stimulus when economy is facing the threat of recession also argue for tight fiscal policy when economy recovers and threatens to grow above trend? Or will rising tax collections and a reduction in deficit that accompany a recovery be used as an argument to legislate more tax cuts or make some of the existing tax cuts permanent? Is this what is known as faith based economics?
Posted by: athreya at Jan 9, 2008 4:45:04 AM
What do we mean by 'fiscal stimulus'? I thought it means: raise taxes. 'Monetary stimulus' means: print more money. Deficit spending is in my opinion monetary stimulus if you have central bank fixing interest rate or fiscal stimulus if you have hard money and no fractional banking - in which case the deficit spending leads to higher interest rate which leads to crowding out...
Can somebody explain how could taking money from people and spending it have any effect on slack resources compared to the situation of lower taxes (i.e. not taking money from the people)?
Posted by: andy at Jan 9, 2008 7:28:40 AM
Andy -
Fiscal stimulus usually means means lower taxes in conjunction with greater government spending (financed by borrowing). Its not an either/or between spending and tax cuts, its both.
Posted by: quanticle at Jan 9, 2008 3:29:53 PM
quanticle - what's the difference between deficit spending and higher taxes assuming fixed money supply?
What's the difference between monetary stimulus and deficit spending considering if the money supply grows to cover the deficit?
Posted by: andy at Jan 9, 2008 4:00:09 PM
Govt spending lowers productivity by making less efficient use of the money than the private sector and also represents a future tax as that spending will have to be repaid by citizens. So lowering spending is the stimulus. This would also allow even larger tax cuts. Cut regulation (another effective tax) and you have the triple play (not that I'm holding my breath for any of this to happen).
Posted by: bob at Jan 9, 2008 9:35:30 PM
A paper that tries to measure the multiplier effect of tax changes on the economy. Looks like a tax reduction for fiscal stimulus results in a multiplier of between 2 and 3 and plays out over about 30 months.
http://elsa.berkeley.edu/users/cromer/RomerandRomer707.pdf
Posted by: Scott at Jan 9, 2008 11:58:20 PM
I said above "No one suggests that we might already be spending at 'stimulus' rates?"
Apparently Justin Fox is willing to suggest it:
You've heard the talk about a possible fiscal stimulus package to counteract the recession we may already be in.Maybe we need it. It's important to note, though, that the Bush administration has had a fiscal stimulus package of sorts in place ever since the middle of 2001. That's when the federal government started spending more than it takes in. Just to review the deficits of the past six years: [...]
Posted by: odograph at Jan 14, 2008 1:25:19 PM
I thought people spending more money than they have is what got the US in this mess? Shouldn't the government be encouraging people to save and invest some money?
Posted by: Vincent Clement at Jan 19, 2008 10:13:18 AM
I do feel that a fiscal stimulus package is needed. A tax rebate to individuals and a tax credit for business investment would do the one thing that needs to happen to keep our economy from slipping into recession. It would increase demand for goods and services and therefore increase consumer spending and decrease unemployment. A tax rebate to individuals has to be looked at for more than it actually is. The government is basically tricking people into thinking they are better off than they actually are. If a married couple gets a check for $1600 (that’s the highest number I’ve heard being floated around), they are probably not going to be that much better off than they were before. Whether they spend that money directly or pay off existing debt, the result is they are going to feel better (consumer confidence) and therefore more likely to go out and spend money in one of the sectors of our economy that depends almost exclusively on individual consumer spending.
An investment tax credit for business will have much the same effect in terms of capital expenditures. It will give businesses an incentive to spend money now because of the implication it will have on their tax return. This will increase labor demand and lower unemployment. Lower unemployment then means our economy is running at closer to capacity and it also has the effect of putting more income into people’s pocket, which then continues to increase consumer confidence and spending. Obviously, before any solution will work long term, our government has to become much more fiscally responsible. Lower taxes are great as long as spending is lowered to. If our government continues to insist on unnecessary spending, then at some point taxes will have to go up. Otherwise, our dollar will continue to devalue and eventually substantial inflation will set in and takeover. But, for the short term, I do feel that pumping money into the economy in the form a tax credit or rebate will help us avoid a recession, or at least soften the blow.
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