Against Fiscal Stimulus

by on January 8, 2008 at 7:23 am in Economics | Permalink

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.

1 huggy January 8, 2008 at 9:56 am

$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.

2 huggy January 8, 2008 at 10:44 am

I got the amount wrong! It was a $300 rebate (some have a problem with using the term rebate). Sorry!

3 Alex Tabarrok January 8, 2008 at 11:48 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.

4 huggy3575 January 8, 2008 at 12:45 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.

5 happyjuggler0 January 8, 2008 at 2:09 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?

6 odograph January 8, 2008 at 3:40 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.)

7 odograph January 8, 2008 at 6:35 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.)

8 steve January 8, 2008 at 8:19 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 🙂

9 andy January 9, 2008 at 7:28 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)?

10 andy January 9, 2008 at 4:00 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?

11 Scott January 9, 2008 at 11:58 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

12 Vincent Clement January 19, 2008 at 10:13 am

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?

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15 Matthew February 11, 2009 at 1:25 pm

Lets cut to the chase, the only way to stimulate this economy is a big fat check to the people that pay these morons that are running our glorious country in to the ground. I’m talking $50,000 to $100,000 a piece. no money to the unemployed and no money to the ones on welfare or ss. we are the ones working our butts off for those idiots to sit around and make stupid decisions. Don’t you worry, we will spend it.
I mean come on, the house and senate make decisions with our social security money but they don’t even pay in to it. If it was their retirement also I think they would think twice about pissing it away like they do.
Obama makes me laugh, he said he inherited this economic mess. well, lets remember that he was a senator and that he has been part of creating this mess all along. Seems to me there are a lot of those fannie mae and freddi mac foreclosures on the south side of chicago.

signed
a tax paying american whose getting shit on by the government

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