Is Fiscal Stimulus the Answer?

January 11, 2008

The economy is slowing, and if we are not already in a recession (I think we probably are) the risks of one are certainly high. So should our politicians do something with fiscal policy? Alex Taborrak says no:

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.)

I admit to being dubious of legislation and federal government action being useful for short term economic swings. Here are the other quite compelling reasons why:

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.

My emphasis above. I am always amused at the power people ascribe to what seems to be a large action, but in the context of the US economy and financial system is actually pretty paltry. That goes for most actions undertaken by the Federal Reserve as well. Finally, even for those amongst us, especially economists, who find those arguments uncompelling, we should all remember this:

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.

My own view relates to the first reason I quoted. Spending and tax decisions should make sense in and of themselves, not because of some quixotic attempt to influence the short term course of the economy.

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3 Responses to Is Fiscal Stimulus the Answer?

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  2. [...] in no uncertain terms for some time, and I have given my reasons for doubting the efficacy of fiscal stimulus packages. Fiscal stimulus that relies on increasing spending is an especially false hope, except in [...]

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