Right now, there is a weird asymmetry between the economics of politicians and the economics of economists. In the world of politicians, supporting economic stimulus is synonymous with stupidity, greed and shortsightedness. It’s as if the idea is so shockingly wrong that only moral or intellectual failure can explain someone’s support for the American Recovery and Reinvestment Act (ARRA).
Among economists, however, the case for stimulus enjoys support across the political spectrum, although the details of how best to execute a stimulus vary. In Tuesday’s Wall Street Journal, for example, Martin Feldstein, a Nobel Laureate economist who designed many of Reagan’s policies, advocated the need for stimulus, even as he distanced himself from the ARRA.
You might not agree with the case for stimulus. But I hope that hearing the case will calm some people down. Today, I endorse economic stimulus.
What is the theory of economic stimulus? It’s the idea that a government can pull the economy out of a recession by borrowing money and using it for tax cuts or deficit spending.
Why would that work?
It turns out that many parts of the economy are confidence games. Businesses hire workers and buy equipment based on today’s earnings. Consumers make purchases based on today’s household income. But the businesses’ hiring is the consumers’ income, and the consumers’ purchases are the businesses’ income. It’s a circle that depends on confidence.
If something happens that shakes our confidence, then consumers and businesses stop spending money in ways that depend on confidence — like buying new dishwashers or retrofitting old plants to make new chemicals. People save money instead. Up to a point, more savings will lower interest rates and increase business investment, but when the interest rate hits zero, then business investment maxes out. Higher savings lower business income, so businesses cut investment and employment, which lowers income for consumers and other businesses. It’s a vicious cycle.
One goal of a stimulus is to stop the self-fulfilling prophecy caused by a loss of confidence. Basically, the government says to the American people, “I will give you some government bonds if you give me some of your savings.” Then, the government just gives the money right back to the people via tax cuts and deficit spending. So the people’s total wealth — their money plus the stock and bonds they own — is unchanged, but the people’s present income is greater. A higher present income restores confidence.
Fine, but isn’t the stimulus expensive?
The Tea Party movement complains that stimulus spending burdens the U.S. with debt and will make the country poorer in the future. They are right to worry about the long-term budget outlook, since Medicare and Medicaid are insanely unsustainable, but wrong to worry that the stimulus has anything to do with it.
Why not?
First, investors have been scared to lend to consumers or corporations, so the government can borrow at ridiculously low interest rates — about 3.3 percent. Therefore, interest on the stimulus debt won’t impose noticeably higher taxes down the road. The Congressional Budget Office estimate from Jan. 2009 predicted about $347 billion in interest over 10 years. This is about $35 billion per year. Today’s GDP is $14.2 trillion.
Second, deficit spending is the cheapest way for the government to buy things it needs to buy anyway. Prices and wages fall during a recession. So, if the government is going to repave a road, it’s cheapest to buy the materials and workers during the recession.
Third, stimulus spending makes the U.S. wealthier. The nation’s wealth depends on its technology, work force and capital. Period. If the stimulus restores confidence, and thereby causes businesses to build more factories, offices, houses and machinery, then the nation will be wealthier. If the stimulus keeps people healthy and educated, then the nation will be wealthier.
It’s important to see through the illusion that debt can create in times like ours. The true cost of something is what must be given up to obtain it. And in normal times, when the government buys things, the cost is tangible. That is, the labor and factory capacity required go to government production, so they can’t go to private production.
But in a bad recession, workers are unemployed, and factories run far below capacity. Putting workers and factories to work doesn’t impose much of a real cost on society, because society wasn’t using them anyway.
The fact that the government will have to have to collect money from some Americans and then give it to others (the debt holders) is an accounting trick. The only effect by which the debt payments make America poorer is that the taxes required to raise $35 billion per year will reduce citizens’ work effort ever so slightly.
Why isn’t the stimulus working?
I have been talking about stimulus spending as a concept. The American Recovery and Reinvestment Act is a real bill, made by politicians in the messy real world. It has a lot of flaws. In my next column, I’ll talk about the specifics of the ARRA. I hope, though, that I’ve made the case that there is a case to be made for stimulus.
