We do not need a second stimulus plan

As the US unemployment rate has risen to 9.5 per cent from 8.1 per cent since the $787bn fiscal stimulus package was enacted in February, many Democrats have become very nervous. They say that another large stimulus may be needed to keep unemployment from rising well beyond the 10 per cent rate that President Barack Obama has predicted will be reached this year.

Another stimulus would be a grave mistake. The first one was justified by extraordinary circumstances. But it must be given time to work. People should not allow their impatience to lead to the adoption of policies that will not only fail to reduce unemployment this year, but could stoke inflation in the not-too-distant future.

The problem is that the Obama administration was much too optimistic about how quickly stimulus spending would affect the economy. Christina Romer, chair of the Council of Economic Advisers, and Jared Bernstein, chief economist to vice president Joe Biden, forecast in January that the stimulus would reduce unemployment almost immediately.

The forecast also showed the unemployment rate peaking at 8 per cent with the stimulus and 9 per cent without. Obviously this was wrong. Yet it would be incorrect to conclude that the stimulus was doomed to failure, as many Republicans and conservative economists argued.

Indeed, buried in an appendix, the Romer-Bernstein document presents reasonable estimates of how quickly different forms of spending would raise gross domestic product. Tax cuts and government transfers are slow to have an effect and have a low multiplier, raising GDP less than $1 for every $1 increase in the deficit even when fully effective after two years.

By contrast, government purchases stimulate growth much more quickly and have a higher multiplier, raising GDP by $1.57 for every $1 spent. Unfortunately, the low-impact spending has been the fastest to come online while the high-impact spending is dribbling out very slowly.

In a recent report to the International Monetary Fund, Doug Elmendorf, Congressional Budget Office director, looked at the rates of spending for different components of the stimulus package. He estimates that by the end of fiscal year 2009, which falls on September 30, 32 per cent of the income transfers for things such as food stamps and extended unemployment benefits will have been spent and 31 per cent of the tax cuts will have been disbursed. By the end of fiscal year 2010 virtually all of the money allocated to these programmes will have been spent.

However, just 11 per cent of the discretionary spending on highways, mass transit, energy efficiency and other programmes involving direct government purchases will have been spent by the end of this fiscal year. Even by the end of 2010 less than half the funds will have been disbursed and by the end of 2011 more than a quarter of the money will be unspent.

Consequently, it is hardly surprising that five months after the stimulus bill passed it has not yet affected the unemployment rate. Unfortunately, other government data suggest that Mr Elmendorf may have been too optimistic about how fast stimulus spending would affect the economy. According to www.recovery.gov, which tracks this spending, at June 26 only $56.3bn has been paid out from the $157.8bn in funds allocated to various government agencies.

But even this overstates the economic impact because the agency primarily responsible for public works, the Department of Transportation, has spent virtually nothing. The website says it has made $20.5bn available, but just a tiny $441.5m has actually been spent.

While there may have been a few “shovel-ready” projects that could be started immediately, the vast bulk of public works projects take a long time to be effective, economically. Plans need to be drawn up, land purchased, environmental impact statements prepared, contracts written and put out for bid, and many other things before the first construction worker is hired.

Mr Elmendorf estimates that only 27 per cent of highway spending is spent in the first year after being made available, rising to 68 per cent in the second and 84 per cent in the third. Thus a considerable amount of the public works funding in the February stimulus bill will in fact be spent years from now.

What all this means is that it is foolish to think that any sort of stimulus that is enacted now will have an impact on the economy any time soon. We just have to wait for the medicine we have already taken to work. Pushing ahead with another stimulus will only make it harder to tighten fiscal policy down the road to keep inflation in check.

The writer was a Treasury Department economist in the George H.W. Bush administration. His latest book is The New American Economy: The Failure of Reaganomics and a New Way Forward, to be published by Palgrave Macmillan in October