Stimulus ambivalence

By David Backus

My daughter has a T-shirt that reads: “I’m confused. No wait, maybe I’m not.” Obama’s stimulus package has a similar effect on me: “It’s a great idea. No wait, maybe it’s not.” Or maybe I’m just confused. Government spending could very well help get the economy going again. And its example might raise business and consumer confidence: in times of trouble, strong leadership can be a wonderful thing.

But there are also reasons to be sceptical. I can’t help it, I’m an economist, we’re trained to think this way. I’m sure everyone can think of reasons why a stimulus package could be less than a brilliant idea, but here’s my list.

Hard to do. It’s not easy to spend large amounts of extra money quickly. And harder still to do it in a way that creates good value for society and doesn’t bring out the worst in our politicians. I can hear Jon Stewart on the Daily Show: “Where’s Ted Stevens when we need him?”

Hard to time. Right now, most forecasts call for continued shrinkage in the first half of 2009, modest growth in the second half, when the stimulus starts to come online, and faster growth in 2010, when spending hits high gear. In short, we get the most stimulus when we need it least. This is, of course, the classic argument against countercyclical fiscal policy: it’s hard to get the timing right.

Small multiplier. Let us say that for every dollar of extra government spending, GDP goes up m dollars. The “multiplier” m is a measure of how big a bang we get out of every dollar of extra spending. The evidence is fuzzy, to be sure, but it suggests to me that the multiplier is around one, and some think it could be smaller. Even stimulus cheerleader Paul Krugman is only willing to claim 1.1. If the multiplier is around one, then the impact of the government spending (say) 700b over two years is barely enough to reverse the decline in GDP we’ll see from the middle of 2008 to the middle of 2009. That might lead you to propose a larger stimulus, but remember: it’s hard to spend that much money.

Long-term budget issues. I don’t spend much time in Washington, but I thought the mainstream view among government economists was that our retirement and health-care programs were likely to bust the budget over the next 2-3 decades. The numbers, in fact, swamp anything we’ll see in a short-term stimulus package. Recent directors of the Congressional Budget Office under both Republican and Democratic Congresses have made this point, and I hope I wasn’t the only one listening. The US is not Argentina — we can do this without ruining our credit rating — but it still seems a little incongruous to advocate massive increases in spending when the long-term problem is paying for spending already on the books.

It’s the financial system, stupid. Japan in the 1990s is a Rorshach test for macroeconomists, so not everyone sees this as I do. But in my view Japan demonstrated that the central issue in a financial crisis is the financial system. If you don’t fix it, no amount of fiscal stimulus will make much difference. That’s one of the reasons I’m optimistic about the US right now: unlike Japan, we’ve faced up to our problems, ugly as they are, and have acted decisively to correct them.

What would I do? I’d prefer to remain in my comfortable academic office at NYU and avoid policy altogether, but if forced to make a recommendation, I guess I’d say: Go ahead, spend a few hundred billion over the next two years. It could help, especially if the economy performs worse than we expect. But spend it on things that have clear social value. At the same time, try to make some progress on the long-term spending issues built into our current retirement and health-care systems. That won’t be nearly as popular as spending money now, but it’s an opportunity to show some real leadership. And make sure you keep your eyes on the financial system: if the banks don’t recover, none of us will. Good luck!

David Backus teaches at New York University’s Stern School of Business. This piece is part of the NYU Stern project, “Repairing the US Financial Architecture: An Independent View.”

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