Bush Favoring Larger Stimulus Package

Amidst fears of a recession and a jittery stock market Bush has signaled that he is open to a larger fiscal stimulus package–i.e. larger deficits.

Jolted by global recession fears, the Federal Reserve slashed interest rates Tuesday, and President Bush and leaders of Congress joined in a rare show of cooperation in promising urgent action to pump up the economy with upwards of $150 billion in tax cuts and government spending.

One of my big problems with “fiscal stimulus” is that I see it as somewhat better than simple re-arranging the deck chairs on a sinking ship, and not much more. After all, how does a government run a deficit? By borrowing money. Now if that money could be used for productive purposes such as investment, or spent, then the impact of deficit spending is reduced. Further, there is the work of Robert J. Barro on deficit spending. Under certain assumptions, such as intergenerational altruism–i.e. you care about your kids, grandkids, etc., then any increase in the deficit is precisely offset by increased savings in the terms of government bonds, and there is no net increase in output. Of course, not everyone has kids, or in some cases they may prefer to spend their kids inheritance on themselves, so the strong conclusion above is mitigated somewhat.

Further, another problem with fiscal policy is the concept of time inconsistency. For example, a president might say, “We are on the brink of a recession, so we should increase government spending and run a deficit to avoid the recession and the pain they cause. Latter, when the economy recovers we’ll increase taxes to pay down the debt that was incurred. Since economic expansions are typically longer than contractions, the tax increase will be modest and we will be able to afford it.” Sounds eminently reasonable. Now imagine you have are that politician in the future and you are looking at the debt and the prospect of raising taxes. People don’t like higher taxes generally. Further, you have an election coming up. So, do you keep your promise you made earlier or do you renege and come up with a reason why raising taxes during an economic expansion is imprudent? Even if you are a benevolent dictator, by delaying paying back the debt1 social welfare can be enhanced, so even in that case of dictator there is an incentive to deviate from what was, earlier, perceived to be the optimal policy.

When you look at the last 50 years of how the government has handled its finances you see that deficits are pretty much a constant. Running a surplus is actually the exception to the rule. Factor in that politicians have even less incentive to work towards a balanced budget or paying down the debt and fiscal policy could become geared towards running permanent deficits which could end up having an adverse impact on growth if the debt gets to be large enough.
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1Note this does not mean not paying back the debt. Delaying could merely be paying the interest on the debt vs. paying the debt off. If the economy is growing this could be seen as a choice that enhances social welfare since you can avoid raising current taxes and the burden of the debt in the future diminishes as a ratio of GDP.

FILED UNDER: Economics and Business, , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Dave Schuler says:

    Yeah, I’ve been posting against the inevitable stimulus package for the last week or so. The key problems in my view are the “time inconsistency” one you mention and the likelihood that whatever package is adopted is unlikely to produce the stimulus necessary because it’s incorrectly targeted.

    Any stimulus of $800-$1,600 targeted at middle income Americans (practically a dead cert) will either be saved (like last time) or spent on lowish end consumer goods. Most of the benefit in that will go to China (where they’re produced). The idea that retailers are going to boost employment, raise wages, or increase capacity as a result of the stimulus packages I’ve seen proposed is patently absurd.

    We’re already too dependent on consumer spending. This ain’t gonna help.

    You might want to take a look at Joseph Stiglitz’s proposals I commented on this morning. Everybody’s got their muzzles in the trough.

  2. Paul says:

    Aren’t we in this mess because Americans aren’t saving enough? And so we want to fix it by borrowing more and urge people to blow it all on a spending spree? In fifty years we will be wiping our asses with dollar bills because they will be worth less than toilet paper. God didn’t make America the #1 economy in the world, the hard work of earlier generations did. Voters today seem to have no appreciation that it is possible to blow that.

  3. DC Loser says:

    So now it’s okay to drive inflation up to “stimulate the economy?” Wouldn’t it have been better if they’d nip the problem in the bud when the real estate scam started and clamped down on the easy credit? It’s not like nobody knew this was going to happen. I’ve been watching this train wreck develop for the last 3 years with the crazy real estate frenzy which was clearly unsustainable.

  4. DC Loser says:

    Time to move my investments into hard assets. Hyperinflation is one way to wipe out our national debt. Wouldn’t the Chinese be pissed when their $1.4 trillion holdings in US notes turn out to be worth the equivalent of a loaf of bread a few years down the road?

  5. FireWolf says:

    In the interests of my savings account I say “Show me the money!”

    If they want to send me $1600 (I’m married) I can certainly use a boost in my savings. Otherwise, I will continue to pinch my pennies, look for the better deal, and buy only those things I need to get by comfortably.

    ….where did I put that Xbox 360?

  6. Paul says:

    Wouldn’t the Chinese be pissed when their $1.4 trillion holdings in US notes turn out to be worth the equivalent of a loaf of bread a few years down the road?

    Not as pissed as the many Americans who would lose even more. By the way, I don’t know the exact figures, but I believe that China owns “only” around $400 billion in US debt and that Japan is actually the largest foreign owner.

    Where is McCain on this? Straight talk or vote-for-me talk?

  7. Dave Schuler says:

    As I pointed out in my post on the subject yesterday, the Chinese (meaning the Chinese leadership) are getting what they’ve paid for.

  8. DC Loser says:

    Paul – read James Fallows’s article in the Jan 08 Atlantic. The current number exceeds $1.5 trillion as we speak.

  9. Michael says:

    If our current mess is largely because of people defaulting on their mortgages, how is giving them less than 1 month’s mortgage payment going to improve anything? Or is the stimulus package going to become a monthly thing?

  10. Paul says:

    I think the situation is that China owns about $1.4 in dollar-denominated assets, of which $300-400 billion is in US treasuries (the public portion of the national debt). But whatever the numbers it sounds like most here agree that the general theory of the stimulus plan is suspect.

  11. Christopher says:

    Who cares about the Chinese or the Japanese? So what that they have a lot of our debt. Winnie the Pooh could be the biggest debt holder and it wouldn’t matter. The fact is we have so much of their money because we are the best safest largest economy in the world hands down.

    Steve,
    Raising taxes hurts the economy. Cutting taxes, like Bush has done, reinvigorated the economy and resulted in a flood of govt. revenues. Why is this such a hard lessor for you liberals and moderates to learn? And the current deficit the last few years has nearly all been the war on terrorism (which democrats voted for and continue to support, despite their rhetoric). Without it, budget is balanced.

    Of course, if we just stopped the insane spending and entitlements, things would be just fine. Why can’t you push for that, Steve? You always come back to taxes. TAX TAX TAX. I guess that shows what a liberal you are. Ultimately Americans will have to decide: higher taxes or less handouts to lazy libs. We all know what the bleeding hearts want.

  12. Paul says:

    Actually it seems to be the Republican strategy to talk and act always on taxes and never on the real issue, spending. Our current “tax cuts” are not cuts at all for young people, they are tax deferrals for the bills for our spending orgies that will eventually become inescapable, AFTER it is too late to collect them from the Lazy Boomers who are chiefly responsible for this mess. A tax cut funded by a spending cut is giving the people back their money. A tax cut funded by deficit spending is just more heroin for the american debt junkies, a government handout welfare check to lazy liberals AND lazy (so-called) conservatives.

    The “war” on terrorism is small fry compared to the Medicare disaster that is looming. Bush’s unnecessary, unfunded tax cuts were irresponsible because we should be running big surpluses AND/OR making big cuts to Medicare. So what does Bush do? Cut taxes and push through a massive Medicare prescription bill that made the bad situation even much worse. I don’t see how anyone can call the reckless TAX CUT and SPEND policies of recent years “conservative.”

  13. Christopher says:

    All true, Paul. Republicans and Dems together can’t stop spending, and us voters can’t stop electing them for doing so. But big cuts to Medicare during this war that Bush gets lambasted for so often? That’s political suicide. And, like I said, the current deficit the last few years has nearly all been the war on terrorism. Without it, budget is balanced, due to tax cuts.

    Yes, we need more spending cuts, but a healthy economy spurred by tax cuts is the best way to raise money.