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Stimulus Spending as Deficit Reduction: An Idea that Just Needs to Die



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Both the Schakowsky deficit reduction plan, which I wrote about today, and the Rivlin-Domenici plan, which Veronique wrote about below, call for increases in Keynesian stimulus spending to happen immediately, right now, as an essential step in the struggle to get deficits under control eventually. Their arguments rest on one correct assumption and two incorrect ones: While it is true that restoring economic growth will make the task of reducing the deficit much easier, it is not true that short-term bursts of fiscal stimulus will get us there, and it is crazy to think that the 112th Congress will do more fiscal stimulus.

But let’s assume for arguments’ sake that some amount of short-term fiscal stimulus can produce lasting growth and that Congress could be persuaded to pass another stimulus bill. Even if we made those assumptions, it would appear that neither the Schakowsky nor the Rivlin-Domenici stimulus proposals would provide enough fiscal stimulus to get the job done — at least not according to Paul Krugman, a.k.a. the stimulus lover’s stimulus lover.

Krugman is an ardent proponent of the idea that the trillion-plus we have spent on stimulus since early 2008 was far too little to get us to that magical tipping point where short-term stimulus begets sustainable growth. And the figure he relies on when making that argument is the CBO’s output gap, which represents the difference between real GDP and the CBO’s estimate of what GDP would be if all the nation’s underutilized resources were fully employed. According to the CBO, we had an output gap of about $2 trillion over the two-year period covered by Obama’s stimulus bill, and according to Krugman, that means the stimulus bill should have spent $1.2 trillion, because, if you make some optimistic assumptions about Keynesian multipliers, then that would have filled the gap.

The CBO’s output gap remains wide, which is why Krugman thinks our next grand adventure in Keynesian fiscal stimulus needs to be on the order of $1 trillion, at least. But the Schakowsky plan only calls for about $200 billion in new stimulus, and the payroll-tax holiday called for in the Rivlin-Domenici plan would only provide a jolt of $650 billion. And again, all of this assumes that lots of people are going to make big decisions with long-term implications — such as how many workers to hire or fire — based on temporary policies. If the people who are praising the stimulus ideas in the Schakowsky and Rivlin-Domenici plans subscribe to the Krugman view that the last stimulus wasn’t big enough, then they’re not being consistent: Neither of the stimulus plans they’re embracing now would be big enough, either. And if they don’t subscribe to the Krugman view regarding output gaps and the need for a WWII-sized stimulus package, then what’s their explanation for why the first stimulus failed? 



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