The Agenda

How Not to Stimulate the Economy

Paul Krugman argues that we tend to exaggerate the scale of the debt problem caused by fiscal stimulus in a liquidity trap. To summarize, fiscal expansion leads to smaller output losses than we’d see otherwise, and this in turn leads to a “crowding in” of private investment that will enhance the long-term growth potential of the economy. Higher GDP growth in the short and the long term mean that we’ll be better able to carry the debt burden.

Assuming this is true, and I think Krugman makes a reasonable case, the design of the fiscal stimulus remains relevant, i.e., how much bang for the buck are we getting in terms of smaller output losses? Desmond Lachman of AEI suggests that President Obama’s fiscal stimulus package didn’t move quickly enough. 

The degree to which unusually large gaps have been allowed to open up in the US labor market highlights how ill-designed was the Obama fiscal stimulus package. If the purpose of the US$780 billion stimulus was indeed to jump-start the economy, one has to ask why only around one third of that package was concentrated in 2009 when the economy most needed support. One also has to ask how much economic sense it made for the fiscal stimulus to rely so heavily on the sort of temporary tax cuts that were seen not to have worked in 2008 and why the package was allowed to be so laden with pork that was sure to result in very little bang being obtained for the buck.

A particularly unfortunate consequence of the Obama Administration’s botched 2009 fiscal stimulus package will be to complicate the prospect for any further fiscal stimulus in 2010. Sadly, the need for a second stimulus is all too likely in the event that the economy indeed experiences a double dip later in the year as consumer demand remains weak.

That is, the slow-working stimulus allowed unemployment to increase sharply. Once the unemployment rate takes off, it is very hard to lower it, not least if the main instrument at hand is fiscal stimulus. The president’s allies could argue that conservative Republicans are to blame, as the stimulus was loaded with temporary tax cuts in an effort to win Republican votes. This does not, however, account for the slow-moving spending initiatives that were included in the legislation.   

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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