January 18, 2009

Reason's five arguments against stimulus-by-spending

There are two basic tools of fiscal policy that a government can use to stimulate the economy: increase spending and decrease tax rates. Because, given the sorts of things the government spends money on, it puts money more or less immediately into the hands of workers, increased spending is often called a `demand-side' stimulus; this is the centrepiece of a Keynesian approach to economic stimulus. And, because the proposed taxes to be cut are often capital gains taxes and the highest marginal income tax rates, decreases in tax rates are often called a `supply-side' stimulus.

Anthony Randazzo has five arguments against stimulus-by-increased-spending over at Reason. Let's take a look at them.

  1. Stimulus packages frequently misdirect national resources

    The argument here is that the government, because it's not omniscient like the market, doesn't know as well as the market where to invest. If the government decides to invest in, say, counting the number of gains of sand in the nation's beaches, the stimulus won't be as effective as if the money was invested in, say, rebuilding aging bridges so they don't fall down. The market, by contrast, will use price signals to direct money to the areas where it can be most effective.

    There are two problems with this argument. First, the basic structure of the business cycle shows that the market is not omniscient, especially in the short term. You might argue that the two bubbles we've seen over the last ten years or so (the stock bubble connected with the dot-com boom, and the housing bubble) are caused, in part, by government mismanagement of the economy. Monetary policy could, and should, have been used to make it harder to get a mortgage (by increasing interest rates) several years ago. But the housing bubble came into existence in the first place by virtue of the simple fact that a lot of people had the profoundly irrational belief that housing prices would never, ever go down under almost any circumstances. Similarly, Alan Greenspan called the dot-com bubble `irrational exuberance'. This isn't to say that the government always does better than the market, or anything along those lines. It's just to say that the market is not, in fact, omniscient.

    Second, and more importantly, this argument fails to understand the economic diagnosis, and proposed treatment, of a Keynesian stimulus plan. The fundamental problem with our economy is not that people want to buy lots of a certain kind of widget, but there aren't enough of these widgets around for them to buy. It's not, in a word, undersupply, to be corrected by encouraging the production of the highly valuable but scare commodity. Indeed, our problem is exactly the opposite: we have too much supply, and not enough demand. Commodities are sitting around, unsold, due to a vicious combination of fear and unemployment. (Remember FDR's inaugural? `The only thing we have to fear is fear itself' was -- and is -- exactly the problem.) Hence, the increase in production is actually entirely incidental. It doesn't matter what people are doing to get the government money. The nice thing about building bridges and repairing school roofs -- as opposed to counting the grains of sand -- is that, afterwards, you have some brand new, durable, public goods. But the value created is, again, an entirely incidental benefit. What you're really doing is giving people money to spend.

  2. Stimulus packages don't increase aggregate consumption

    The argument here, in its entirely, is as follows: `In order to inject money into the economy, the government has to take money out of the economy. Whether by increasing taxes, national debt, or printing the money (growing inflation), the government has to damage long-term wealth in order to provide short-term economic activity.'

    I don't see any charitable way to interpret this argument. In theory, a Keynesian government uses deficit spending to stimulate the economy during a bust; Randazzo has that part right. But -- assuming the stimulus works -- the economy will be booming again before too long. At that point, between the increased tax revenue (because the economy is booming) and the decreased spending (because the stimulus spending is a short-term thing), the government is able to pay down the accumulated debt. Similarly, if the government prints money to pay for the stimulus, the result is inflation, but the idea is that the economy will eventually grow fast enough to balance out the harmful effects of inflation.

    You might object that, as a matter of fact, the government will not reduce spending as the economy booms -- the sand-counting firm enjoys a pretty lucrative contract, so they pay off members of congress and senators to keep the contract going, or some such -- but this isn't what Randazzo is arguing (that's argument 5). He's making a purely economic argument. But then he has to assume that the stimulus will be unsuccessful, which makes it question-begging.

  3. Stimulus packages don't create sustainable jobs

    Here Randazzo argues that, since stimulus spending in short-term, the contracts are for short-term jobs, and hence the people hired to perform the work won't expect any kind of long-term security. So the stimulus spending doesn't actually escape the cycle of fear and hoarding -- workers will just take the government money and hide it under their mattresses, saving for the day their short-term jobs end.

    This is a good argument, actually. It's an entirely legitimate way in which demand-side stimulus can fail to work. But there are two reasons I don't find it persuasive in the case of Randazzo's article.

    First, a supply-side stimulus proposal (lowering capital gains tax rates, for example) would be vulnerable to exactly the same problem. The only difference is that, instead of working-class people hoarding their money and not spending it on consumer goods, you can imagine capitalists hoarding their money and not spending it on new business ventures. Randazzo doesn't give any reason to think that a tax cut proposal would do any better on this front than a spending proposal.

    Second, the way to prevent this failure is for Obama and his economic advisors (and other people who know a lot about the economy) to say lots of positive, optimistic things about the stimulus plan. It doesn't really matter whether the stimulus money goes directly toward creating long-term or short-term jobs, just like it doesn't really matter whether it's used to build bridges or count sand. The goal is to get consumers spending, and the hope is that, once consumers are spending more, the usual engine of economic activity will finally catch and restart.

  4. Stimulus packages increase national debt or cause rapid inflation

    This argument doesn't seem any different from argument 2. The only thing I would add here is that since we're currently experiencing deflation*, which is far, far worse than even moderate inflation, funding the stimulus by printing money isn't an idea to be dismissed out of hand.

    * To read that chart: The number in each box is the percent change in prices for a fixed bundle of goods since, like, 1982. So an increase in the number from month to month is inflation, while a decrease is deflation. Notice that we've been experiencing deflation since last July, to the point where inflation over the last year has been basically zero.

  5. Stimulus packages are pork-laden and caught up in federal bureaucracy

    This is another good argument. Like 3, it expresses a real practical worry that must be kept in mind when designing the stimulus package. Fortunately, once again, it doesn't really made what the money is used for, so long as it gets into consumer's hands, and they turn around and spend it.

    There is something a little disturbing about the projects Randazzo identifies as pork, though. In particular, he derides proposals to build `[d]uck ponds, dog parks, sports parks, tennis centers, and swimming pools'. I don't think of the creation of parks and public spaces as pork. These are things that everyone -- or at least a large swath of the citizenry -- can use and enjoy. How is it wasteful, or a mismanagement of public funds, to build and maintain public spaces?

So, all together, I think Randazzo has a couple legitimate worries about the actual design and implementation of the stimulus plan. But the best way to avoid these problems is to have an honest and thoughtful public discussion about how it's supposed to operate -- and how things can go wrong. And then, of course, for the people to keep an eye on their public officials, and make sure the money is going where it's supposed to be going. In a order, the stimulus needs to be handled democratically.

Finally, Randazzo says a few things that suggest he thinks a spending-based stimulus and a tax-cut-based stimulus are mutually exclusive -- you can do either one or the other, but not both. But this is not the case. There's an important technical debate over which we can expect to be more successful -- but why not try a mix of both?


MC Shalom said...

Chairman Ben S. Bernanke, You Bail Out, We Opt Out.

All of Our Economic Problems Find They Root in the Existence of Credit.

Out of the $5,000,000,000,000 bail out money for the banks, that is $1,000 for every inhabitant of this planet, what is it exactly that WE, The People, got?

They Bail Out, We Opt Out

Opting Out Is Completely Anonymous.

The Credit Free, Free Market Economy

Is Both Dynamic on the Short Run & Stable on the Long Run, The Only Available Short Run Solution.

I Propose, Hence, to Lead for You an Exit Out of Credit:

Let me outline for you my proposed strategy:

Preserve Your Belongings.

The Property Title: Opt Out of Credit.

The Credit Free Money: The Dinar-Shekel AKA The DaSh, Symbol: - .

Asset Transfer: The Right Grant Operation.

A Specific Application of Employment Interest and Money.
[A Tract Intended For my Fellows Economists].

If Risk Free Interest Rates Are at 0.00% Doesn't That Mean That Credit is Worthless?

Since credit based currencies are managed by setting interest rates, on which all control has been lost, are they managed anymore?

We Need, Hence, Cancel All Interest Bearing Debt and Abolish Interest Bearing Credit.

In This Age of Turbulence The People Wants an Exit Out of Credit: An Adventure in a New World Economic Order.

The other option would be to wait till most of the productive assets of the economy get physically destroyed either by war or by rust.

It will be either awfully deadly or dramatically long.

A price none of us can afford to pay.

“The current crisis can be overcome only by developing a sense of common purpose. The alternative to a new international order is chaos.”

- Henry A. Kissinger

They Bail Out, Let's Opt Out!

If You Don't Opt Out Now, Then When?

Let me provide you with a link to my press release for my open letter to you:

Chairman Ben S. Bernanke, Quantitative [Ooops! I Meant Credit] Easing Can't Work!

I am, Mr Chairman, Yours Sincerely,

Shalom P. Hamou AKA 'MC Shalom'
Chief Economist - Master Conductor
1 7 7 6 - Annuit Cœptis
Tel: +972 54 441-7640

Buy Cialis said...

the only problem with this is, is that government only want to make money, so them don't care if you are spending your money in many things, you have to pay your taxes and each day is more and more money.

www.palencia-3d.com said...

A great deal of effective info for me!

How to Make Your Hair Grow Faster said...

i do not know much about economy, but what i think is that if the government care for their country , they will reduce tax... period..

Find info on How To Make Your Hair Grow Faster Tips from my blog !!