2009-02-05

On The Stimulus Plan: Note to Washington, “There is No Spoon”

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For the past few weeks I’ve been trying to follow the debate surrounding Obama’s “bipartisan” stimulus package, and found it to be exceedingly hard to cut through the noise. The constant revisions, the inclusion of additional tax breaks to appease the right, the debate over "shovel ready" infrastructure projects, and all the experts weighing in on the matter have only further complicated any reasonable person's ability to have an informed opinion.

Yet despite all of the knowledge out there ready to be digested, it appears that this has all been an exercise in reaffirming each of our preconceived ideas on the issue (a problem I've addressed before). Case in point, a recent Rasmussen poll found that support for the bill is decreasing yet 64% of Democrats still support the proposal, compared to only 13% of Republicans and 20% of people unaffiliated with either party.


Stimulus Truthiness or Economic Tom-Foolery


The stimulus plan is (from what I understand) a textbook example of Keynesian economic theory in that it targets demand rather than supply. Now I’m no economist, so I’ll paraphrase Tyler Cowen who states that classical economic theory relies on the notion that the economy will right itself during a depression when prices adjust downwards until they reach a point where people are finally stimulated to reenter the market. Keynes' theory turned that on its head in the 1930’s by stating that during a time of depressed demand, there is a break in the natural supply & demand relationship and that the government should step in to fulfill the role of the consumer through increased spending. The current projected gap between fully employed output and actual output is around $1 trillion (this is where the idea of a very large number comes into play), yet a stimulus need not be that high due to the multiplier affect… (and exhale)

The problem with the whole debate however is that when economists tweak their assumptions, the stimulus will result in either streets paved with gold, $500 in the hands of every taxpayer, and an extra $15k for every new home buyer, or the further expansion of the welfare state and the eventual bankrupting of our once proud nation as we blindly march towards Socialism (depending on the source). Though these assumptions are cleverly disguised behind the masks of complex economic variables like the Keynes Effect, the Housework Effect, the Galbraith Effect, and the Feldstein Effect, or behind terms like the aforementioned multiplier effect and the crowding out effect, they are assumptions nonetheless.


Experts Weighing In


Now, I have absolutely no idea if the proposed stimulus plan will work as planned, however neither do guys like Warren Buffett (h/t Calculated Risk):

SUSIE GHARIB: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

WARREN BUFFETT: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it.

Or here we have the bastion of liberalism that is (Nobel Laureate) Paul Krugman explaining why traditional monetary policy will not work this time:
In 1982, interest rates — elevated in part thanks to high expected inflation, in part because a tight-money policy was what caused the recession — were high. This meant that conventional monetary policy had plenty of room for action, and thus offered an adequate response to the slump.

Today, however, with expected inflation roughly zero and a recession that is the fruit of past irrational exuberance, conventional monetary policy has run out of room. That’s the point of the Goldman Sachs exercise, shown below, which asks what the familiar Taylor rule would prescribe for monetary policy over the next few years; the answer is a Fed funds rate of -6, which isn’t possible.

Some Republicans are even saying that the bill doesn't go far enough and are calling for drastic increases in infrastructure spending. Here is the ranking Republican on the transportation committee Rep. John L. Mica proving this point:

"They keep comparing this to Eisenhower, but he proposed a $500 billion highway system, and they're going to put $30 billion" in roads and bridges, he said. "How farcical can you be? Give me a break."


Even Obama himself took to to the Washington Post today to plead his case:

...if nothing is done, this recession might linger for years. Our economy will lose 5 million more jobs. Unemployment will approach double digits. Our nation will sink deeper into a crisis that, at some point, we may not be able to reverse.

That's why I feel such a sense of urgency about the recovery plan before Congress. With it, we will create or save more than 3 million jobs over the next two years, provide immediate tax relief to 95 percent of American workers, ignite spending by businesses and consumers alike, and take steps to strengthen our country for years to come.

This plan is more than a prescription for short-term spending -- it's a strategy for America's long-term growth and opportunity in areas such as renewable energy, health care and education. And it's a strategy that will be implemented with unprecedented transparency and accountability, so Americans know where their tax dollars are going and how they are being spent.



My Take


The current plan will prove to be an imperfect answer to our current situation; this seems to be the best case scenario. Our economy has become increasingly reliant upon consumer spending (~70% of GDP), and we are now faced with the inevitable fact that our spending habits cannot be sustained. This is why, at first blush, I tend to agree with Republicans that adding to the $1.2 Trillion deficit is in a sense "borrowing our way out of debt." But then I remembered that these were the same people who created the large deficit in the first place, so what do they know about fiscal responsibility other than to not to give money to Democrats.

As consumers continue to delever due to the collapse in housing and the debt to GDP ratio reaching astronomical levels, a recession appears to be inevitable. And though our economy may continue to falter throughout 2009, the bottom line is that something must be done. The good news is that the current version of the bill will, according to the Congressional Budget Office report, should raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011. That is a reality I can live with.

So while Congress reads tea leaves works tirelessly to figure out which plan will provide the perfect jolt to our economy (through a hybrid approach of $900 billion in increased spending and tax breaks), the truth in fact may be that "there is no [perfect answer]". If we can get them to agree on that much, perhaps we can avoid a total economic collapse and maybe even improve our country's infrastructure as a nice side-effect.


Thoughts?


*Click here for a breakdown of the stimulus bill

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