The idea of fiscal stimulus for the U.S. economy is all the rage, but what’s been missing is a thorough discussion of all possible results.
Minnesotans testifying at a congressional hearing held in the Twin Cities earlier this week certainly seem to think the federal government needs to act, and many members of Congress agree. I tend to concur, but we need to pay some attention to details. A bad package could be much worse than no action at all.
“Fiscal” refers to government taxing and spending. “Stimulus” describes actions to speed up the growth of output and to reduce unemployment. A fiscal stimulus might be tax cuts, government spending increases or both.
Why might we need such action?
John Maynard Keynes, a 20th century British economist, argued that free markets do not necessarily maintain optimum levels of production and employment. If market economies slow, as part of the natural business cycle, government fiscal and monetary stimulus can return them to growth.
Not all modern economists agree with Keynes, and experience with Keynesian policies in many countries was mixed.
Monetary stimulus occurs when a central bank increases the money supply, which tends to force down interest rates. That’s been done: The Federal Reserve has been cutting rates since January. It probably will continue to do so in the short run.
Our political parties are falling into their usual ranks.
Democrats generally favor increasing spending, especially to those most affected by slowing. Extending unemployment compensation is one suggestion.
Republicans favor cutting taxes, especially those on corporations or on individual capital gains income.
Both sides need to keep some warnings in mind.
First, long-term policies shouldn’t be changed to fix a short-term problem. We ran budget deficits for 30 consecutive years and have only had surpluses in the last three. We shouldn’t institute new spending programs that will be difficult to reverse once the need for stimulus has passed.
Lawmakers also shouldn’t make changes in business taxes that would return us to long-term structural budget deficits once any recession is weathered. Economists who argue that a permanent cut in capital gains taxes would benefit the economy broadly may be right, but such a change should be made taking long-run costs and benefits into account and not as an emergency effort.
Second, both fiscal and monetary policy changes take time to make a difference. If effects don’t kick in until the economy is already recovering on its own, stimulus efforts may do nothing in the way of recovery and instead will fuel post-recovery recession.
Finally, whatever Keynesian theory policymakers learned in their college econ courses, Keynesian economic management has a checkered history. There were some successes and many failures.
Politics plays a part in the failures. Incumbents usually see the need for more spending and fewer taxes just before an election year, such as 2002. Presidents and members of Congress all like stepping on the stimulus gas pedal more than on the brakes.
A temporary cut in withholding tax might have the most immediate effect and reach the greatest number of people. Extensions of the usual 26-week unemployment benefit period might help individual unemployed people but would not pump much extra spending into the economy before the third quarter of 2002. That is probably too late.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.