The current debate about the Obama administration’s $850 billion fiscal stimulus plan propagates such misconceptions that I feel compelled to put aside my general skepticism about how well such Keynesian policies work in the real world and explain—and even defend—this particular package.
The plan seems destined to pass, with Thursday’s House approval of an $819 billion version, largely on partisan lines, getting it halfway through Congress. The Senate is expected to approve it this week. Then, over time, we will see its actual effects. Meanwhile, Americans need to understand how countercyclical policies— those designed to counter extremes of the business cycle – like this one are intended to work and what they are intended to accomplish. There are at least two issues on which there is much confusion:
Issue 1 — Does some spending stimulate and other spending not? Opponents of the administration’s plan argue that it includes spending that won’t provide any economic stimulus. House Minority Leader John Boehner, a Republican from Ohio, cited a line for broader Medicaid provision of birth control. “How can you spend hundreds of millions of dollars on contraceptives? How does that stimulate the economy?” (This provision was removed from the House bill at Obama’s request.)
Similarly, New York Times columnist David Brooks, in a column that ran in last Sunday’s Pioneer Press, argued that “Many parts don’t even pretend to be stimulus measures.”
Both Boehner and Brooks labor under a misconception about Keynes’ ideas. They apparently assume that stimulus is limited to make-work efforts like those started by Herbert Hoover and expanded by Franklin Roosevelt. Stimulus apparently only occurs if some one can link some specific job to a specific project funded by a specific federal budget item.
But Keynes’ idea of the effects of government spending was much broader, not a one-to-one linking of outlays and jobs. Increased government spending can boost “aggregate demand,” the broad willingness and ability, across society as a whole, for households and businesses to buy things. The total amount of additional government spending is important. Exactly what it is spent on is not nearly as important, at least in terms of the stimulus effect.
Brooks cited government funding of basic research as an example of outlays with no stimulus effect. But to Keynesians, such outlays can bolster overall economic activity as much as an equal amount spent on a new bridge – or on contraceptives.
Yes, money should be spent as wisely as possible in terms of producing public goods and services that benefit society. But that is a separate issue from general boosting of an economy that is falling into recession.
Issue 2 – Can counter-cyclical policies make an economy grow faster? Some conservative think tanks argue that a stimulus package is doomed to failure because economic growth can only come from increased productivity, in other words from more output per worker, and that additional federal spending does not increase productivity.
This is true over the long run. Government spending in general cannot increase the long-term growth rate of a nation. But when a nation is in serious recession, when many resources, both human and capital, are standing unused, then increased government spending can indeed foster greater output by putting idle resources back to use. And we clearly have increasing levels of idle resources right now.
When Adolf Hitler came to power in Germany, unemployment in that country was high. Factories and mills stood idle. Enormous increases in military spending rapidly put those labor and physical capital resources back to use. Germany quickly left the Depression behind while Britain, which did not start to rearm until 1938, and the United States, where FDR’s ill-fated effort to balance the budget in 1938 stunted recovery, did not do nearly as well.
Some German spending happened to be on labor-intensive initiatives. Some was not. But it was the overall level of spending rather than its specific allocation that accelerated the German economy.
One can find examples, such as 1930s Germany, where increased government spending clearly ended severe recession as a side effect of reaching another goal. It is much harder to find examples of where overt Keynesian micromanagement of garden-variety recessions accomplished much. Indeed, research by Christina Romer, a Berkeley professor who now heads Obama’s Council of Economic Advisors, found that fiscal stimulus efforts generally accomplished little.
Does that mean the administration’s stimulus plan is a bad idea? I’d say no, because we don’t face a garden-variety recession right now. Many indications point to the broadest and deepest economic slowdown in 80 years, one substantially more severe than any in the 1970s or 1980s.
In 1936, Keynes noted that a Depression-weary world was receptive to new ideas. “At the present moment people are … particularly ready to receive it, eager to try it out if it should be even plausible.” The administration’s fiscal stimulus package is far from a slam-dunk. But it is plausible and the likely potential benefits outweigh the possible costs. I’d try it.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.