Economist Debates: Fiscal stimulus: Statements

Economist Debates: Fiscal stimulus: Statements This house believes that America needs substantial new fiscal stimulus.

The status: by Greg Ip

Does America need another fiscal stimulus? In a few weeks' time Barack Obama will urge Congress to give the economy an added boost, such as by extending a payroll tax cut and enhanced unemployment insurance benefits. Republicans in Congress sound sceptical.

It is remarkable that two years after the official end of the recession we are even having this debate. Recovery from the worst recession and financial crisis in over 60 years was bound to be slow, yet it has been shockingly so. Real GDP has grown at just a 2.5% annual rate since mid-2009 and has yet to attain its pre-recession peak. In the first half of this year, it has slumped to about 1%. This is in spite of the Federal Reserve lowering short-term interest rates effectively to zero and implementing two rounds of "quantitative easing"—that is, buying government bonds with newly printed money to drive down long-term interest rates as well.
And, of course, there is Barack Obama's stimulus, passed in early 2009, worth some $830 billion, since supplemented with various extensions and expansions such as the payroll tax cut, which expires this December.

The paucity of results naturally raises a question: does such stimulus work? And should we have more of it? So many factors affect the broad economy that it is impossible to definitively identify the effect (or lack of it) of macroeconomic policy.
Economists divide into two schools on this question. One blames the lack of more encouraging results on the magnitude of the headwinds the economy faces, and argues the right response to the current bout of weakness is more stimulus.

There is certainly circumstantial evidence for this. The GDP revisions show that the economy had fallen even further during the recession than the Obama administration realised at the time of its first plan. Moreover, many of the underlying causes of the crisis have yet to be cured: house prices are still under pressure, and some 23% of homeowners owe more on their mortgage than their home is worth. To make matters worse, Middle East unrest jolted oil prices this year while a tsunami and earthquake in Japan severely disrupted supply chains.

Richard Koo belongs to this first school, and argues in favour of our proposition. His analysis is shaped by the experience of Japan in the past two decades. Like Japan, America has experienced the collapse of an asset bubble. Because its private sector is trying to chisel away at debts accumulated during the inflation of that bubble, it is reluctant to take on additional debt no matter how low interest rates are. "Since the government cannot tell the private sector not to repair its balance sheets, the only way for the government to keep the economy from collapsing is to borrow and spend the unborrowed savings in the private sector and put them back into the economy's income stream," he writes in his opening statement.

In the second school are sceptics who say the economy has shown so little response to the massive injections of stimulus because it was badly designed and flouted some elementary principles of human behaviour. First, the bureaucratic delays inevitable when executing even "shovel-ready" projects mean that much of the money took too long to be spent, or has not been spent at all. Meanwhile, temporary tax cuts were as likely to be saved as spent, as a large body of literature would predict.
Second, by adding to the nation's already crippling debt load, the stimulus would have naturally led households to conclude that their taxes were going to go up. So they simply saved more, thus offsetting the purpose of the stimulus.

Finally, sceptics add one more indictment of the stimulus: by expanding the welfare state, it added to a pervasive and suffocating atmosphere of uncertainty that has discouraged business from hiring and investing, and individuals from making big purchases.
If they are right, another stimulus package would be not only a waste of money but also potentially counterproductive. Allan Meltzer of Carnegie Mellon University makes this point in his opening statement against the proposition. "It is not enough to point to the number of unemployed and part-time employed to claim that something must be done," he says. "Mistaken actions do much more harm than good in part because they destroy confidence."

I hope you will read these two statements carefully and make your own comments. We will be highlighting excerpts from these comments as well as soliciting the opinions of thoughtful outsiders. In a few days Mr Koo and Mr Meltzer will rebut each other's opening statements, and then we will get their closing statements—just in time to help Mr Obama and Congress decide what to do