The Case Against Stimulus

Steve Randy Waldmann has a very good post up noting some problems with discretionary fiscal stimulus. I recommend it to one and all because I think that reading the detailed case for skepticism about stimulus as a general matter only drives home how strong the case for stimulus in the current actual situation is.

This all actually reminds me of a story from my youth in the distant land of the USA. Once upon a time an asset bubble burst, but there was little leverage involved and the ensuing downturn was relatively mild. The federal reserve had room to run in terms of cutting interest rates, and the previous ten years’ worth of fiscal policy had seen a series of measures, some bipartisan (1990 & 1997) and some partisan (1993) to improve the country’s budget situation. But the newly inaugurated young president argued that the country needed to enact a large discretionary fiscal stimulus program to combat the downturn, even thought his would shatter the fragile consensus that had guided improvements in the fiscal posture. Oddly, this stimulus program would be phased in and out over a ten-year time horizon. Even odder, the nominally temporary nature of the stimulus was clearly a fraud — everybody understood that the key authors of the stimulus in fact intended the policy change to be permanent in nature.

I refer, of course, to the Economic Growth Tax Relief Reconciliation Act of 2001, a.k.a. “the Bush tax cuts,” which IIRC were roundly applauded by most of the right-of-center economists who can today be found assuming a debt-averse and stimulus-skeptical posture.

Which is just to say that in the economic policy domain, there’s always a fair number of esoteric arguments (or, to coin a phrase, bullshit) lingering around. But as Waldmann (against whom I level no such accusation) argues, fiscal stimulus really is a risky endeavor which is precisely why you don’t want to engage in it in circumstances like those of 2001. Indeed in general discretionary fiscal stimulus is not a great idea, and the smart thing to do in terms of fiscal policy is to develop better “automatic stabilizers” to mitigate the pro-cyclicality of state and local budgeting without creating terrible moral hazard problems.


But we’re not talking about the 6.5 percent unemployment of the last recession, we’re talking about 9.3 percent unemployment:

Unemployment – Google Public Data ExplorerEdit risk that resources will be misallocated by non-market means is real enough as a general matter, but when you’re talking about unemployment of 9.3 percent you can be sure that the low hanging fruit in terms of “doing this is a more valuable use of a person’s time than doing nothing” is pretty expansive. We don’t need to — indeed, shouldn’t — try to keep fiscal pumping our way all the way down to October 2000’s 3.6 percent unemployment or October 2006’s 4.3 percent. But how about back down to the 7 percent level where the economy should still have massive slack compared to recent experience? That would make a huge difference in the lives of millions of people, and would avoid massive society-wide loss of output that can otherwise never be recovered.