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First Stimulus, We Hardly Knew Ye

Friday, July 10, 2009

The first stimulus was controversial among economists; it seemed to discard a great deal of what had been learned about macroeconomics in recent decades. The calls for a second stimulus seem to discard logic altogether.

As unemployment rises ominously toward 10 percent and the economy continues to appear listless, leading economic voices have begun to call for a second fiscal stimulus. The first stimulus was controversial among economists; it seemed to discard a great deal of what had been learned about macroeconomics in recent decades. The calls for a second stimulus seem to discard logic altogether.

To see why, let’s go back to the promising days just before President Obama took office. The economy was in trouble and his economic planners were given the urgent task of reviving it through fiscal stimulus. Let’s assume that they were entirely immune to parochial spending concerns and were simply looking for the best way to rev up economic activity.

Fairly early on in the process, there was rough agreement on a total stimulus cost of near $800 billion. The question was how best to spend this sum. Ideally, given the urgency of the crisis, it would all have been spent in 2009. That would have provided the strongest possible jolt to the economy and perhaps set us back on track. Had such a path been followed, we might have expected that roughly $400 billion would have been spent by mid-year.

There is no economic theory by which spending money years down the road stimulates the economy now. There is a theory by which it hurts.

Instead, we see now that just over $100 billion has been doled out. Why so little? The planners faced some tough choices. Tax cuts or direct transfers could get the money out more quickly, but the planners worried this money would just be saved, not spent. There is only so much money one can devote to extended unemployment insurance. Transfers to states were also fast, but seemed to reward the profligate. The discretionary project spending that was most appealing to the planners––roads, bridges, energy infrastructure––takes a long time to get going.

There was a real preference among the Obama team for the project spending, but also a real constraint on how quickly it could be disbursed. That constraint was so binding that only about half of the project money is due to go out even by the end of 2010. Of course, the planners would have liked to have gotten that money out faster; they just couldn’t.

So now we come back to discussions of a second stimulus. We have presumably exhausted all reasonable possibilities for discretionary project spending in 2009 and 2010. We know this because we’re still planning to spend hundreds of billions of stimulus dollars in 2011 and beyond.

We have presumably exhausted all reasonable possibilities for discretionary project spending in 2009 and 2010.

There is no economic theory by which spending money years down the road stimulates the economy now. There is a theory by which it hurts: it stokes market concern about debt and drives up interest rates in the present. In fact, interest rates did rise fairly dramatically in the wake of the stimulus package, slowing an essential revival in the troubled housing market.

The extent of spending in 2011 and beyond under the initial package can have one of two interpretations. Either this was the excess that spilled over after all sincere attempts at near-term stimulus were exhausted, or there was a serious misallocation of resources in the initial plan.

And this is exactly the logical problem with a second stimulus. If we accept the premise that the Democrats did the best that could be done and exhausted all stimulative spending possibilities for 2009 and 2010 on their first try, then there’s nothing left to be done in a second stimulus. Additional spending would just pour uselessly into the out-years. If there are still good near-term options available to be funded by a second stimulus, that just speaks to the poor design of the initial stimulus package that passed them over in favor of ineffectual spending years later.

Neither of those possibilities argues for opening up the public coffers for hundreds of billions of dollars more.

Phil Levy is resident fellow at the American Enterprise Institute.

Image by Dianna Ingram/Bergman Group.

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