In classical economic theory markets are supposed to be self-regulating. Individuals pursuing their own self-interests are believed to promote the general good of the whole community by a process Adam Smith dubbed the “invisible hand.” While the idea is sound in principal and when applied to “ideal markets” in practice, when applied to real markets, there are problems with the theory that some economists believe can only be addressed by the government through the tools of fiscal policy.
According to this theory the tools that the government in a market economy has at its disposal fall into two categories, monetary policy, which includes such things as tax measures, bank reserve requirements, interest rates and fiscal policy which means government spending. The term “economic stimulus” refers to the use of these tools to help support or revive an economy in recession.
For our purposes a recession may be defined as a condition which exists when supply exceeds demand. In recent years the government response to such a “slow down” in the economy has centered on lowering interests rates and cutting taxes, both of which increase the supply of money available to the consumer and thereby stimulating demand.
In the current crisis, however, such a policy is not believed to be workable. The Federal Reserve Bank has already cut interests rates to almost zero, so there are no further cuts possible. This situation is known as a “liquidity trap.”
In such a situation some economists believe that the government must turn to its other economic tools, specifically fiscal stimulus which, according to the New York Times, the Congressional Budget Office defines this way; “Fiscal stimulus aims to boost economic activity during periods of economic weakness by increasing short-term aggregate demand."
The belief is that in the short run more government spending on goods and services will increase demand, prevent layoffs and stimulate spending by the private sector.
The way this is supposed to work is that spending on public works creates contracts for firms who in turn provide short to medium-term employment. An additional benefit is that once the infrastructure projects are complete they provide business with improved communications and lower transportation and energy costs.
Investment in scientific research and technological development are believed to foster innovation and develop new industries, which in turn employ new workers.
It is the intent of the current stimulus package, known as the “American Recovery and Reinvestment Bill, is to use a combination of monetary and fiscal policies to stimulate employment in critical sectors of the economy and to increase consumer spending. It allocates $550 billion for spending on new projects and $275 billion in tax cuts.
Specifically, the bill intends to do this by putting “…people back to work today and reduce our dependence of foreign oil tomorrow” by spending to transform the energy transmission, distribution and production systems, increase spending on scientific research and expand broadband internet access, repair and modernize roads, bridges, public transit and waterways, expand spending for public education, cut taxes on middle income earners and small businesses, lower healthcare, extend unemployment coverage and increase funding for food stamps.
Otto Von Bismarck observed that “politics is the art of the possible.” While the theory behind the stimulus seems, sound the harsh reality of partisan politics in Washington, combined with President Obama’s attempts at bipartisanship, which have been dramatically spurned by the Republicans, has had a deleterious effect on the final bill that passed the House and Senate and was signed into law.
For one thing, it is far too small and too much of it has been wasted on tax cuts in an effort to woo Republican support. While $787 billion seems like quite a bit of money it is inadequate to plug what Nobel Prize winning economist Paul Krugman calls a “well over $2 trillion hole” in the economy.
For another thing an unduly large portion of the bill has been “squandered” on tax cuts which are likely to have very little impact in the short run in stimulating consumer spending or in stimulating the economy. According to Moody Investor’s Service, tax cuts are among the least simulative part of the bill with each dollar in tax cuts generating only $1.02 in stimulus compared to $1.59 for infrastructure projects and $1.79 for food stamps.
As if that were not bad enough it would appear that many Republican lawmakers are using the current crisis to score partisan political points. Although the Republicans had a hand in crafting both the House and Senate versions of the bill, House Republicans voted unanimously to reject it and only three “moderate” Republican senators could be persuaded to sign on to that version.
One can speculate as to their motives for such behavior. It has been suggested that this tactic was based on a belief that the bill would pass with or without their votes and by voting against it Republicans were positioning themselves to claim, in the event the bill succeeds in stimulating the economy, that “natural market forces” were the real cause for the recovery, and if the plan fails they can claim that they had been right all along.
It would appear that not only are Congressional Republicans using the current economic crisis to make political hay, but that many Republican governors are likewise adopting obstructionist policies predicated on short term political gains at the cost of the long run welfare of their constituents. Governors like Bobby Jindal of Louisiana and Mark Sanford of South Carolina have vowed to turn back money to help pay unemployment benefits for their state’s growing jobless population.
They justify this behavior by claiming that new federal rules that come with the money are aimed at extending unemployment protections to jobless low-income workers who are currently shut out of compensation, would place an “undo burden” on the state’s taxes once the money runs out in three years.
Thus far, these tactics do not appear to be working in the Republicans’ favor. After a month in office President Obama’s poll numbers are still in the high seventies while Republicans have seen their numbers go into freefall in recent weeks. A recent New York Times/CBS News survey found that 8 out of 10 Republican voters disapproved of their lawmakers behavior and believed that “the party should be working in a bipartisan way.”
The consequences of the stimulus package are dire for the American economy, at least in the short run since we can expect to see unemployment rise and, as a consequence, demand fall even further. Bankruptcies, home foreclosures, and failing businesses will all follow in the train of stimulus failure. As America goes, so goes the world, which would mean that the failure of the American plan would reverberate throughout the world economy and might, possibly, trigger an even deeper world wide economic crisis.
Win or lose, however, the stimulus will further increase the national debt and raise the risk of foreign debt default. President Obama is well aware of this and of the long term threat to the American economy of maintaining the current massive debt load that America currently labors under.
Those who say that sooner or later the natural forces of the economy will “fix the problem” are right, up to a point. Demand has not ceased during the current crisis, it has only been deferred. While Americans are not currently buying cars in any great numbers cars, eventually wear out and will need to be replaced, as will household appliances, clothes, housing stocks and all the other goods and services that go to make up the current “American lifestyle.”
Sooner or later the economy will begin to grow again on its own. However, sooner would be better than latter and, flawed though it may be, the current stimulus package provides our last, best hope for a speedy recovery.
When that happens it will be vital to pay down the national debt, which is a major drag on the economy and an important culprit in the current tax rates, which could be lowered if we did not have to service the interest on the debt.
Politically the success of the stimulus would cement the Democratic majority in Congress and strengthen the Democratic hold on the White House, with all the social and political consequences that implies. Failure, however, while bad for the average consumer, may not have the political effects many Republicans hope.
Since their actions in opposing the stimulus bill have been seen by most voters as obstructionist, and their behavior in general as partisan in the face of a President who has gone out of his way to be bipartisan, rightly or wrongly failure of the stimulus could be laid at their feet. One can imagine Democratic pundits saying “the bill would have worked but for Republican obstruction.”
However this plays out the next few years should be very interesting for students of economics. Interesting, but stressful. The Chinese scholars knew what they were saying when they cursed someone by saying “may you live in interesting times.”