Wednesday, November 26, 2008

Fiscal Stimulus: Permanent, Pervasive, Predictable versus Temporary, Targeted and Timely

The incoming Obama administration and congressional Democrats are now considering a second fiscal stimulus package, estimated at more than $500 billion, to follow the Economic Stimulus Act of 2008. As they do, much can be learned by examining the first.

The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart above reveals the answer.

The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July. The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

What are the implications for a second stimulus early next year? The mantra often heard during debates about the first stimulus was that it should be temporary, targeted and timely. Clearly, that mantra must be replaced. In testimony before the Senate Budget Committee on Nov. 19, I recommended alternative principles: permanent, pervasive and predictable.

The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.

~Stanford economics professor John Taylor, in yesterday's WSJ

On Greg Mankiw's blog, others have suggested that the fiscal stimulus will be: a) pointless, political, and pork-filled; b) clumsy, corrupt, and counterproductive; or c) expansive, extensive, and expensive.


At 11/26/2008 9:39 AM, Anonymous Anonymous said...

The problem now is too much debt at all levels business, consumer and government. The government can borrow the money from foreigners or is now likely to soon be the case just print it but by doing so the debt increases. This country need savings and goods and services that can be used to pay the debt.
The government can stimulate all they want and it is only going to make the problem worse.

At 11/26/2008 9:57 AM, Blogger K T Cat said...

The fellow who runs the UK Housing Bubble blog had a short description of the world where Keynes grew up. Governments were much smaller back then. The fundamentals of the economy are so much different than they were in Keynes' time that applying his theories, however valid they used to be, doesn't seem to make sense now.

At 11/26/2008 11:07 AM, Anonymous Anonymous said...

Calling this stimulus which enriches the few and gives the illusion of helping the masses while burying future generations under a pile of government debt should be called what it is Rape.

At 11/26/2008 11:29 AM, Anonymous Anonymous said...

so if I go out and max out my credit cards tomorrow - have I stimulated myself?

where do I send the bill?

any volunteers to pick up the tab?

I think it would be patriotic of the Democratic party to pay for my Christmas shopping. I'll be out early tomorrow, so have your check book handy.

At 11/26/2008 11:49 AM, Anonymous Anonymous said...

The cost of hedging against losses on U.S. Treasuries surged to an all-time high after the Federal Reserve’s new $800 billion effort to combat the financial crisis raised concern about how the ballooning debt will be funded.

Benchmark 10-year credit-default swaps on U.S. government bonds jumped six basis points to 56, according to CMA Datavision prices at 12:20 p.m. in London. The contracts have risen from below two basis points at the start of the credit crisis in July 2007.

“There is a lot more money to be spent and it is not clear how it is going to be financed,” said Tim Brunne, a Munich-based credit strategist at UniCredit SpA. “Credit spreads don’t reflect expectation of default, just the uncertainty over the enormous cost to the government.”]

Printing press is how it will be finanaced.

At 11/26/2008 12:18 PM, Blogger PeakTrader said...

Real GDP did spike higher in the second quarter of 2008, and the chart shows aggregate demand did flatten and then fall shortly after the rebates. So, the fiscal stimulus must have had a positive effect on the economy.

I'd be interested what individuals or households actually did with their stimulus checks. A random sample of how the rebates were used should add more information.

At 11/26/2008 2:32 PM, Blogger Arman said...

The fundamentals of the economy are so much different than they were in Keynes' time that applying his theories, however valid they used to be, doesn't seem to make sense now.
Keynes success was not in his ability to comprehend, but in his ability to convey his ideals into his students and into the political mainstream. He never did make any sense.
The government can borrow the money from foreigners...
The debt is in the money and held by the people who accept the money. Debts to foreign banks will transfer to the US bank system when the check is deposited. The foreign bank will owe the US bank just as the government owes the foreign bank. The debt follows with the money. This strains the US bank's willingness to lend, and so makes consumer and commercial loans less available. I have heard that credit cards are shrinking their limits as they are paid. Government borrowing makes consumer borrowing less available.
Government bailouts are NOT conducive to a stable economy, and neither is the cutting of interest rates.

At 11/26/2008 6:38 PM, Blogger Rui Yu said...

There has been too much demand for loans, cars, mortages...therefore, we need more demand!

At 11/26/2008 9:22 PM, Blogger PeakTrader said...

A study of the 2001 Bush tax cut suggests expansionary fiscal and accommodative monetary policies have positive effects on the economy and can help smooth-out the business cycle:

In a new paper, Sumit Agarwal of the Chicago Fed, Chunlin Liu of the University of Nevada, and Nicholas S. Souleles of Wharton used data from 75,000 credit card accounts as a proxy for what tax filers did with their rebates.

Standard economic theory tells us that consumers smooth their spending habits over a lifetime. Part of what that means is when consumers receive a temporary spike in income, spending shouldn't necessarily rise because rational humans would be expected to keep that extra money around for less luckier times.

The trio found that consumers did initially save some of the rebate by paying down debt, but then increased spending by an average of $200 in the following nine months. They also found that consumers without easy access to credit (likely to be lower income) were much more likely to spend their refund (average expenditure here was estimated at $333) while the more well-off were more likely to save theirs.

At 11/26/2008 11:54 PM, Anonymous Anonymous said...

My "stimulus" was diverted and applied to student loan debt - instead of cash I received a form letter indicating where the money went.

Did that count as disposable income?

If so, I had a darned good reason for not spending it.

At 11/26/2008 11:59 PM, Anonymous Anonymous said...

Acton said:

There has been too much demand for loans, cars, mortages...therefore, we need more demand!

Since I can't get any of those things, I could argue that what is needed is more supply, not more demand.

At 11/29/2008 10:03 PM, Blogger crestcap said...

One element of the Economic Stimulus Act of 2008 that is often overlooked is the expanded limits of Section 179 intended to help small business. I work in the equipment finance industry, and from my perspective the ESA was serving as a stimulate equipment sales earlier in the year - but as we get closer to year end and the economic outlook for 2009 looks bleaker - equipment sales are dwindling.


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