Why What, When, and How Matters in a Stimulus Package

The House and Senate are debating their contrasting versions of a fiscal stimulus package:

WASHINGTON — The Senate agreement on a roughly $827 billion economic stimulus bill sets up tough negotiations with the House, primarily over tens of billions of dollars in aid to states and local governments, tax provisions, and education, health and renewable energy programs.

Congress is racing to try to finalize the legislation this week.

The price tag for the Senate plan is now only slightly more than the $820 billion cost of the measure adopted by the House. Both plans are intended to blunt the recession with a combination of tax cuts and government spending on public works and other programs to create more than three million jobs.

But the competing bills now reflect substantially different approaches. The House puts greater emphasis on helping states and localities avoid wide-scale cuts in services and layoffs of public employees. The Senate cut $40 billion of that aid from its bill, which is expected to be approved Tuesday.

The Senate plan, reached in an agreement late Friday between Democrats and three moderate Republicans, focuses somewhat more heavily on tax cuts, provides far less generous health care subsidies for the unemployed and lowers a proposed increase in food stamps.

Partisans and ideologues are touting the benefits of their own approaches vehemently and lambasting their foes for lack of sympathy, lack of common sense, lack of good will, or all three.

There are some who oppose a stimulus package of any sort and I’m not sure how they could be persuaded. I don’t fit into that category. I think we’re in a recession and that the conditions of this downturn are ideal for using counter-cyclical government spending to prevent economic conditions from becoming as bad as they might. But what, when, and how matter.

First, when. According to the National Bureau of Economic Research, the scorekeepers for these things, the current downturn began in 2007:

The Business Cycle Dating Committee of the National Bureau of Economic Research met by conference call on Friday, November 28. The committee maintains a chronology of the beginning and ending dates (months and quarters) of U.S. recessions. The committee determined that a peak in economic activity occurred in the U.S. economy in December 2007. The peak marks the end of the expansion that began in November 2001 and the beginning of a recession. The expansion lasted 73 months; the previous expansion of the 1990s lasted 120 months.

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion.

Because a recession is a broad contraction of the economy, not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The committee believes that domestic production and employment are the primary conceptual measures of economic activity.

The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then.

The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis. In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales. However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.

Other series considered by the committee—including real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment estimates based on the household survey—all reached peaks between November 2007 and June 2008.

The committee determined that the decline in economic activity in 2008 met the standard for a recession, as set forth in the second paragraph of this document. All evidence other than the ambiguous movements of the quarterly product-side measure of domestic production confirmed that conclusion. Many of these indicators, including monthly data on the largest component of GDP, consumption, have declined sharply in recent months.

As I read their conclusions the current recession began no later than April 2008. If past recessions are any guide that means that some sort of recovery should be in progress no later than the first quarter of 2010, when the downturn will have been ongoing more than 24 months, significantly longer than typical post-WWII economic downturns.

Whatever the virtues of largescale infrastructure programs, no such program for which spending begins in 2011 or 2012 wil have any impact whatever on economic conditions in 2009 or 2010. Consequently, I think that such spending should be dumped from the primary stimulus package to be debated as part of a second bill.

Second, how. Let’s say you’ve got two electricians who make the same income, have roughly the same skill level, and generally the same habits. If you take money away from the first electrician and give it to the second, there is no multiplier. And there’s no increase in welfare, either.

As unpalatable as going into debt is you’ve got to borrow (or debase the currency) to get the multiplier effect. But borrowing has its hazards (as does debasing the currency). Unless you’re willing to pay back pro-cyclically what you’ve borrowed counter-cyclicakly, which we’ve shown no political appetite whatever to do, borrowing in order to boost the economy during a down phase will reduce the amplitude of your up phase. And you’ll be paying for it forever.

Finally, what. Let’s take a second example. A stimulus package that gives $800 billion to one person probably won’t have as high a multiplier as a stimulus package that gives $8,000 a piece to each of 10 million people, particularly when those 10 million people are at the lower end of the economic spectrum. Why? Because those 10 million people are more likely to spend whatever you give or, at least, more likely than that lone billionaire. How high the multiplier is depends on the velocity at which the money changes hands.

However, this is where things get a bit sticky. This isn’t the 1930’s and building roads and bridges isn’t unskilled labor any more. It’s skilled labor or at least semi-skilled. I doubt that we can execute enough infrastructure projects (where infrastructure is defined as the kind of heavy construction people are imagining) to have a serious multiplier effect. And because they’re skilled or semi-skilled, the people we’ll be paying have a higher pay rate and are less likely to spend and more likely to save. That lowers the multiplier.

I believe that some sort of fiscal stimulus package regardless of its merits is a political necessity. However, we should be careful to ensure that we get the most bang for our buck that we can. To my mind that means that the ideal fiscal stimulus package would consist of extending unemployment benefits, expanding the food stamp program, and a permanent reduction in the FICA both on the employer and the employee side.

Debate the infrastructure projects in a separate bill.

Other people thinking about the same subject:

James Hamilton muses about the paradox of thrift:

What, then, do I propose? The first principle that’s quite clear to me is that drops in state and local government spending, or increases in state and local taxes, are a likely response to the current situation and are clearly counterproductive. Hence I’ve advocated ([1], [2]) additional federal borrowing in order to provide unrestricted block grants to states. That’s a simple, effective plan that could and should be immediately implemented, while still preserving complete flexibility in responding to our serious longer run challenges.

I also am very comfortable endorsing additional government investment in infrastructure for which the argument can be made that the facilities could make a significant contribution to future productivity. At the top of my personal list would be investments in the electricity transmission grid, mass transit, and basic scientific research.

Pundita is worried about all of the borrowing and the prospect of inflation:

There is no plan for scaring up the trillions of dollars to pay for the combined 2008 and 2009 economic stimulus plans and various TARP plans.

Before you spend money you don’t have it makes sense to figure out how you’re going to pay for what you can’t afford. And it would be nuts to say that because you don’t know exactly how much you’ll spend in the coming year it’s no use figuring out how to pay for it until you know how much you’re going to borrow. Yet putting the cart before the horse is exactly what the U.S. government has done: they’re first putting into law how many billions are to be spent on aiding banks and the economy, then they’ll figure out where to get the billions from.

“We need about a trillion dollars” would be a close enough estimate to start thinking about how to raise huge amounts of U.S. dollars to pay for all the stimulus and rescue plans. The thinking hasn’t been started — at least not in public. That’s because there are only two ways for the debt-ridden United States to come up with hundreds of billions of dollars in short order, and neither way is palatable:

Either the Federal Reserve will have to create the hundreds of billions and/or outright borrow the billions on the world financial markets. Here we come to a snag…

Arnold Kling supports my point about the problems with rapid changes in the economy:

I agree with the point about technological frictions. I think the friction is worse now than it was fifty years ago, because the labor force has more advanced and specialized skills.

referring to James Hamilton’s post above.

Steve Antler fisks President Obama’s comments on the economy. I’m honestly a little concerned when the White House’s “top man on the economy” is somebody who’s probably never taken an economics course or a business course.

15 comments… add one
  • Brett Link

    It’s a pity, then, that some of the “centrist” cuts in the Senate plan were to Food Stamps and aid to states.

    If only Obama had kept the plan large and simple, relying on existing devices. Block grants to states (or extreme low-interest loans with a moratorium on payment until the GDP is above 3% growth for two quarters consecutively), more funding for unemployment benefits, more money to Head Start and Medicaid (Medicaid especially), and a rebate on payroll taxes to some degree. Everyone one of those proposals uses an existing mechanism and can’t really be attacked for pork, and Obama could hammer his opponents for callousness over and over again if they tried to cut any part of it.

    As I mentioned before, I’m guessing that they’re afraid that if they passed something like the above in of itself, they won’t get a chance to pass an infrastructure/public investment/energy-and-future-goodness bill later on.

  • Brett Link

    To add-

    I wouldn’t really want to do a permanent reduction on FICA unless we figure out how the alternative funding for Social Security would work out. FICA pays Social Security, after all.

  • Andy Link


    Interesting post! I’m wondering, though, wouldn’t saving (or paying down debt) by individuals be beneficial as well? ISTM that would provide more capital to banks and other institutions, making them more solvent in the long run and better positioned to lend more money. At least that’s what I remember from the few econ classes I took 20 years ago.

    Personally, I think a really good stimulus would be to simply cut payroll taxes completely (for both individuals and businesses) for a year (maybe more) and then slowly ramp them back up after that.

  • That’s where the “paradox of thrift” bites you. Saving—good;everybody saving at once—bad.

  • I don’t know…when you are talking about a supposed “emergency” bill, where the normal democratic scrutiny is to be suspended, I don’t think it is too much to ask for the measures invovled actually be related to the supposed emergency. (I know….I’m freakin nuts.)

    I wouldn’t necessarily be against a lot of the things that are unrelated, but who knows if the funding proposed is appriopriate? No one, because it is now deemed “wrong” to ask questions about it.

    Who needs “1984” when you’ve got 2009?

  • PD Shaw Link

    I have slightly longer assumptions on the timing. I think there is reason to believe the recession unofficially began in September of ’08, which would extend the recovery period out for several years. And if we assume an “L” shaped recovery, there may be reason to believe a stimulus may still have advantages on the tail-end.

    But I’m also skeptical that the “shovel-ready” projects are really ready. And the one’s that are ready are simply projects that state and local governments were going to do anyway, but that are being packaged for federal disbursement to relieve pressure on government pensions.

  • PD Shaw Link

    One question I’ve not seen answered on extending unemployment insurance benefits is whether this would be passed on to the employer through taxes. Unemployment insurance taxation has never been very clear to me, and it might differ by states, but if a business is laying off people, it’s rate goes up. In Illinois it can go up to 7.2% (for the first $12,300). Now, this might deter some firings, but also might deter some hirings.

  • Unemployment insurance varies from state to state and in most states (and the federal government) is financed by taxing employers. When I say “extending unemployement” I mean financed by federal dollars which are in turn financed by borrowing. Anything else won’t have a stimulus effect.

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