Tuesday, January 29, 2008
Stimulating the economy over the short and long term
Foreign Policy magazine interviewed Harvard economist and erstwhile Reagan administration advisor Martin Feldstein, about the prospects for a recession in the United States and the best method for avoiding or shortening same. The interview included this exchange over the value of fiscal stimulus, which explains for the layman the circumstances under which it can increase growth.
FP: U.S. President George W. Bush has proposed a roughly $140 billion stimulus package that centers on one-time tax rebates. But George Mason University economist Russell Roberts says the very idea of an economic stimulus package is “like taking a bucket of water from the deep end of a pool and dumping it into the shallow end.” As he put it, “If you can make the economy grow, why wait for bad times?” So, is the idea of a stimulus package just political theater, or do you expect it to really help?
MF: I do expect it to help, but let me be clear about why it’s not like moving water from one end of the pool to the other, or more accurately, why it is not a way of making the economy grow under all circumstances. If the economy is fully employed and growing at a normal pace, 3.5 percent, with unemployment under 5 percent and no expectation of a downturn, then aggregate demand is not the problem. Then, the only way to get the economy to grow more is to have more investment in capital equipment, people working harder, more innovation, and so on. And you can’t do that by simply giving money back to taxpayers to spend more. So, the “spend more” approach to increasing economic activity is not about long-term growth. What it’s about is offsetting the risk of an economic downturn.
In other words, if everybody is working hard you can only accelerate growth by investing so that they work more productively. If lots of people are not working then you need to put fuel in the fire to get them to work. The objection, I suppose, is that stimulus today comes at a price tomorrow, at least if you debase the currency to accomplish it. Does the knowledge of that future inflation undermine the effectiveness of the stimulus today? That is what happened during the 1970s, but perhaps so many Americans have forgotten that experience that it can work again until we learn the lesson again.
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