Many readers are not keen about the idea of a fiscal stimulus program (I presume they are of the Austrian view, that taking the pain, no matter how bad, is the better course of action. And your humble blogger believes that stimulus without cleaning up our broken financial system is likely to have blunted impact). But let’s put that aside for the moment.
If you are going to have a “rescue the economy” plan, particularly on the scale envisaged, one would hope it was efficient, that is, sufficiently well designed and targeted so as to get maximum bang for the buck. But we live in a world of compromise and head fakes.
Paul Krugman has analyzed the stimulus plan as it now stands, using accepted techniques (various multipliers for various types of spending) and finds it falls well short of its objectives. Given the determination of the Obama crowd to jolt the economy into some semblance of life, this strongly suggests that towards the end of the year, more stimulus measures will be on the table, with large dollar figures attached to them.
Bit by bit we’re getting information on the Obama stimulus plan, enough to start making back-of-the-envelope estimates of impact. The bottom line is this: we’re probably looking at a plan that will shave less than 2 percentage points off the average unemployment rate for the next two years, and possibly quite a lot less. This raises real concerns about whether the incoming administration is lowballing its plans in an attempt to get bipartisan consensus.
Yves here. To give a sense of how far this falls short, a recent paper by Carmen Reinhart and Kenneth Rogoff analyzed recent financial crises and found that, on average, unemployment increased by 7 percentage points from its previous level,
Krugman next goes through the various elements of the proposal and applies various multipliers to the components. Even though he calls this “wonkish” it’s quite accessible to the lay reader. And he explicitly makes some assumptions that he deems to be optimistic. Here we get to the bottom line discussion (and note that Krugman’s expectations for unemployment are more upbeat than ours and Reinhart/Rogoff’s):
Suppose that we’re looking at an economy that, absent stimulus, would have an average unemployment rate of 9 percent over the next two years; this plan would cut that to 7.3 percent, which would be a help but could easily be spun by critics as a failure.
And that gets us to politics. This really does look like a plan that falls well short of what advocates of strong stimulus were hoping for — and it seems as if that was done in order to win Republican votes. Yet even if the plan gets the hoped-for 80 votes in the Senate, which seems doubtful, responsibility for the plan’s perceived failure, if it’s spun that way, will be placed on Democrats.
I see the following scenario: a weak stimulus plan, perhaps even weaker than what we’re talking about now, is crafted to win those extra GOP votes. The plan limits the rise in unemployment, but things are still pretty bad, with the rate peaking at something like 9 percent and coming down only slowly. And then Mitch McConnell says “See, government spending doesn’t work.”
Update 2:45 PM: Some confirmation that the Obama team believes that stimulus will be ongoing comes from a Bloomberg article, “Obama Says Deficit Likely to Approach $1 Trillion“. Note the boldfaced section:
A “trillion dollar deficit will be here before we even start the next budget,” Obama said after meeting in Washington with his economic advisers, including Peter Orszag, who has been designated as director of the Office of Management and Budget. “Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on.”