What Ends Recessions?

With the economy slowing and fears of recession percolating, the Bush White House and both Democrat and Republican lawmakers are talking about possible stimulus legislation to get the economy moving. Before they pass anything, and before the press and the public get all excited about “bold,” bipartisan action, we should ask ourselves whether stimulus packages are helpful in ending recessions.

The definitive historical review of U.S. government responses to recession is Christina and David Romer’s 1994 NBER Macroeconomics Annual paper “What Ends Recessions?” [$]. The Romers examine each U.S. recession from the end of World War II to the article’s publication date (that is, the recessions of 1954, 1958, 1960, 1970, 1975, 1980, 1982, and 1991) and determine what government actions were taken in response and how successful those actions were.

Government response to recessions comes in three forms: monetary policy (the Federal Reserve’s Open Market Committee lowers interest rates to spur investment and borrowing), automatic fiscal policy (the automatic increase in government spending during recessions that results from increased unemployment insurance claims, welfare disbursements, etc.), and discretionary fiscal policy (the adoption of stimulus packages that contain increased government spending and/or tax cuts).

The track records for both FOMC action and the automatic stabilizers are strong, the Romers show. Both kick in quickly when recessions begin, and the economy turns around fairly soon afterward.

Stimulus packages have a much shoddier record, however: they take months to move through Congress, and additional months to implement — long after the recession has come and gone. Moreover, many of the specific actions initiated by stimulus packages are hardly stimulatory — extending unemployment benefits or launching major government construction programs requires several months to several years (and sometimes even decades) before the federal monies hit the economy.

A look at the various proposals now floating around Washington show that a 2008 stimulus package will be more of the same.

Saturday, New York senator Charles Schumer used the weekly Democrat radio address (who listens to those things, anyway?) to outline his party’s stimulus package proposal, which would use a temporary (and likely tiny) tax cut for the middle class, coupled with “longer-term investments such as in clean energy and infrastructure” — not exactly the stuff of effective economic stimulus.

President Bush’s proposed stimulus package focuses on tax cuts. The package includes a proposal to move up an already-approved income tax cut (President Eisenhower made a similar move — with some effectiveness — in his stimulus package for the 1954 recession) and abolish taxes on stock dividends. The centerpiece of the Bush proposal, however, is the permanent adoption of his 2001 and 2003 tax cuts that are set to expire in 2010 and 2011 — a desirable proposal but also not the stuff of economic stimulus in 2008.

If I were a cynic, I’d say these proposals indicate that neither congressional Democrats nor the Bush White House is really interested in stimulating the economy to ward off recession. Instead, I might believe that the Dems and the Bushies are just trying to look like they’re doing something about the economy during an election year when, in fact, they want to use the risk of recession as cover to adopt policies that they’ve wanted to adopt all along and to funnel money to special interests. But then, if I were a cynic, I’d say that Congress and the White House used 9/11 as an excuse to adopt just about every bad, police-state idea that’s been floating around D.C. bureaucrats’ offices for a decade. If I were a cynic…

The good news is that the two government tools that are effective at combating recession are already at work. The automatic stabilizers are in play and the FOMC has cut interest rates significantly since October. Fed Chairman Ben Bernanke has indicated that more cuts are forthcoming as long as recession risks are elevated.

Thus, I have to agree with this excellent Washington Post editorial on recession-fighting: Congress and the White House should leave recession-fighting to the Fed and the automatic stabilizers, and still their stimulus package excitement.