Stimulus Now, Restraint Later?

Journalists have been repeating lately that “economists say” that we need yet more government spending now to keep on goosing the economy, even though — to be sure — we will need to cut back on spending at some point in the undefined future, to avoid the fate of Greece. Well, maybe some economists. But I’m sure this “economists agree” claim is no more true today than it was a year ago. Here’s one example, from NYU economist Mario J. Rizzo, coauthor with Cato senior fellow Gerald P. O’Driscoll Jr. of The Economics of Time and Ignorance:

But let’s look at the arguments made by the opponents of fiscal stimulus.


Some have argued that, as deficits increase, people now offset the putative stimulus by increasing their savings in anticipation of future tax increases. So there is no stimulus now.


Others have argued that, for example, extending unemployment insurance (again) to those unemployed for more than six months will increase the length of unemploymentnow (by subsidizing it) while failing to stimulate.


The stimulus failure is due to the relatively small increase in spending induced by non‐​permanent increases in income (as unemployment insurance is certainly not permanent source of income). Even more, producers know that the spending is non‐​permanent so it is unlikely to result in increased employment of labor. Thus, there is no stimulus now; in fact if unemployment continues there is a kind of anti‐​stimulus now.


Austrians have argued that failing to allow the housing market to adjust by both fiscal and monetary propping‐​up measures, worsens the situation now by prolonging the inevitable adjustment to a bubble sector. As the adjustment is dragged out and the rest of the economy suffers the dampening effectsnow. This must include the uncertainty as to when (in calendar time) the market will be allowed to adjust.


In empirical work, John Taylor finds that to the extent there was some effect of the fiscal stimulus it was very small and lasted only a matter of two or three months for each major injection. So I guess the long run is four or five months by this reckoning:

Compared with the 2008 stimulus, the 2009 stimulus was larger, but the amount paid in checks was smaller and more drawn out. Nevertheless, there is still no noticeable effect on consumption. I also show the timing of the “Cash for Clunkers” program in Figure 7; it did encourage some consumption, but did not last and cannot be considered an effective method to stimulate the economy. In addition, my analysis of the government spending part of the stimulus is that it too had little positive impact.

Even frameworks that stress future consequences of current stimulus need not be long‐​run theories in the calendar sense. For example, if the anticipated taxes required to pay off or service current deficits consist of rises in marginal income tax rates, output will be considerably lower and the real interest rates higher in a matter of a couple of years than without stimulus.


The upshot of all of this is that the anti‐​stimulus economists are not claiming we must trade off benefits now for some long‐​term pie‐​in‐​the‐​sky benefits. Most are saying: The stimulus route leads to (almost) no benefits now as well as costs later.