Thursday, September 15, 2011

Why Stimulus isn't Stimulating

Obama's jobs bill (so named, presumably, on the theory that no one could be against jobs) (and yes, I know the Republicans do the same sleazy thing, for example with the Patriot Act) has renewed the debate over stimulus: whether we need it, how much good it does, and how big it should be. Conservative writers I respect, like Ross Douthat have offered measured voices of approval, but generally reaction to the plan breaks along partisan lines. The Wall Street Journal offers the conventional conservative perspective:

With $4 trillion in debt in three years, it is hard to see how another $400 billion in debt will lead to more economic growth and job creation. We've already had the biggest Keynesian stimulus in 60 years, and the result has been more than a million job losses since January 2009.
That $4 trillion number really jumps out, but in this case the conservative desire to bash Obama is hiding the true scope of the problem. While borrowing has accelerated since Obama was elected, G.W. Bush was borrowing on a scale almost as extreme. By looking at Obama's decisions in isolation, we lack the context to ask a fundamental question: are these stimulus measures doomed to failure because our economy was already highly stimulated before the recession even started?

The chart above shows the annual level of borrowing from 1990 through 2010. During the early 1990's, we see the level of borrowing peak at the end of Bush the First's presidency, and decline until we actually had a small surplus at the end of Clinton's second term. And then things reverse, the line trending up almost as steeply as it does during Obama's time in office. Why? Because Bush the Second decided to 'give back' the surplus in the form of tax cuts, and then the 9/11 attacks both hurt the economy and led to unpaid-for wars.

If the essence of stimulus is that the government borrows to increase overall demand in the economy, than the 2002-2004 saw a massive, if unnamed, stimulus effort. And perhaps it worked. The economy didn't go into a severe recession after 9/11, so perhaps it had some sort of effect. Add to that the historically low interest rates and loose borrowing standards that led to a massive injection of private credit spending into the economy, and we had a truly massive "stealth stimulus."

Now, before those borrowing levels even had a chance to go down much, the crash of 2008 hit and government borrowing quickly spiked to the trillion-plus levels to which we've now sadly become accustomed. But why hasn't deficit spending, this time specifically structured to be 'stimulative', had the desired effect?

I think there are three potential explanations:

1) The fundamentals of the economy are so bad that much more deficit spending is needed to have an effect. (The Krugman thesis)
2) Stimulus doesn't really work, especially if the numbers we're borrowing are so high that lenders and investors doubt we can pay it back (The Republican thesis)
3) Stimulus has to be temporary to work, and we already had one last decade that we haven't even started to pay off. (My lonely theory)

Whether the first explanation is true or not is really academic: to borrow a significantly higher amount was never going to be politically feasible. (And could any recovery be strong enough to pay off the incurred debt in a reasonable period?)

But I think the second explanation, much loved by conservatives, risks positioning the Republican party as do-nothings who aren't trying to help the jobless. As Jacob Weisberg wrote recently on, "Pick up any standard economics textbook, and it will explain how governments respond to cyclical downturns with temporary deficit spending." You can fight this argument, or you can concede it and point out that we have had a decade of unprecedented stimulus, and there is no longer anything temporary about our deficit spending. A simple question to ask your pro-stimulus friends (or for the eventual Republican nominee to ask Barack Obama), "In what year do you foresee the government taking in more money than it spends, and how will you get us there?"

Since 2002 (or maybe even since Reagan began large-scale peacetime borrowing in the 1980's) that we have been using government borrowing to mask weaknesses in our economy. The sad truth is that doing so made those weaknesses more severe, and now our problems are worse and the tools we have previously used to juice the economy have lost their effectiveness. Which should tell us that, just maybe, we should not act as if we know how to control something as complex and unpredictable as the nation's economy in the first place.

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