Stimulus and Deficit

By Richard A. Posner

My last post elicited a number of very interesting comments. Some very intelligent-seeming commenters insist that the $787 billion stimulus program enacted last February has had no effect on unemployment. I think this is wrong, but I understand the underlying concern, which is with the impact of the program on the federal deficit.

The stimulus program was months late in being enacted, was poorly designed, and has been lackadaisically executed. And critics are right that the claims made by the administration, and for that matter by private economists (both academic and business) and economic journalists, concerning the number of jobs saved by the stimulus are arbitrary. Economic science has not advanced to the point at which the effect on unemployment of a given increase in deficit spending can be estimated. Take the claim that the stimulus saved the jobs of hundreds of thousands of public school teachers. It is said that but for the stimulus moneys that were allotted to state governments, the teachers would have been laid off. But would they have been? Might not the states have cut other funding, or increased taxes, to keep teachers and other public employees on the payroll? Or reduced wages in lieu of layoffs? Such cuts, whether of other funding or of teachers' wages, could, by reducing money in circulation, have led to layoffs elsewhere, but no one knows how many of those other layoffs there would have been and therefore how many jobs the stimulus money allotted to the states saved. And the money that was distributed to individuals in the form of tax credits or other benefits--how much of that money was saved rather than spent, and saved in forms that do not stimulate economic activity?

Still, something like $300 billion was injected into the economy in the last three quarters of 2009, increasing GDP by about 3 percent, and that is not a negligible amount and must have been a factor in keeping consumption growing (albeit modestly) though incomes were falling, and the more consumption, the more production and hence jobs. More important is the psychological effect of the stimulus--not today, when the effect has turned negative as I'm about to argue--but back in February 2009 when the stimulus program was enacted. The public mood was very bleak then; deflation was in the air; there was a lot of scary talk about an impending repetition of the Great Depression--and indeed the economic indicators were falling faster than they had fallen in the corresponding period of that depression. The bank bailouts and the expansion of the money supply and the other restorative measures that had been taken seemed not to be working. It was psychologically important for the new administration to move resolutely to spur recovery rather than to throw up its hands and tell the people to let nature take its course. Psychology is a key factor in the decision of businesses to invest and consumers to spend. The government had to do something to prevent producers and consumers from freezing and hoarding rather than investing and spending.

The fact that unemployment kept rising after the stimulus program was enacted and stimulus money began being disbursed does not prove that the stimulus failed, because if I am right that pouring all that money into the economy, however belatedly and ineptly, had to have some positive effect on employment, especially by virtue of its psychological impact, then were it not for the stimulus the unemployment rate would be even higher than it is--and that would be disastrous. Think what the current 9.7 percent unemployment rate is doing to public morale and to politics, and then think what the effects would be if the rate were 11 percent.

The problem with defending the stimulus is that the defense, ineptly made by the administration and by private economists and economic journalists, all of whom have failed to explain depression economics to the public, has been overtaken by public concerns with the federal deficit. The health care debate has amplified these concerns, less I think because of the $1 trillion price tag on the administration's program of health care reform as because of the attention that the debates over the program have drawn to the seeming hopelessness of the federal fiscal situation. Not only is it difficult to believe that $1 trillion in additional government spending on health care can be recouped by a combination of a tax (on pricey health insurance plans) that is designed to discourage costly plans rather than to raise revenue, and of huge cuts in Medicare that could be achieved only by limits on treatment that would cause a revolt by the elderly; the search for the means of paying for health care reform has underscored the apparent political blockage to any substantial measures to reduce the federal deficit. Liberal economists point out correctly that while the economy is in the doldrums, efforts to reduce the deficit will impede recovery--and they add, also correctly or at least plausibly, that the economy is likely to remain in the doldrums for years to come because this is no ordinary "recession" we are in. But for every year of continued economic weakness, the deficit increases by a trillion dollars or more. By the time the economy recovers, the seemingly inexorable rise in Medicare will take over, as it were, and assure continued growth in the deficit. The only hope, as I have argued, is for very rapid economic growth that will keep the deficit from increasing as a percentage of the GDP; and the prospects for rapid economic growth do not seem bright.

This article available online at:

http://www.theatlantic.com/politics/archive/2010/02/stimulus-and-deficit/36317/