The Case for More Stimulus

This week Congress will take up a stimulus bill liberals hope will extend benefits to the unemployed and send money to states to avoid hundreds of thousands of public sector layoffs. Republicans and conservative Democrats are dragging their heels and raising concerns about adding to another trillion-dollar deficit.

What is the case against additional stimulus? It's here. To hear the case for more stimulus, I spoke with William Gale at the Brookings Institution. A lightly edited transcript follows:

First, why don't you explain the basic argument for stimulus spending.

When the economy is suffering from a shortage of aggregate demand, which is what we're facing right now with workers who are not being employed and machines that are not being used, there is a role for government in increasing aggregate demand to make use of existing capacity. Direct government spending can put people and machines to work. Tax cuts puts more money in pockets and gives people the opportunity to spend it themselves. The argument is that as long as the economy is facing that shortage, there is a role for government to play.

Economic conservatives and libertarians will counter that the government isn't stimulating anything. There's no multiplier, or positive impact of each dollar spent. There's no guarantee you're even spending it efficiently. And worse, families might cut back because they expect their taxes to rise later to recoup all that money you're spending. How would you respond?

The evidence rejects the idea that the multiplier is zero. And the idea that people cut back by the full amount of spending, well, the evidence decisively rejects that view, too. Instead the research indicates that spending increases by direct government purchases and tax cuts can boost the economy in the short run.

So, what's the best way to do it?

I'd refer you to the Congressional Budget Office list. [It's here.]

Let's assume that we listen to the deficit hawks and do nothing. What could happen?

At this stage the danger of doing nothing is we have a slower recovery, or we fall back into a second recession, or we bump along in a lost decade like Japan. The cost of that in terms of unemployment and lost output, the human costs, are immense. People are out of work, and that hurts their spending, their kids, their skills. The lost output we're talking about is a huge amount and if the government can help that, I don't see why it shouldn't.

So we want the economy to recover today. But we can't run a deficit equal to 50 percent of government spending forever. How do you balance these goals: short-term stimulus and long-term balance?

What I like to say is that right now, the economy is more important than the budget. We need to stimulate in the short term and get order in the long term. Those aren't tradeoffs. If you just stimulate now, then you create worries about the long-term situation and it creates investor uncertainty [which puts upward pressure on interest rates]. If you just do fiscal discipline now, you help the budget but hurt the economy, and then that hurts the budget again [lower production means lost tax revenue]. But, if you stimulate now, coupled with medium to long-term deficit plan, you cap that potential increase in interest rates.

What could that deficit-busting plan look like?

On the spending side, I think if you can dig into Social Security benefits for current retirees that shows people that we're serious about this. Farm subsidies can be cut. In the medium term and the long term, you've got health care. I would also look at defense. I think the main thing right now is big visible cuts to show that there are no sacred cows. One easy way is to increase the gas tax. Each dollar of gas tax raises a GDP percentage point in revenue. We might have to look at the value-added tax, as well. That's where the money is. We also have to trim back tax expenditures, because they're expensive, regressive, and not effective.