Tuesday, January 29, 2008

Fiscal Stimulus

I participated in a discussion on the Oregon economy and the government's fiscal stimulus plan this morning on OPB's "Think Out Loud" program so I thought a post that summarizes my thoughts would be appropriate.

The fiscal stimulus plan being proposed by the federal government is based on good old Keynesian theory that in a temporary down turn in the economy, fiscal policy can have a role in stimulating the economy and lessening the blow. Keynesian theory underwent a withering attack from the rational expectations revolution in macroeconomics which suggested that fiscal policy is ineffective as agents in the economy understand that any fiscal spending today has to be paid back in the future so behaviors will adjust immediately. However, assuming this is true, economies do not adjust immediately to behavioral changes - there is wage and price 'stickiness' - which means that, in the short-run, fiscal policy can still be effective. The key with fiscal policy as opposed to monetary policy is that if it appears that consumer confidence is low and present and future consumer spending is and will be low then firms react my lowering investment and employment and wages suffer - further enhancing the low consumer confidence and spending. This leads to the downward spiral that can enhance and lengthen recessions. Cash transfers to those that are likely to spend it will cause a temporary shock in this cycle which, it is hoped will lead to new investment and job recovery - further stimulating consumption - and lessen the extent of the economic downturn.

So two pertinent questions are: does the current situation look like the one I have described, and what is the catch to such a policy?

First, it is not entirely clear that we are in such a cycle and that this is the appropriate policy response and the main reason I say this is that it is not clear we are seeing the big effect on investment and jobs probably due to the very strong export market thanks to the weak dollar. But it is hard to know exactly as data lag the present. I am weakly in favor of the plan broadly conceived (but I think we could do a lot better targeting benefits to those most likely to spend them) - largely because the risk of a severe downturn is real and recessions hurt the most vulnerable hardest, so I generally err on the side of caution.

Second, the catch is that short term stimulus increases the debt which will be a drag on the economy when it returns to sustained positive growth. So, once again, there is no free lunch.

What does this all mean to Oregon? Well, there are two competing facts: one, Oregon has traditionally be a high unemployment state and was hit particularly hard by the last recession, and two, Oregon's housing market is is good shape (so far) relative to other parts of the country. Local conditions matter only partly for the economy so any national recession will be shared by Oregon, but I do think we will not be exceptional like last time. Exports are strong (10% of Oregon GDP), house values have not crashed and there is a chance that tourism (generally down when incomes fall) will remain healthy in Oregon as people substitute Oregon vacations for overseas ones due to the dollar. So I remain cautiously optimistic. The wood products industry and construction industry are already being hit hard by the slump in construction, however, and demand for Oregon's manufactured goods within the US is falling. So, only time will tell.


jessibeaucoup said...

I was super excited to hear you on OBP this morning! I'm concerned that any stimulus plan put the money in the hands of those who are the most vulernable. I would agrue that those with joint incomes approaching $150,000 are not our most vulnerable. I would further argue that many of those most vulnerable, for various reasons, do not pay income tax and/or do not file income tax returns. There has been some discussion of providing a refund to all individuals who pay payroll taxes. I would point out that payroll taxes (FICA) applies to the first $100,000 some odd dollars of wages. Therefore, providing a refund to all of those people would, by definition, be providing a refund to some who make well in excess of $150,000 (which is an income level that I already think is too high). To achieve the purport results of this stimulus package, I would think that we'd be better off to provide a higher refund to those at much lower income levels that $150,000.

That's my two cents. I'm interested in yours...

Patrick Emerson said...

Thanks! My only objective was not to make an ass of myself on radio. I hope I managed it.

Quick answer, yes. If you want short term stimulus you give it to low income folks who will spend it and right away. The fact that this also achieves another objective is nice, but secondary to the stimulus objective. I support the extended unemployment benefits and food stamp benefits ideas but for stimulus reasons. I support transfers to low income households for other, equally economically legitimate reasons. Killing two birds with one stone is great, but a one time cash transfer of $500 say, does not solve the poverty problem, so I don't what this policy sold as a anti-poverty program.

jessibeaucoup said...

You did great!

I agree that poverty is a much bigger issue and that a one time cash refund isn't going to solve it. BUT, I don't like it when stimulus packages, tax cuts and the like give too many benefits to people who really don't need them. And get sold as an anti-poverty program or tax cuts for the middle class when they aren't. It's just that the lay person doesn't always understand the subject matter enough to know that they're being lied to. Similarly, they don't know how or they just don't follow up to see if the things they were promised (lower taxes, say) come to pass.

This is one of my pet peeves, if you can't tell;).

Patrick Emerson said...

On this we agree completely. A big for my doing this blog is to try and help separate the politics of policy with the economics, as the two are so often in conflict. This is a classic example.

Jonathan said...

Hello! I have a blog at, http://oregonrising.blogspot.com/. It's for people to leave suggestions and ideas on how to help stimulate Oregon's economy. I would be pleased if you took a look and left a comment(or comments). Thank you ahead of time for looking at my blog. You can add a link to my blog on your blog, if you'd like. That'd be great! Thanks for your time.