Wednesday, February 11, 2009

What is Stimulus?

I had an epiphany the other day whilst talking to a reporter about the confusion over spending and stimulus. The reporter was asking me about spending and jobs. It is quite possible that I am very dense about these things and that others have made this connection before, but for me it suddenly made sense why economists' message is not being understood. I think there is a widely held perception that federal spending that you would call stimulus has to be directly linked to a job. So if government says, we are going to hire ten people to fix potholes, or we are going to pay a firm to hire ten people to fix potholes, then people are ready to understand this is stimulus. They also make the link between these particular jobs and the claim of job creation. So if the state claims it will spend money and create 3,000 jobs, I think people think that this number refers to the actual jobs for the actual projects. [And, in fact, the state might be thinking this way]

But this is not what economists talk about when we talk about job creation through stimulus. We are talking about any spending by government regardless of whether it is directly linked to a job, and the job gains we are talking about refers to overall, permanent job creation that comes as a result of increased economic activity. Creating specific jobs in, say, the construction industry directly is nice, because it helps a distressed population and we would expect this population to have a high propensity to consume from their income which helps the multiplier effect - meaning they are likely to spend most of what they earn. Government spending that prevents cuts at the state Department of Transportation by filling in budget holes does exactly the same thing. The difference is that while there will be lags in getting new people hired to fill potholes, the state DOT is ready to go today. Even spending on things like a national health information system is stimulus. It is new spending that will become income for workers, computer manufacturers, software engineering firms, etc. It is the increased economic activity that comes from this stimulus that creates the jobs that helps lift us out of the recession.


Mike said...

Unfortunately, prominent political voices like Michael Steele are misleading (I can only assume purposely) the public by making sweeping statements that the stimulus will NOT create any jobs, rather it will further harm our economy.

This is the type of talk that promotes confusion for us regular people.

Chuck said...

Isn't government spending only a stimulus if it is based on: 1. borrowed money, 2. New fiat money, or 3. Redistribution from income brackets that invest most of their income (perhaps in China) to income segments that spend today in the U.S.? I'm assuming an endogenous theory of money in macro theory.

Or, does taxing income segments
(80% of income earners)that spend today to pay for spending by government stimulates nothing but merely reallocate where spending occurs (i.e. urban to rural)? This may be desirable but isn't stimulus?

Patrick Emerson said...

Fiscal stimulus works in two ways in my view: One, and intertemporal transfer of resources and, two, tapping into idle resources.

The intertemporal transfer is the borrowing and spending now and paying later (this only works, btw, if there is not forward looking rational agents who adjust their spending one-for-one with government). The idle resources argument is that there are untapped savings because banks don't want to lend due to systematic uncertainty. So government can mobilize the resources that the private credit market cannot right now.

So the intertemporal part is your 1 (and 2 to some extent). The idle resources idea could apply to your 3, but more so if rich people are stuffing money into mattresses.

Yes, if you tax today to pay for spending today (and the multipliers are equivalent) than you have not achieved anything in terms of stimulus.