Stimulus Arguments

From everything I understand a fiscal stimulus is a necessary course of action to avoid a drastic decline in economic activity. It also seems that there is consensus among most economists and economic thinkers, but over the course of the last few days there has been a sizable group arguing that tax cuts not government spending is the more effective way to stimulate the economy.

This is an interesting argument, and the research seems quite appealing. And the basis idea is this; the multiplier effect of tax cuts is about $5 per $1 of tax cuts, where as the effect is only about $2 or 3$ per one dollar of government spending.

First, I think that this evidence is strong, and that seems to be part of the reason that the Obama fiscal stimulus will have tax cuts as a piece of the plan. But there are three arguments for government spending as fiscal stimulus that I find quite appealing.

(1) The trouble that the folks at the Federal Reserve and the Treasury have found is that investors, banks, and other market participants are hoarding money; so what makes us think that individual tax payers will not do the same in the form of savings, paying down debt, or foregoing purchases until prices fall further - deflationary spiral anyone? (I believe it was Mark Thoma who first articulated this idea). The other piece of this argument is that the fiscal stimulus multiplier effects of tax cuts were found in a more normal economic environment, so even if the last sentence is incorrect, how can anyone be so sure that tax cuts will yield those same results.

(2) The Obama Argument - The multiplier effect arguments may even be a little bit scewed because it is quite difficult to take into account all of the benefits that result from government spending and even tax cuts for that matter. A perfect example is electronic medical records, it is unclear the productivity increases that will result from increases in information transfer and greater medical efficiency. It is also unclear how more advanced efficient care made possible through electronic medical records will affect the overall health and productivity of the work force. It is difficult to say that the Obama argument is unequivocally correct, but it is also difficult to assume that the exact benefits of such fiscal stimulus are quantifiably deficient.

(3) The Summer's Argument - In a Washington Post article Larry Summers began to lay out the outline of and rationale for the incoming administration's fiscal stimulus plan. His point about our economy's problems and our over-reliance on consumer spending are well taken. I think the general idea is that more tax cuts to only boost consumer spending were part of what got us into the mess we are in, so we probably should try something a little more creative and hopefully more effective.