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Economy & Business

More spending or lower taxes? Economists debate the proper stimulus for the economy

This article first appeared in the St. Louis Beacon, Feb. 10, 2009 - While the House and Senate get down to work on a compromise between their two multibillion-dollar stimulus packages, many economists remain unconvinced that the big-money spending plans will solve the nation's financial plight.

"I would say that a large part of this is motivated by the notion that politicians want to be seen as doing something," John Howe of the University of Missouri at Columbia said Tuesday morning as the Senate was approving its version of the stimulus bill.

"So they're doing something. But how effective that will be is an open question. I come down on the side that it won't be effective at all."

Howe is one of dozens of economists, including Nobel laureates, who signed a statement sponsored by the Cato Institute that disputes President Barack Obama's declaration that everyone agrees on the need for a government spending plan to jump-start the economy.

"It is a triumph of hope over experience," the statement said, "to believe that more government spending will help the U.S. today. To improve the economy, policymakers should focus on reforms that remove impediments to work, saving, investment and production. Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth."

The debate over the better remedy for the current economic situation -- spending, or fiscal policy, as opposed to controlling interest rates and money supply, or monetary policy -- is not a new one, of course. But the push in Washington for passage of a plan is shining a new spotlight on the age-old question.

For Howe and Rik Hafer of Southern Illinois University at Edwardsville, another signer of the Cato statement, monetary policy can stimulate the economy if it is given the chance to work. Hafer says the pressure for a quick solution is being fed by a climate of uncertainty, underscored by a seemingly endless drumbeat of bad economic news.

"The fear factor has been raised by people who are getting out there and saying if you don't do anything, it's going to be the Great Depression all over again," Hafer said. "It's not clear that that's true.

"The Federal Reserve basically didn't do anything in the Great Depression. In fact, it made things worse. It had the wrong view of the world up until 1933-34, when it finally got its act together. It's not fiscal policy but monetary policy that gets us out of recessions."

Added Howe: "I think a lot of people are speaking with a high degree of certainty for whatever policy they want. That is unwarranted."

On the other side are economists like Steve Fazzari of Washington University, a self-described "debt dove" who thinks that monetary policy alone wouldn't have a large enough effect.

"This problem is much larger," he said. "Monetary policy is out of gas. Interest rates are cut about as much as they can be cut. I don't think we can rely on interest rate cuts along to get the economy moving again."

Fazzari notes that when Obama and others talk about the effects of a spending stimulus, they cite more than the need to create jobs; they also talk about the need to stem the pace of job loss. Right now, jobs are being lost at a rate rarely if ever seen before.

"I don't want to underestimate the effect of that," Fazzari said, citing the need to strengthen the safety net with benefits for those who are suddenly unemployed. Failing to do so, he said, would be "unconscionable."

"We need to support those who have been hit hardest by this recession," he added. "But failing to do so would also lead to the opposite of a stimulus, if people have to cut back on their spending."

And, he says, history shows that spending has a positive effect on economic downturns, regardless of the debt it leaves behind.

"If you look over long periods of time," Fazzari said, "government debt is less damaging than it appears. With deficit spending, whether it was in the Reagan administration or in World War II, a big increase in government debt led to a fairly robust infrastructure and long periods of economic growth."

But when Howe takes the longer view, he worries that the massive spending in the stimulus package, and the government borrowing that goes with it, will have a dampening effect far into the future.

"We are talking about a trillion dollars worth of debt," he said, "and sooner or later that is going to be a drag on the economy. Is it going to make things worse next week? No, I don't think so. But it's bad fiscal policy that will be harmful in the long run."

Regardless of the approach, fiscal or monetary, the economists on both sides agree that the economic picture is likely to get darker before it begins to brighten, possibly by the end of the year.

"I see continuing losses of jobs over the next six months," said Fazzari, probably throughout the year. The pace hopefully will start to slow. I am also hoping for more stability in the financial markets."

For Hafer, the bigger question comes when the spending in the stimulus package is gone.

"The whole Keynesian idea is if you throw dollars into the pot, tax receipts will rise and the government will be able to fade into the background because the economy has taken over by creating income. But I haven't seen what the exit strategy is.

"Is the economy going to start growing again? Are immediate consequences going to have longer-term benefits? The likelihood is that this is a structural shift in how government is going to business. The federal, state and local governments are going to be a much larger part of the economy than in the past. It will be as big a structural shift as during the Reagan years when he declared that the role of government was too big."

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