Stimulus or tighter reins? Economists debate on the one hand and the other
This article first appeared in the St. Louis Beacon, July 7, 2010 - With one eye on the growing deficit and another on the still-sluggish economy, economists are debating whether the United States needs more stimulus spending from Washington or a tighter grip on the reins to ease the financial burden on coming generations.
The situation brings to mind what President Harry S Truman famously said when he wished for a one-handed economist, so his financial advisers would stop saying: "On the one hand ... but on the other hand."
Still, economics can't be as predictable as science done in a sterile laboratory, where well-designed experiments done over and over again yield precisely the same result. Too many factors are influenced by hard-to-figure human nature, and the lessons of history can't always be repeated, or even interpreted the same way by different economists.
The Beacon put the question to area economists: Given the current state of the economy and the deficit, is this the time to pull back on stimulus spending and pay more attention to the deficit, or should Washington worry more about the short term and let the long term take care of itself?
Here is their even-handed analysis.
Jack Strauss, director of the Simon Center for Regional Economic Forecasting at Saint Louis University:
Strauss pointed out that it is not only the federal government that is hurting financially. State budgets in Missouri, Illinois and elsewhere are also suffering, but they can't print money, so if Washington begins to spend less money on stimulus programs, states will have to cut back even further. He projected that more than 2 million state workers could end up losing their jobs.
"A good third of the stimulus money was spent so states wouldn't have to fire workers," Strauss said.
Such cuts would make a bad jobs situation even worse, he noted, pointing out that even now, unemployment may be as high as 16 percent, if it were counted properly, and that the picture is not likely to change very quickly.
"It's not like there's a lot of fat," he said. "This is the third year in a row that state budgets would be cut, so for every cutback, someone is going to lose a job."
Given that scenario, Strauss said, tightening the spigot from Washington could have a pretty drastic effect -- maybe even touching off what happened in 1937, when the nascent recovery from the Depression took a U-turn when federal spending was cut back because of pressures to balance the budget.
"We can't get out of this vicious circle downward until somebody starts to spend," Strauss said. "The government started that with the stimulus, but because we suffered such a severe recession, we have got to prolong the stimulus to prevent states from firing more workers."
He warned against what he termed "Hoover economics," where states end up balancing their budgets by cutting payrolls.
"I'm not for dumping money down the drain," he said, "but I think it's important that states don't practice Hoover economics.
"The federal government has a choice. States have no choice. What the federal government should be doing is lending states money over the next year, and after the unemployment rate is more normal, like 6 percent, work on solving the budget deficit. You don't take away the medicine until the patient has fully recovered from the shock."
To opponents of the stimulus, like Tea Party candidates and others, Strauss points out that in 2009, state and federal tax collections were at a 60-year low, so they cannot legitimately argue that tax burdens are too high.
"It befuddles me how the Tea Party can say we are paying too much," he said. "We aren't.
"Deficits do matter in the long run, but not in the short run. What we should be doing is spending now and constraining entitlements over the long run. Even minor changes in Social Security may have very little impact today but a big impact in 10 years."
R.W. Hafer, distinguished research professor and chair of the Department of Economics and Finance at Southern Illinois University Edwardsville (and a Beacon columnist):
Hafer isn't so sure that the double dip in 1937 was caused by restrained spending by Washington. Instead of blaming fiscal policy, Hafer points to monetary policy, where the Federal Reserve imposed new restrictions that ended up slowing the money supply.
The situation is far different today, he said.
"Monetary policy isn't cutting back," Hafer said. "You have continuous very strong monetary stimulus. Short-term interest rates are close to zero, and long-term interest rates have come down for a variety of reasons, not the least of which is that the Fed funds rate is staying next to zero and there is uncertainty in international currency markets.
"I don't think there's a double dip in the future, unless the government does something crazy, like raising taxes."
To that end, Hafer says he would not let tax cuts from the Bush administration expire.
But he agrees that government spending will have to continue to help end the slowdown. A large part of the impact of such a policy is psychological, he added, but the effects can't last forever.
"People are going to expect government to bail them out or bail the economy out when times get tough," Hafer said. "Once people realize that the government is not going to be supporting economic activity, they may start accepting jobs that they wouldn't have taken before, or they may be willing to take pay cuts or be more willing to move to take a job."
He was not sorry to see Congress back away from extending unemployment benefits, saying that the package contained too many unrelated items. He prefers seeing Washington remain on the steady course it has been following.
"This is a different kind of recession," Hafer said. "It's not a recession where the Fed raised interest rates to stop inflation, and when the economy got rid of the inflation, it can lower rates again and get that big boom. Recessions caused by social crises are very different from the textbook monetary kind of recession like we had in 1982.
"You don't want to have massive changes in the direction of policy. There is a fairly small camp, the Paul Krugmans of the world, saying spend, spend, spend, and when the recession is over, then you can cut back. But this is a time for having a steady-as-you-go kind of policy, and you have to be somewhat flexible.
"The world is different from what it was three years ago."
Steve Fazzari, economics professor, Washington University:
Fazzari has a simple explanation for why he thinks this is a bad time for the federal government to pull back on spending.
"One person's spending is someone else's income," he said. "When the government cuts spending, it's cutting income to someone. A cutback in the deficit is just going to make unemployment worse, and the economy is still way below full employment. We are about 10 million jobs away; that's pretty bad."
He said a retrenchment from Washington might make sense if the economic recovery were more robust, "but I don't see that anywhere on the horizon now." He also said that concern over the deficit may be misplaced in times like these.
"I take some issue with the notion that we are pushing the problems off to the next generation," Fazzari said. "Before we try to do fiscal tightening right now, we have to ask if there is any obvious benefit to the next generation. When we cut deficit spending, incomes fall. And an improvement in the deficit is less than a dollar for a dollar. I would put it at 50 cents on the dollar, so a dollar cut in deficit spending really only reduces the deficit by 50 cents."
He can understand people's concern about the deficit, if they look at the problem like they look at their own household budget, but he thinks that point of view is the wrong one to take.
"That fits people's sense of responsibility," he added, "that if they are spending beyond their means, they need to cut back and things will get better. But that model is inappropriate. If I cut back on my spending, I might help out my personal situation, but if I go out to eat less often, I'm hurting the restaurant owner. Income destruction is not what we need right now."
Like Strauss, he uses a medical analogy -- the side effects from the big fiscal stimulus may not be pleasant, but you still need it for the economy to get better.
"We have a huge economic problem," Fazzari said, "but our economic problem is not the deficit. In my opinion, we should have a deficit, and it should be huge, given the size of the hole we are in."
The key, he said, is to spur economic growth that will lead to increased government revenue and, eventually, a smaller deficit.
"I don't want to suggest we can pull a switch to turn that growth on," Fazzari said. "If it was that easy, we would have done it already. There is a long-term issue -- the problem of health-care costs. I would welcome some discussion of how we are going to finance health care in the coming decade. That might create confidence in the markets. We can talk about those changes down the road, but it's not something we should be doing now."