CBO: Stimulus Will Reduce Long Run Economic Performance

Peter Suderman, our colleague over at, points out recent testimony by Congressional Budget Office (CBO) director Douglas Elmendorf that the $800 billion stimulus package passed in February 2009 will have a “net negative effect on the growth of GDP over 10 years.” This is quite notable (and Suderman links to the video testimony; listen for Elmendorf’s comments around 1:20 mark.) It’s also worth expanding on a little.

The effects of the Stimulus program are being debated (see my extensive critique here from 2010), but the fact that the CBO recognizes the potential for all that money dumped into the economy becoming a drag in the long run implies at least their forecasting models recognize spending has to be productive in order for it to really lift the economy. Much of the support for the Stimulus package was based on a very crude Keynesian economic model that presumed that the problem with the economy was almost exclusively an artifact of depressed consumer spending. In this naive model, all you need to do is pump money into the economy so that people spend it. And, most forecasting models, don’t differentiate between productive and unproductive spending. So, literally digging ditches and filling them back in again generates “positive” economic impact. (See also my comments on economic multipliers at for more on this.) Of course, as national unemployment continues to hover around 9 percent, we can pretty much recognize the crude model didn’t work.

In the real world growth occurs when productivity is enhanced and investment is directed by entrepreneurs into the production of goods and services that people want. Whether the product or service has been determined by a bureaucrat to be “shovel ready” is irrelevant. It’s not the spending per se that drives the economy, it’s the succesful investment of resources in goods and services that improve our standard of living and quality of life in meaningful and tangible ways on a broad level that boosts economic growth. That’s why Apple’s investment in iPads and iPods is productive investment and boosts growth while unnecessarly replacing curbs and sidewalks because they are shovel ready does not.

The hard-core truth is that the economy is in fact going through a major realignment. The housing market is in shambles, and, as my colleague Anthony Randazzo points out, we probably have a way to go before it really bottoms out. Developers, builders and buyers were responding to the wrong price signals for over a decade, creating a massive housing bubble. But the housing market is only part of the problem. Mixed into the housing market debacle is a financial system seriously out of whack. Until the financial market sorts itself out, capital won’t be available for consumers or businesses to spend at the levels before the housing bust. And, it’s going to take a while before businesses have a good read on what consumers really want.

The good news is that if the government can keep from jumping back into the market too soon and further distort prices, the economy should be on a firmer foundation for sustained long-term growth. That’s another way of saying the short-term spending focus of the Stimulus Package set us back more than it pushed us forward. It may have solved a political problem at the time, but it probably did more to delay the necessary re-adjustments than speed them up.

That conclusion, I believe, is the takeaway from the CBO testimony.