Treacherous stimulus

This stimulus thing is tricky. Anthony recently posted about the merits of private investment vs. government investment. I’d add to that a tip from Peter Gordon’s blog that the marginal costs of public funds is not trivial–there is a cost to raising additional funding for government spending, even when it is “stimulus” spending. Think of this this way. A dollar spent by the government does not create as much growth as a dollar invested by the private sector, and the government dollar has a cost associated with it that further lowers the return on investment. The last stimulus package in the form of tax rebates was nice on an individual level–I spent mine on a vacation in Europe. But a look at the data shows it did not increase consumer spending, hence, permanent tax cuts are the best stimulus.

. . . government spending does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low. The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.

The latest round of stimulus talk focuses on arguing either that the larger size of this stimulus will cause it to effect consumer spending the way the last one did not, or that by focusing on infrastructure spending it will create jobs and thus spur consumer spending. The size argument only works if people suspend whatever instincts they have about the costs of govermnet spending. A big stimulus won’t have as much effect on consumer confidence if people are concerned about the deficit and how all this will be paid for. As for government infrastructure projects creating jobs, they will in the short run, but people who get jobs that they know are only funded for a short time don’t spend the way people who have permanent jobs with career prospects do. And they will still be worried about how we are going to pay for the deficit. Add yet another layer, deficit spending by the federal government gobbles up a lot of the credit out there, the same credit that is so scarce it is a leading cause of the current financial crisis. My point is there are many wide avenues for unintended consequences in this stimulus plan. We’d be far better served by a plan to use permanent tax cuts and incentives to spur private investment, job creation and consumer spending. That is the path out of the recession.