The stimulus package had two components, new spending and tax cuts. Everybody knew that the spending component would take time to put into place, six months or more for a lot of the infrastructure projects, and that meant that we needed something to increase demand and provide a bridge until the new spending comes online.
Enter the tax cuts that the GOP insisted upon, tax cuts that were a larger part of the stimulus package than I thought justified. These cuts were to come online immediately and stimulate demand until the spending could begin taking up some of the slack later in the year. I would have preferred targeted, non-infrastructure spending that could have been put in place almost as fast as the tax cuts (particularly those that simply require making existing programs more generous), but that type of spending was considered wasteful because it didn't add to our long-run capacity for growth and hence had little chance of being part of the stimulus package.
The problem was partly bad luck. A crisis hit and we had the bad luck of having an administration that opposed active intervention and though there was a bit of a stimulus attempt through a one time tax rebate, a strategy theory predicts won't do much to help, the real action in terms of stimulating the economy was left to the new administration. So nothing was done, nothing could have been done until the new administration took over, and given the insistence that any new spending be on infrastructure projects with clear benefits, tax cuts were the main hope for an immediate effect.
So if the policy has failed at this point, it is not the spending component since, fully consistent with predictions when it was enacted, it was going to be months before it could be of any help. What failed is the GOP's insistence that tax cuts be used to provide an immediate boost to the economy. Increasing food stamps, unemployment compensation, payments to help states with declining revenues and increasing demands for social services, payments to help unemployed workers maintain health care, digging (needed) holes, there were many, many other ways to provide more immediate relief and stimulate the economy at the same time, but no, it had to be tax cuts or nothing.
Finally, I want to note that what we maximize matters. For example, we can maximize GDP growth over the next ten or twenty years, or we can maximize employment over the next few months. Which we choose to maximize has a big effect on the policies we put in place. If we use the stimulus money to maximize GDP and growth - which is essentially what we did - that will have a much slower effect on employment than if we maximize employment directly. The efficiency argument always leads you to maximize output, and efficiency prevailed in the structure of the current package, but I think an argument can also be made that maximizing employment provides social benefits that are just as large, or larger.
Just noticed this, which makes a surprisingly similar point:
A Message to President Obama: Stop Priming the Pump, Hire the Unemployed, by Pavlina R. Tcherneva: Many have called President Obama’s stimulus plan a return to Keynesian policy. Some of us who like reading Keynes professionally or for leisure have already been scratching our heads. I have wondered in particular whether the plan isn’t set up to work in a manner completely backwards from what Keynes himself had in mind when he advocated economic stabilization by government.
There are two things to remember about Keynes’s fiscal policy proposals: 1) government spending was always linked to the goal of full employment... and 2) to achieve macro-stability and full employment, the government had to employ the unemployed directly into public works.
By contrast, most modern economists believe that 1) there is some natural level of unemployment that includes the structurally unemployed, which governments cannot generally tackle, and that 2) public employment is an inefficient use of public resources.
So, when the government is called to action, the economic profession has replaced Keynes’s “fiscal policy via public works” with a “leaky bucket pump-priming mechanism.”
How is the latter policy supposed to work? Instead of employing the unemployed directly, the idea is to generate large enough government expenditures to produce a level of economic growth that would, in turn, gradually reduce unemployment. For example, the government could spend money on various private sector contracts, stimulate different private industries, offer investment subsidies and tax cuts, and increase unemployment insurance payments, in hope that it will boost GDP sufficiently to reduce unemployment to desired levels. This is essentially the underlying logic behind President Obama’s stimulus package. But it is also a bit of a gamble.
Not all of these injections will be effective because the fiscal stimulus enters the economy through “a leaky bucket”. Some of the money will be lost in transit (because of administrative costs, for example) and much of it will have no direct job creation effects (e.g. the tax cut component of the recovery act). Nevertheless, despite this leaky bucket, the theory goes, sooner or later, large enough government expenditures will produce the kind of growth that would reduce unemployment. ...
All of this is ... why Keynes never had any “leaky bucket” or “pump priming” idea in mind. For him “the real problem fundamental yet essentially simple…[is] to provide employment for everyone” (Keynes 1980, 267) and the most bang for the buck from fiscal policy would be achieved via direct job creation. This he called “on the spot” employment via public works.
As I have argued elsewhere, it is useful to think of Keynesian fiscal policy, not as aggregate demand management, but as labor demand management. ...
Commentators often call this a policy of “make work” but Keynes didn’t advocate digging holes, burying jars with money and digging them out, or any other similarly worthless projects. The key was to marry the two goals: to employ the unemployed directly and to make sure that they do useful things. Once they are put to work on a particular project, Keynes argued, “there can be only one object in the economy, namely to substitute some other, better, and wiser piece of expenditure for it” (Keynes 1982, 146). We might as well ask a very basic question: is there really a shortage of useful things to do?
If we insist on calling ourselves Keynesians again, and more importantly, if President Obama’s plan for economic stabilization should generate rapid reduction in unemployment, it would help to set fiscal policy straight. Instead of relying on “leaky fiscal buckets” we could return to “labor demand management” a la Keynes that provides immediate employment opportunities to the unemployed via bold and creative public works projects, which generate useful output and services for all.
This post was republished from Mark Thoma's blog, Economist's View.