Stimulie, I

by Russ Roberts on January 22, 2008

in The Economy

After my commentary on NPR, I spent a lot of time last week talking to bright non-economists about the various proposals to stimulate the economy by giving people money. Most of them presumed that of course giving people money will improve the economy. I realized that most people have trouble with what might be called "macro intuition." So I thought I would start a series of brief observations on why giving people money is unlikely to cause the economy to grow.

Let us begin with the most basic question. If you received a windfall, that is, an unexpected increase in your income, what would you do with it? The right answer is that it depends. If it is a one-time increase, you would respond differently than you would if it were a permanent increase. A one-time increase is more likely to be saved compared to a permanent increase. With a one-time increase, you might use it to pay off current debt. Or you might add it to your savings. Or you might spend some of it and save the rest. Or you might spend all of it.

Would the answer depend on where the money comes from? It would seem to be irrelevant, but it’s not. If you are the only person receiving the money, say from an unexpected inheritance, you might respond differently than you would if you knew that everyone was getting a tax reduction.

Let’s consider two different situations.

1. Your rich uncle dies who hated you. But he left you money anyway—$1600. What do you do with the money?

2. The government announces a $1600 rebate for all families, financed by borrowing. What do you do with the money?

With the inheritance, you feel a little richer. You might splurge on a fancy weekend in New York. Or you might save all of it. Or something in between. But with the rebate, you are less likely to spend it. Why? Because your taxes (or someone’s taxes) are going to go up in the future and that will discourage the feeling that you’re wealthier. It’s not just a feeling. We as a society aren’t any wealthier. To see the importance of this effect, imagine that the government announces that there will be no taxes collected this year. Concerned about a recession, the government is collecting no taxes in order to encourage consumer spending.

Consider a family that because of the magnitude of this tax cut, finds they have an extra $16,000 available rather than a mere $1600. Imagine the husband calling his wife. "Honey, great news. The government isn’t going to collect any taxes this year. We have an extra $16,000 to spend. Now we can finally (choose one: take that cruise, replace the minivan, renovate the bathroom)."

The wife replies "Well, if the government isn’t going to cut spending (and they’re not, because that would offset the stimulus of the tax cut, wouldn’t it?), then it’s going to have to borrow all the money to cover its spending for this year. The bonds the government sells are going to have to be repaid. We’re going to have higher taxes next year and the year after. I think we better put that $16,000 aside to pay for those taxes."

Who wins that argument?

The wife, don’t you think. So if a $16,000 tax rebate isn’t going to stimulate spending, why would a $1600 rebate? Because people won’t realize that they’re going to have higher taxes in the future?

And as will see in future posts, even if it is different, it still isn’t clear that it will stimulate the economy.

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muirgeo January 22, 2008 at 10:06 am

I'm having trouble understanding why the "stimulus" package to individuals is any different then the Fed pumping billions of new money into the system to save Wall Street and the lending institutions.

Russ Roberts January 22, 2008 at 10:09 am

Muirgeo,

Stay tuned. I think they have a lot in common–they do more for particular groups of people than they do for the economy as a whole.

Mark January 22, 2008 at 10:15 am

Muirgeo, where have Russ or Don ever advocated for inflation from the Federal Reserve? I've never seen them do so.

Randy January 22, 2008 at 10:23 am

I think its just a matter of "doing something" to comfort those who have "faith" in government – those for whom a government that does nothing would be truly horrifying.

Brad Hutchings January 22, 2008 at 10:51 am

The husband/wife argument doesn't ring. I get what you're trying to do here, but most people don't think that way about income taxes. Employer withholds, they never see the money. Now if you're talking property taxes, that argument resonates. Except few people have $16K property tax bills.

tw January 22, 2008 at 11:07 am

Mark, I agree with your view on inflation. Haven't heard much talk about inflation in light of today's 75 basis point cut by the Fed…days after we were told inflation in December was 'surprisingly high.'

Chris January 22, 2008 at 11:16 am

I think this is one of those things where a politician believes that "if there's a drought, you better be outside doing a rain dance." The politician doesn't really believe the rain dance will do any good, but he will be pilloried if he doesn't do it. Remember what happened with the current President's father.

But, in the end, the willingness of consumers to take risks has something to do with the economy's performance. And, if consumers believe that the stimulus plan will improve the economy, they may be willing to take on some more risk.

Bret January 22, 2008 at 11:41 am

If one is attempting to stimulate demand, and the demand based on the contents of one set of pockets is relatively inelastic when compared to the demand generated by the contents of another set of pockets, one can clearly increase demand by transferring the money from one set of pockets to the other.

Brandon Erik Bertelsen January 22, 2008 at 12:13 pm

Personally, I think the Husband would win because the only people that think like the wife are economists. `

muirgeo January 22, 2008 at 12:18 pm

Muirgeo, where have Russ or Don ever advocated for inflation from the Federal Reserve? I've never seen them do so.

Posted by: Mark

I never said they did. I do remember all the talking head econ-TV-pundits screaming for help. Kramer from Mad Money was practically begging the Fed to act.

I have a hard time seeing the Fed as part of a Liberal economic system but I also have a had time imagining what would happen with out them.

gorak January 22, 2008 at 12:44 pm

You forget the government could just monetize the debt and not take it back honestly in taxes. They may keep the 16,000, but in the value of the new money pool.

John V January 22, 2008 at 1:11 pm

Quite frankly, Muirgeo,

You read and post here far too often to not understand the real POV of Russ, Don and the majority of posters here.

Repeated attribution errors are a norm with you.

Your insistence on constantly treating this site as somewhat of a Republican blog has soiled your image and everything you say is now suspect and treated like workings of a troll. It's your own fault.

The Albatross January 22, 2008 at 1:19 pm

"I have a hard time seeing the Fed as part of a Liberal economic system but I also have a had time imagining what would happen with out them."

Muirgeo,

The Fed was a creation of the "Progressive Era. Although a gross simplification, it was created for two reasons:
1. Demand from grass roots progressives such as the grange movement calling for cheap credit.
2. An overall demand to try and regulate the economy's boom and bust cycles by creating a lender of last resort.

So what would happen without it? Well, we have some idea based on the 80 some years this country went without a central bank. In those days, banks that made irresponsible lending decisions would go broke, as they often did (and should). However, often banks would loan each other money to prevent collapse or form consortiums to buy or save a failing bank. This is what was famously done by JP Morgan in 1908.

mark seery January 22, 2008 at 1:27 pm

I have a regular savings plan. Because I have, other spenders in my family feel justified in spending what ever is left over; after all the future is taken care of already right? Plus we always have debts of one type of another, or don't have enough money for a vacation, or something. Not trying to justfiy any of this thinking, but I really wonder whether the average consumer realizes that today's gift might be tomorrow's inflation. Most people work in the here an now. Here and now they have wants and debts. The money gets spent. Is there any evidence that savings goes up when these kinds of things happen?

Secondly, I suspect most consumers are under the impression that the last round of giveaways and tax cuts stimulated the economy. The economy got better afterwards did it not? Therefore, I think before someone can make an argument about what this round of giveaways is going to produce, they might want to revisit the last round and make an argument about that. Note: I am not arguing the last round of giveaways had any effect, just that it is likely many people believe it did.

Milton January 22, 2008 at 1:31 pm

The basic question is whether you want to transfer wealth or create wealth. Transfer of wealth = Bush refunds I, New Orleans stagnation and Paris Hilton. Creating wealth by cutting taxes = economic growth, investment and innovation.

Bret January 22, 2008 at 1:41 pm

The Albatross wrote: "So what would happen without it [The Fed]? Well, we have some idea based on the 80 some years this country went without a central bank."

Some idea, perhaps, but not much. The currency was gold based then, it's fiat now. The population is 3 times as great now. The GDP is about twenty times as large (correct for inflation). Finance is far more sophisticated.

There are very few similarities between then and now.

Saum January 22, 2008 at 2:13 pm

I am trying to understand Russ's central point that a short-term tax rebate doesn't help because consumers factor in future higher taxes and are less willing to spend this one. Can anyone point me to studies, emperical or otherwise, that support this theory?

I am thinking a temporary tax rebate even if partially spent will increase aggregate demand and thereby help the economy. It may not be much in actual $$ terms, but psychologically it may lead consumers to anticipate a shallower reccesion, which itself may be a net +ve result? After all economics and psychology are not very distant cousins in the minds of a layman. I don't have data to support my theory either, but I will look for it.

I would like to know which of the 2 theories is correct based on some facts. I follow this blog and comments fairly regularly, but don't post that often. I am really trying to learn here, so please don't jump on me or dismiss my question as another left wing whacko.

Nick January 22, 2008 at 2:23 pm

This is of course partly true, but Riccardian equivalence is violated when:
1. Demographic shifts–perhaps someone else's children will be paying for it.
2. Uncertain taxes–if you have no idea how much taxes you will pay in the end.
3. Proportional taxes and uncertain wages–same basic idea.
among many others.

I think Barro's original argument assumed an overlapping generations model (where you value your children's utility just as much as your own future utility–with the same discount rate, there are no changes in population, and only lump-sum taxes).

There is one final way out–inflation, or I think Sargent and Prescott (or was it Sims?) called it the Fiscal Theory of the Price Level. In the strict version of their theory…the govt runs a deficit and the Fed inflates it out of existence. In the original version, the "game of chicken", the govt runs a deficit and plays chicken with the fed…who has to inflate just enough to guarantee solvency.

Your guess what happens next….

The Albatross January 22, 2008 at 2:38 pm

Bret: "Some idea, perhaps, but not much. The currency was gold based then, it's fiat now. The population is 3 times as great now. The GDP is about twenty times as large (correct for inflation). Finance is far more sophisticated."

Fair enough, I was just trying to run with what we got, but the economy maybe bigger and finance more complicated but are the fundamentals of banking any different? Finance was much more complicated and the economy many times larger when the Fed was created in 1913, than when the Second Bank of the US expired in the 1830s. The country flirted with fiat currency during the Civil War, and the economy managed an amazingly complex trade in notes circulated by banks. I'm just saying that the economy managed to function and prosper without the Fed and could probably do so again, and this might be preferable to the current practice of the Fed creating bubbles in the economy and then trying to fix them by laying on another bubble

mark seery January 22, 2008 at 2:51 pm

Albatross,

"..the Fed creating bubbles in the economy and then trying to fix them by laying on another bubble."

is the proper way to think about this that the Fed is subsidizing the cost of money when it attempts to keep the interest rate low; a subsidy which a) stimulates activity beyond where it would otherwise be and b) is a cost, via a subsidy, to the taxpayer?

The Albatross January 22, 2008 at 3:13 pm

Saum,

Sorry, cannot think of any studies. One of the problems about measuring the effects of fiscal “stimulus” is that economies have a habit of coming out of recessions, if stimulus is passed, then did the economy just recover or did the stimulus do the trick? All I can give you are a few historical examples. Fiscal stimulus during The Depression is considered a failure as the economy was not in much better shape in 1940 as it was in 1933 (although there is disagreement). The Kennedy tax cuts (enacted after his death in 1964) did appear to stimulate, but these cuts were permanent, and thus not the same as the stimulus being discussed and probably had some supply-side effects (people more encouraged to make money, ect.) If I remember right there was a one-time stimulus in 1976(?), but the result was that in that age of uncertainty most people just held onto the money. There was the Clinton stimulus package that never passed, and the economy recovered anyway. The Japanese spent a fortune trying to stimulate there economy in the 90s (huge public works etc), which also appeared to have little effect. The same occurred in Eastern Germany, where the government spent massive amounts of money to stimulate the east, which has not appeared to do much. In conclusion, the record on stimulus is not that great, I think Russ’s point is that the reason for this is that any stimulus comes at the expense of stimulating something else, the net effect of which is an economic wash. Some economists argue that if you pick the right thing to stimulate then it will work. I think the latter group tends to favor investment credits but I could be wrong.

Dave January 22, 2008 at 3:42 pm

I agree that the example conversation is unrealistic. You really expect the same Americans who are running themselves into bankruptcy with debt can comprehend that the government will have to recoup this money later?
Having said that, I agree that people are unlikely to spend one-time windfalls (because it only raises their long term means by the interest of the money gained). So I'd expect it to either be saved or used to pay down debt. My biggest problem is with calling them "stimulus" plans instead being more honest that they are wealth transfers to help keep lower income households above water.

The Albatross January 22, 2008 at 3:43 pm

Mark Seery,

a) Exactly
b) The "beauty" of Fed action over stimulus from a political standpoint is that it appears to cost the taxpayer nothing. The government spends nothing and takes on no additional debt or higher taxes. The subsidy of money shows up later to bite the taxpayer, when the inflation it produces reduces the real value of his wages and savings. Although, conveniently for politicians this inflation comes later and complete with scapegoats–middlemen, business, hoarders, wasters, speculators, etc. There is also the inevitable cost to the taxpayer of losing his job when the distortions pile on top of one another. We may all be dead in the long run, but I've got a ways to go.

Saum January 22, 2008 at 3:45 pm

Thanks, Albatross. Gives me something to think about.

Maybe measuring the impact of a stimulus can be fine tuned to say…

1. Length of time required to come out of a recession/downturn when a stimulus is injected or isn't.
2. Post recovery growth and strength of that growth.
3. Did aggregate demand go up from the time when a fiscal stimulus was injected through the recovery period? (test this theory as well).

A catalyst in a checmial reaction enables a reaction but doesn't actually participate in it. I am wondering if a stimulus acts in a similar fashion – enables a recovery but doesn't actually participate in it.

Saum January 22, 2008 at 3:49 pm

4. Did savings go up from when the stimulus was launched through the recovery period?

Saum January 22, 2008 at 3:53 pm

5. Did individual debt burden go down from when the stimulus is launched thru' the recovery period?

4 & 5 are based on comments that say they "expect" individuals to behave in this manner. Seems like there are some measurable variables here to test this theory. Given the complex nature of transactions that drive an economy, I am not confident we can get to a definitive answer, but a more scientific/empirical study would convince me than theory and some expectations/assumptions.

Andrew January 22, 2008 at 4:00 pm

It would seem that a rebate at that level is more of a symbolic gesture than an actual measure to increase consumer spending. Whether being seen to be working on the problem will cause market confidence in excess of the actual effect of the action is unlikely in the current climate.

Saum January 22, 2008 at 4:03 pm

Stimulus spending takes away spending from other areas of govt spending. Agreed. But isn't all govt spending (or individual spending for that matter) a trade-off between various priorities? Threat of a deep recession is a serious one and maybe spending on reducing this threat is worthwhile.

Wouldn't a tax rebate to an individual be better than big public works projects since free marketers believe that individuals are better equipped than the govt bureaucracy to make sound economic decisions?

muirgeo January 22, 2008 at 4:15 pm

"….and everything you say is now suspect and treated like workings of a troll. It's your own fault."

Posted by: John V

John,

What are YOU talking about? I basically just asked an honest question and Russell gave me a respected reply that seems to have legitimized the question. As my teen age daughters would reply, "Stop being a hater".

muirgeo January 22, 2008 at 4:23 pm

Creating wealth by cutting taxes = economic growth, investment and innovation.

Posted by: Milton

But I'm not so sure. Clinton raised taxes and much wealth still followed. Bush cut taxes and look at the mess we now have.

My uneducated opinion suggest had we not wasted billions and billions of dollars on this war and had used it to build infrastructure in our own country we would have a very different ecoomy regardless of tax cuts or increases.

brotio January 22, 2008 at 4:25 pm

If I understood him correctly; Schumer said an income tax rebate is unfair because the poor and middle class don't pay any income tax. He suggested the rebate come from FICA withholding instead.

Conservatives and libertarians ought to run with this idea. Let's lift the burden permanently and let people take their FICA withholdings and invest them as they see fit. A fifteen percent raise might just spur the economy and allow people to adequately plan their own retirements.

Bret January 22, 2008 at 4:41 pm

The Albatross wrote: "The subsidy of money [from Fed Action] shows up later to bite the taxpayer, when the inflation it produces reduces the real value of his wages and savings."

Maybe yes, maybe no.

In the case where you have liquidity drying (like now), the Fed action simply replaces some of the liquidity that was lost. The Fed can pull the liquidity later as the other lost liquidity comes on line.

In the case where unemployment is rising (like now), if the Fed action stems the increase in unemployment or even helps reduce unemployment, then the total goods and services are increased and we are all better off (in aggregate) regardless of the resulting inflation (if any, since the larger economy can absorb the extra liquidity).

The economy can adjust pretty quickly to modest changes in the rate of inflation.

brotio January 22, 2008 at 4:41 pm

Murthaduck ("the children they've killed in cold blood") presumes that with Iraq as a safe haven, that al Qaeda and other Islamo-fascist groups would still not have successfully pulled off another major strike. Or, that such a strike would do no harm to the economy.

To know what would have happened if we hadn't removed Hussein would require being able to look into a parallel universe. I realize that Murthaduck lives in an alternate universe, but I don't think it gives us any insight into what would have happened if Hussein was still literally feeding political rivals to the dogs.

The Albatross January 22, 2008 at 5:07 pm

Saum,

Sorry, I don’t think I can help you, although I am sure there is a “blackboard” economist around here that might have something for you. Off the top of my head I would say that so many factors weigh on economic performance and that any fiscal stimulus is dwarfed by the economy that it would be pretty hard to get a clear picture of its effectiveness, which leaves us with theory (as Russ explores above) and rough ad hoc comparisons (historical examples). Economic growth in the early 90s was largely driven by more people going back to work and larger capacity utilization. Growth in the late 90s and in more recent years has largely been a factor of productivity gains. I guess my point is that since recoveries or growth are sometimes characterized by different, the same, or a mix of factors, then this makes evaluating stimulus in the context of a recovery or growth even harder. However, here are the facts of the 75 tax rebate stimulus, followed by the savings rate (the Hoover link), so we can see if there is a correlation. Interestingly, people seem to save more during recession years, and the dip in savings moderates, flattens, then rises a little through the length of the stimulus (through 76). So while I cannot tell for sure (what effects savings is just as complicated), it might be that “stimulus” will end up in the bank.

http://en.wikipedia.org/wiki/Tax_Reduction_Act_of_1975

http://www.hoover.org/research/factsonpolicy/facts/4250756.html

Jeff January 22, 2008 at 5:26 pm

I understand the logic of saving a tax rebate vs. spending it. But wouldn't there be evidence of this phenomenon in the form of higher household savings rates in response to past tax cuts? More basically, I think this logic ignores just how pervasive the "live for now" ethic is in our country. Folks can just as easily conclude that they don't know what's going to happen in the future (and it's likely to be bad) so why not spend now? I have seen this anecdotally among family members and employees of the family business.

The Albatross January 22, 2008 at 5:32 pm

Bret,

I generally agree with you. The subsidy can sometimes shake its way through the economy with minimal disruption or if it primes the pump properly. The misallocations of resources can always be liquefied later in a time of prosperity. Pete Boettke has characterized economic growth as a race between three horses: (1) Smithin gains (trade), (2) Schumpeteran gains (productivity), and (3) stupidity (government policy), as long as horses 1 and 2 stay ahead, then we might be ok. Unfortunately, number three has a nasty habit of making a charge down the stretch.

cpurick January 22, 2008 at 5:53 pm

"I think we better put that $16,000 aside to pay for those taxes."

Aside where? In Mason jars in the backyard? In a mattress? In fact, the money will go into savings and ultimately gets stuffed into an investment on somebody's behalf.

Even "putting it aside" has a stimulating effect.

muirgeo January 22, 2008 at 7:05 pm

To know what would have happened if we hadn't removed Hussein would require being able to look into a parallel universe.

Posted by: brotio

Not really Bro since Saddam DID NOT attack us on 9-11, had NOTHING to do with any 9-11, WAS NOT a supporter of Al Queda and there was NO significant Al Queda in Iraq until after we invaded. No parallel universe needed just attention to the details and the facts and most importantly having another source for your information then Fox News.

Hans Luftner January 22, 2008 at 9:45 pm

It seems to me that "saving" & "spending" are often subject to interpretation. If I spend my $1600 or whatever on candy, than it would be hard to justify it as saving, unless I was a candy speculator. But if I spent it on gold, foreseeing the coming inflation, than would you call it saving or spending? What about college? Am I spending or investing? A house? A car? A miter saw? New shoes? Cocaine? Almost any spending could be interpreted as saving, given the right rationale, or vice versa. When you factor in inflation, it seems like the mason jar plan would be less like saving than if you traded the money for anything that might hold its value. How would economists or pundits even know which category to put it into, if the people spending/saving it don't always consciously know? Does it even matter? Isn't this really just Keynesian bunk anyway?

Also, Muirgeo's right about the Iraq War. Broken clock, I guess.

OregonGuy January 22, 2008 at 9:47 pm

I don't know what rarified air you guys are breathing. You give sixteen hoondie to anyone around here and you're going to see that money spent on cigarettes and beer first. There are a lot of folks who would love to say "Camel" instead of "Generics". And there will be some great parties. Couple of fifths of Jack and a case of brew, that's a party.

Then? Maybe a payment toward an old bill. It's amazing what a hundred bucks toward a bill can do for one's sense of self esteem. And while we're being sensible, a couple of tee shirts for the kids and maybe a new pair of boots. That and gas money, and about $800.00 is gone. Beer, booze, smokes, some shirts and a pair of boots. Maybe buy the parts to fix the heater in the wife's car.

It's not enough to do anything "real". We are not populated by Jack Whittingtons. Try taking a family of four out for Mexican. With a tip? Sixty bucks. A couple of meals, beer, booze and smokes, boots and t-shirts? We've already spent close to a grand.

That six hundred? It's going to Walmart, baby. Video system? Sure. PS3 is 5-hundy. Done.

What have we done with the dough? The billions? Gone to St. Louis, Missouri. Textile mills in China. Spun through retail land and nothing to show for it. Brilliant economic policy.

Cut taxes on the rich? Or, more correctly, cut corporate taxes? More jobs. More capital expenditures. More income. More income tomorrow. And the day after that.

Give money to the blokes who ain't rich? More income. Once. What would you expect them to do, build an oil refinery? In today's political climate?

Thomas Y January 22, 2008 at 10:42 pm

I've just started studying the Macro section of my AP Economics course. This tax rebate from the Feds was pretty much the center of our discussion today and it makes me wonder now how the increase of money in the market will affect the economy in the short run and long run. In class we read this article about how Americans are better spenders than savers. So wouldn't it be more likely that the tax rebate would boost/stimulate the economy? (Given that "some people lack the willpower to cut back spending")

Kyle L January 22, 2008 at 11:20 pm

I have also just began in the Macro part of my AP econ class. Thomas Y knows what he's talking about. Our GDP is 70% consumption, Americans are not going to think 'maybe some time in the future taxes will go up so I should save this money'. They're going to take any extra money available, and spend it on an XBox 360 or a new iPhone or some Hollister clothes for their kids. This will not help the personal welfare of these consumers (except to give them these products that they can't live without), but it will increase consumption and stimulate the economy. No one's going save their extra money; they all want to feed the birds (tuppence a bag)

Martin Brock January 22, 2008 at 11:33 pm

The premise is false. Congress needn't raise any taxes next year to pay for this year's "stimulus". Next year, when the bill comes due, it borrows again. And if the Fed itself holds the notes, Congress doesn't even pay interest on them, because the Fed's net revenue is income to the Treasury.

Creating money to spend it can be inflationary, of course, but if I think the government's policy is inflationary, I could be more inclined to spend the rebate, because I expect the cash to be worth less in the future.

In principle, creating money to spend it could have net benefits to the economy. For example, the spending could employ otherwise idle resources building needed roads increasing the productivity of the rest of the economy. In this scenario, the spending need not be inflationary, even if government creates money from nothing to spend it.

Do I expect this "stimulus" to have beneficial effects? No. On the other hand, I don't see how it could be worse than "emergency appropriations" for the "war on terror".

brotio January 23, 2008 at 1:17 am

"Not really Bro since Saddam DID NOT attack us on 9-11, had NOTHING to do with any 9-11, WAS NOT a supporter of Al Queda and there was NO significant Al Queda in Iraq until after we invaded. No parallel universe needed just attention to the details and the facts and most importantly having another source for your information then Fox News." – Murthaduck

I know, I know. I should get my information from such reputable sources as CBSnooze, Clinton News Network, or the NY Slimes.

Even if, for argument's sake, everything you wrote was accurate; there is still no denying that except for Jimmy Carter (and possibly Castro and Oogo Chavez), that no one hated the US more than Hussein and that seven years is an awfully long time for opportunities of mischief.

There is also the fact that Khadaffy Duck (a relative of yours?) had an attitude adjustment after the Iraq invasion, and no one knows what he might have done otherwise.

So, you would still need to look into an alternate universe to have any evidence that the world would be a better place if Hussein was still feeding live human beings to the dogs, or making men watch the rape of their wives and daughters before the beheading.

andy January 23, 2008 at 3:18 am

I'm having trouble understanding why the "stimulus" package to individuals is any different then the Fed pumping billions of new money into the system to save Wall Street and the lending institutions.

I have to agree with Muriego. Since the government doesn't plan to cut spending but only to cut taxes – thus finance the whole thing with the deficit, there seems to be not much difference between the 2 options.

In principle, creating money to spend it could have net benefits to the economy. For example, the spending could employ otherwise idle resources building needed roads increasing the productivity of the rest of the economy. In this scenario, the spending need not be inflationary, even if government creates money from nothing to spend it.

Martin, could you explain why those resources are idle before the money was created? If it was so, lowering prices of these resources would have solved the problem as well – without the side effects of expanded money supply.

John Dewey January 23, 2008 at 9:03 am

Oregonguy: "What have we done with the dough? The billions? Gone to St. Louis, Missouri. Textile mills in China. Spun through retail land and nothing to show for it. Brilliant economic policy."

I don't know if it is brilliant economic policy, but very little of what is spent will go to textile mills in China. The production cost of most goods sold at Walmart is very low. A larger portion of what is spent at Walmart goes to the transportation network which moves goods from China across the ocean, over rail to Walmart distribution centers, and then over highways to the individual stores. Another big part of what one pays for Walmart products goes to the employees of Walmart. The transportation companies and their employees, together with Walmart and its employees, will then spend most of what they receive right here in the U.S. The ripple effect of spending those billions on consumption should immediately increase economic activity – which is what Congress and the president are hoping for, right?

I'm not arguing that creating money to stimulate the economy will make the economy healthier over the long run. Of course it won't. But the additional spending will probably reduce the immediate shrinkage of the economy.

John Dewey January 23, 2008 at 9:21 am

andy: "Martin, could you explain why those resources are idle before the money was created? If it was so, lowering prices of these resources would have solved the problem as well"

I think the goal of Congress and the president is to limit the human resuorces that become idle. A recession will lead to lower utilization of labor. The first effect of the subsequent recovery would be increased productivity, as output increases but laid off employees remain idle. If an economic stimulus reduces the layoffs, then the total months of idle labor resources should be lower. That's the pain Congress and the president are trying to reduce.

Highly trained economists cannot agree that such a stimulus will work. Bernanke, who is much smarter than I am, favors a quick fiscal stimulus:

The Fed chairman said a stimulus plan of $50bn-$150bn would be “reasonable” adding that the right stimulus plan would have a “measureable” effect on growth.
.
.
.
Mr Bernanke endorsed the view – associated with prominent Democrats – that targeting relief at low to middle-income people would deliver the most “bang for the buck”.

Bush and Bernanke back fiscal stimulus

I have great respect for Professor Roberts also, but I disagree with his suggestion that families will not spend the windfall. Many of my lower middle income relatives will spend their share before it ever gets to them.

vidyohs January 23, 2008 at 11:16 am

Just an aside, but if this nation went back to the gold standard to prevent inflation, would it not then be forced to use only coins of silver or gold and eliminate all paper certificates?

As long as we accept that the government can print paper certificates redeemable for precious metal, the government can still inflate.

What is being pledged as redeemable by those FRNs is the value of our individual labor, because the FRNs themselves are nothing more than instruments of debt. that is the reason they are called notes, as in Federal Reserve Notes.
————
Anyway,
Muirduck, my response in the debate on the topic you chose is available to you on the previous Stimulus thread. Ball's in your court.

I am off again to practice my beloved capitalism.

Martin Brock January 23, 2008 at 11:18 am

Martin:

In principle, creating money to spend it could have net benefits to the economy. For example, the spending could employ otherwise idle resources building needed roads increasing the productivity of the rest of the economy. In this scenario, the spending need not be inflationary, even if government creates money from nothing to spend it.

andy:

Martin, could you explain why those resources are idle before the money was created? If it was so, lowering prices of these resources would have solved the problem as well – without the side effects of expanded money supply.

I don't know why the resources are idle.

I do know that freely accessible, paved roads can raise productivity, and I know that human beings aren't born paving roads. We can have too many roads, of course, and simply throwing money at roads is no panacea, but I'd rather throw money at roads than throw it at bombs. That's just a personal preference of mine.

Lowering prices doesn't automatically employ resources. The price of salt water on the coast is practically zero, but we don't have "fully employed" salt water. At some point, lowering prices may only increase the supply of cheap stuff that no one wants.

Here's a real example. My neighborhood has a derelict house. Apparently, it had a bad roof that no one ever fixed, and water damage ultimately destroyed the house beyond repair. Now, the house is condemned, but no one will demolish it. Why? I'll venture a guess. The cost of demolishing the house and clearing the site exceeds the value of the land underneath. In other words, the real value of the property is now negative, so no one will own it. I wouldn't accept the property if you gave it to me for nothing.

This sort of thing does happen, and it's not simply an artifact of monetary policy. If the value the land doesn't change relative to the value of clearing the site, the real value of this property remains negative indefinitely, regardless of nominal prices. Maybe, removing the derelict house would increase the total value of many surrounding properties enough to justify the cost, but I'm not willing to absorb the entire cost myself, because I can't afford this charitable contribution to my neighbors, many of whom are probably richer than I.

A gold standard and gradual deflation doesn't solve the problem, and deflation does create other problems. Some of the problems are simply accounting difficulties. We could adapt accounting procedures to persistent deflation. We could negotiate long-term lease agreements with gradually falling rents for example, but as a practical matter, most landlords can't wrap their heads around these terms. They'd rather gradually raise rents instead.

Saum January 23, 2008 at 1:22 pm

I am more inclined to believe that what John Dewey and others have said abt spending v saving is correct. Otherwise why would we have those pacyheck advance loan guys around? We are a spend and more spend people!

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