Opinion and Economic Analysis

HICKS: So far, federal stimulus plan isn't stimulating

January 30, 2010

It has been roughly a year since the passage of the economic stimulus, formally the more harmonious American Recovery and Reinvestment Act. This stimulus is a textbook example of what we economists call counter-cyclical fiscal policy. The idea is that government will increase spending today, when we need more people working, and cut back in later years when the economy has recovered.

This idea dates back to the English economist John Maynard Keynes. Franklin Roosevelt adopted the policies, many of which became the New Deal. Since the Great Depression, this type of broad stimulus fell out of disfavor, with virtually all economists preferring monetary policy—primarily interest rate changes—to stabilize the bust-and-boom cycle.

The reasons are practical: The fiscal tools of tax cuts and spending are slow, costly and, for some reason, Congress always forgets to cut spending during the recovery.

This recession called for more than monetary policy because of the banking crisis. The argument (to which I subscribed) went that, as long as banks won’t lend, cutting interest rates won’t help. Some sort of stimulus was called for (I said $220 billion would be all states could spend). The problem is that a stimulus four times this amount isn’t working very well.

Last year, the economists in the Obama administration predicted the unemployment rate with the stimulus would be under 8 percent. This wasn’t political; it was just an error. The types of economic models most economists use would say the same thing. The problem is, without some sort of what I’d call “moral imagination,” deriving policy from economic models is dangerous. You have to try to imagine how people and institutions will react to a policy. Consider the recent stimulus package as a prime example.

When it comes to a good stimulus package, two things have changed since the Great Depression. The first is that workers are no longer homogenous agricultural and factory workers. The second is that public works projects involve far more complex regulatory constraints than ever before. This makes it impossible to accelerate road, sewer or water projects. These factors aren’t easily included in a model, but they clobbered the stimulus. Here’s how.

First, because few good jobs can be learned in a matter of months, there was little movement of workers. Manufacturing workers won’t flee Elkhart for road construction jobs in Florida. Second, the focus on “shovel ready” projects meant the only viable projects were those already planned by state and local governments. The stimulus simply replaced spending that would have otherwise already taken place. This did little to put more folks to work.

Somehow, the administration missed the moral imagination requirement. As a result, the impact of the stimulus languishes. We’ll feel the full effect of it, perhaps in a year or three—when it is not needed. Until then, we need to resist the siren song of more federal stimulus that we cannot spend in time.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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