Political traps for Keynesians

In early 2009 Congress and the president passed an $800 billion economic stimulus (tax cut and government spending) package. A number of analysts argued at the time that given the context — very severe downturn, interest rates already near zero, steep drop in home and stock asset values — the package was too small. Though the stimulus has helped (CBO, Blinder and Zandi), the pessimists appear to have been right: the economic recovery is languishing.

It looks very unlikely that there will be a second stimulus. This isn’t surprising. An initial stimulus that is insufficiently large risks creating (at least) three kinds of political trap:

1. Debt worry. From a post I wrote in January 2009:

Our experience in the 1930s and Japan’s in the 1990s … teach that if early stimulus efforts are too modest, they create a political trap: concern about the government debt produced by the earlier stimulus packages grows, which heightens opposition to further stimulus.

2. Perception that insufficient = ineffective. Here’s Paul Krugman in March of 2009:

Sooner or later the administration will realize that more must be done. But when it comes back for more money, will Congress go along?

Here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed.

But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed…. And as a result, the recession rages on, unchecked.

3. The party-in-power’s need for an optimistic message in election season. Mark Thoma:

The administration joined in pushing the “we are poised for recovery” line because it seemed like good politics and good economics to try to create a sense of optimism. When the economy did start to recover, they could build upon this story of how the stimulus package saved the day.

But what if the economy, and employment in particular, didn’t start to recover before the election, what then? The administration suddenly finds itself in a predicament. There’s not enough time before the election to actually implement a new stimulus program and expect to see results, so they are stuck with the economy they have, an economy they promised would be boosted by the stimulus programs (…).

So the administration has little choice but to argue that the stimulus programs that it put into place have set the stage for the economy to recover, and, in fact, that recovery is already underway.

One thought on “Political traps for Keynesians

  1. I believe Lane Kenworthy is correct in his criticism of the fiscal stimulus; it was far too small to have much of an effect. As Dean Baker has pointed out, it was more than offset by the fall in consumer demand fueled by the “wealth effect” spending of the twin equities and housing market bubbles. Baker asserts;

    “The combined impact of the drop in house prices to date and the loss of stock wealth should be a falloff in annual consumption of between $480 billion and $660 billion. The mid-point of this range would imply a drop in annual consumption of $570 billion. Adding this to the $600 billion drop in construction spending implies a falloff in annual demand of $1,170 billion.”

    http://mrzine.monthlyreview.org/2010/baker290910.html

    A much larger stimulus was needed. In addition, more needs to be focused on direct, job creating spending and social entitlements rather than on tax cuts and state budget deficit relief because such fiscal spending has a much higher multiplier effect.

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