ECONOMIC ANALYSIS: Stimulus plan must work now ... or it never will

July 20, 2009

A couple of my economist colleagues at the Center for Business and Economic Research and I have returned from brief summer jaunts to various places—Chicago, Atlanta, New York. Each of us report having passed at least one highway sign sporting a claim that the roadway repairs were funded by the American Recovery and Reinvestment Act.

These are lies, of course. Any highway work now being done was planned and financed years ago. But these are white lies, not of the finger-wagging denial sort. The big lies with respect to the stimulus involve what a stimulus can and cannot do.

The postmortem and dissection of the stimulus plan have begun in earnest. The president has added to his woes by saying the stimulus will take years, not months, to work, and his chief economist managed to squeak out the headline or two that the worst is ahead of us. This is ready material for criticism and does nothing to speed along the recovery—which is as much about expectations as it is anything else. This is a fairly difficult concept, but it is worth a brief simplification.

Imagine the economy as a car driving at a constant speed down a wide, perfectly straight road. The speed the car is traveling is the long-run rate of economic growth. If the car stays on course, there will be no recessions or recoveries, just constant growth. But, if the car weaves back and forth, its speed, relative to the destination, varies. The effect is that of a slowing economy or recession.

A fiscal stimulus can do no more than bump the economy back to its growth trend, but that is only in the theoretical best-case scenario. A stimulus alone can’t speed the car up, only get it back on track.

Interestingly, though, how the stimulus is spent might conceivably speed the car up slightly in the distant future. If the funds are spent to increase the efficiency of the economy by reducing traffic congestion or reducing the costs of moving goods, we might see a modest increase down the road. (It is worth noting that the world’s expert on that issue was John McCain’s chief economist.) Most stimulus money is not going to these types of things, so any notion of a large-scale productivity boost is sadly mistaken. The president is wrong; the stimulus will work either now, or not at all.

The $800 billion stimulus was based on the worst-case estimate of the economy’s decline extrapolated to the entire year. Even before the stimulus, the economy did not shrink at a rate that would justify $800 billion. It is going to take federal, state and local governments a full two or more years to spend this amount of money.

This leaves us with a huge problem. Having spent less than 10 percent of the stimulus funding, the economy seems to be inching toward recovery. If we start recovering, the excess stimulus funding will simply feed inflation, overcorrecting our economic car—perhaps into the ditch.•




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