The stimulus tragedy

Feb 21 2014, 23:59 IST
Comments 0
SummaryFive years after the stimulus took effect, it is clear that, though the programme did much good, it was also a political disaster

Five years have passed since President Obama signed the American Recovery and Reinvestment Act the stimulus into law. With the passage of time, it has become clear that the act did a vast amount of good. It helped end the economys plunge; it created or saved millions of jobs; it left behind an important legacy of public and private investment.

It was also a political disaster. And the consequences of that political disaster the perception that stimulus failed have haunted economic policy ever since.

Lets start with the good the stimulus did. The case for stimulus was that we were suffering from a huge shortfall in overall spending, and that the hit to the economy from the financial crisis and the bursting of the housing bubble was so severe that the Federal Reserve, which normally fights recessions by cutting short-term interest rates, couldnt overcome this slump on its own. The idea, then, was to provide a temporary boost both by having the government directly spend more and by using tax cuts and public aid to boost family incomes, inducing more private spending.

Opponents of stimulus argued vociferously that deficit spending would send interest rates skyrocketing, crowding out private spending. Proponents responded, however, that crowding out a real issue when the economy is near full employment wouldnt happen in a deeply depressed economy, awash in excess capacity and excess savings. And stimulus supporters were right: far from soaring, interest rates fell to historic lows.

What about positive evidence for the benefits of stimulus? Thats trickier, because its hard to disentangle the effects of the Recovery Act from all the other things that were going on at the time. Nonetheless, most careful studies have found evidence of strong positive effects on employment and output.

Even more important, Id argue, is the huge natural experiment Europe has provided on the effects of sharp changes in government spending. You see, some but not all members of the euro area, the group of countries sharing Europes common currency, were forced into imposing draconian fiscal austerity, that is, negative stimulus. If stimulus opponents had been right about the way the world works, these austerity programs wouldnt have had severe adverse economic effects, because cuts in government spending would have been offset by rising private spending. In fact, austerity led to nasty, in some cases catastrophic, declines in output and employment. And private spending in countries

Single Page Format
Ads by Google

More from fe Edge

Reader´s Comments
| Post a Comment
Please Wait while comments are loading...