Congress has finally agreed on a $790 billion stimulus package. Is it too small, as many Democrats claim (such as Paul Krugman), or too big, as many Republicans claim (such as the minority party leadership in Congress)? The answer is yes. It is too big and too small.
If the criterion is how much annual stimulus to demand is needed to bring the economy back up to the level of potential output in 2010 and beyond, and to bring the unemployment rate back down to the natural rate of unemployment, then $800 billion is to small. The Congressional Budget Office has estimated that the economy will fall short of potential output by about 7 per cent of GDP, in both 2009 and 2010. (The source is testimony on January 27 by the new Director of CBO, Doug Elmendorf – an outstanding choice to run that agency, by the way. The news on jobs and other economic indicators in the two weeks since that testimony was written has continued to show rapid deterioration of the economy.) The $800 billion is to be spread over several years; the peak is to be about $356 billion in 2010, which is about 2 ½ per cent of GDP. The most optimistic estimate of the “Keynesian multiplier” that anyone has is 2, which would imply a 5 per cent boost to GDP. That is less than the 7 per cent gap, and so not enough to return the economy to full employment.
But in another sense, $800 billion is too much. The 2009 fiscal-year deficit is already expected to exceed $1.2 trillion, so we are talking about deficits thereafter that could surpass 10 per cent of GDP. The ratio of government debt to GDP is forecast to surpass 85% already in fiscal year 2009. That includes debt monetized by the Fed, but even if debt in the hands of the public is expected to rise from its current 42% of GDP to about 70% over the next two years.
Everything would be different if we had spent the last 8 years preserving the budget surpluses that Bill Clinton bequeathed to George Bush. Then we would have paid down a big share of the national debt by now, instead of doubling it. We would be in a strong enough fiscal position to undertake the expansion today that we really need.
In that light it is ironic, to say the least, that the politicians who are warning against the size of the stimulus bill (“generational theft”), particularly the Congressmen who are voting against it, are mostly the same Republicans who supported the original fiscal policies that gave us the doubling of the national debt: the huge long-term tax cuts of 2001 and 2003 and the greatly accelerated rate of government spending. What we need now is a fiscal policy that maximizes short-run demand stimulus relative to long-run damage to the national debt. Lots of bang for the buck. The Republicans supported fiscal policies that did the opposite. Lots of buck for the bang. They are still doing it today when they argue that tax cuts give stimulus and spending does not. One doesn’t even hear them give an economic argument in support of this proposition. They just close their eyes and endlessly repeat their “tax cut” mantra, like a religious cult that can’t even remember why.