We are frequently asked whether there should be a “second stimulus” bill. Unfortunately, what is being considered on Capitol Hill is a very different animal from what we did earlier this year.
10-second macroeconomic review
GDP = Consumption + Investment + Government spending + Exports – Imports
= C + I + G + X – M
In January the President proposed, and in February Congress enacted, a bill that was short-term macroeconomic stimulus. We wanted that stimulus policy to be big, fast-acting, an efficient use of taxpayer dollars, and an effective stimulus to broad-based economic growth. We let taxpayers keep more of their wages, assuming that they would spend some of those refunds, thereby increasing consumption (C). We also temporarily cut taxes on business investment in an attempt to increase investment (I). The idea is that these two actions would quickly increase GDP. Millions of American workers and families and thousands of firms can react quickly to a change in their financial status.
This strategy appears to be working. We’ve got evidence from multiple sources suggesting that people are spending some of their stimulus checks, and that this is helping to support increased consumption. It’s harder to tell how much firms are taking advantage of the investment incentives, because it’s hard to measure that in real time.
In yesterday’s Wall Street Journal, Professor Martin Feldstein writes that the stimulus was a “flop.” Specifically, he argues that the recent GDP data show that the boost to consumer spending from the rebates was small relative to the overall size of the rebates. He estimates that $12 billion was spent out of a total of $78 billion in rebates paid out by the end of June. The core of his argument is that we didn’t get a lot of bang for the buck – only a small bump to GDP for a large loss of revenue for the government.
We disagree with this analysis. First, we think the stimulus bang is bigger than $12 B. Prof. Feldstein assumes that the growth in consumer outlays would have been flat had there been no stimulus. He then observes that consumer outlays actually grew by $12 billion more from Q1 to Q2 than they did in the prior quarter, and attributes that to the stimulus. Many observers think that, without the stimulus, consumer outlays would have grown more slowly in Q2 than in Q1. If this is the case (and we believe it is), then the effect of the stimulus is bigger than $12 billion.
In addition, we have felt only part of the bang so far. The stimulus enacted in February will have ongoing impacts in the upcoming months. Almost all the cash to consumers is out the door, but the resulting boost in consumer spending has not yet reached its full effect. We anticipate that the past stimulus law is continuing to increase GDP in the 3rd quarter, with a diminishing amount in the 4th quarter of this year. Monetary policy works with an even “longer lag” – the evidence suggests that when the Fed cuts interest rates, it takes about a year for half of the economic effect to take hold. So there’s more bang left in the remainder of this year from past actions on both the fiscal and monetary sides.
Allowing people to keep more of their money for one year is better than not doing so at all, so the loss of government revenue is actually a good thing if that money stays in the hands of the taxpayers who earned it, even if we can only get Congress to agree to do that for one year. We agree with Marty that the stimulus would be more effective if we had been able to enact a permanent tax cut, rather than a temporary one. Legislative realities forced it to be temporary. Permanent is better than temporary, and temporary is better than nothing.
On the second stimulus question, the following interchange from May 19th is instructive. Our deputy press secretary Scott Stanzel talked with a White House reporter at the “daily gaggle”:
Q: Scott, is the administration looking any more closely at a second economic stimulus package? The Commerce Secretary was on Late Edition over the weekend, and didn’t directly and definitively shoot that idea down.
MR. STANZEL: Well, what’s in the second stimulus package that you’re talking about?
Q: Well, just — I’m saying that many in Congress say we need a second economic stimulus package.
MR. STANZEL: Right, but what’s in that? That’s the thing. The idea of the second stimulus has become sort of this catch-all phrase for adding a lot of additional government spending, or doing things that Democratic leaders in Congress may have wanted to do previously, but are now — would want to sort of put under the umbrella of a stimulus package.
Before last Thursday, there was no second stimulus proposal. Now there’s a proposal from the Chairman of the Senate Appropriations Committee, Senator Byrd (D-WV), but we have seen no indications that House or Senate Democratic leaders have signaled support for that proposal.
For more than two months we were asked to comment on something that did not exist. What does exist is pent-up demand in Congress to spend more money, and then to label that spending as a “second stimulus.” We anticipate that demand will only increase as we get closer to an election.
Congressional advocates for increased government spending this Fall have been arguing, in effect, that we should expand (G) in the equation above, and that doing so will increase economic growth.
But trying to stimulate short-term economic growth through increased government spending has a few problems:
- It’s slow. – Construction projects take years to plan and build. History shows that only about 27 cents of each dollar is spent in the first year.
- It’s often funneled through States. – Infrastructure spending and increased federal funds for programs like Medicaid result in transfers from the Federal government to State governments. This transfer doesn’t actually increase GDP, it just shifts money from one level of government to another. It’s more like putting in motion 50 potential stimulus packages, each of uncertain efficacy and speed. Some States might try to spend the funds quickly. Others might shift money around and use the Federal dollars to pay down debt, or wait until their State legislature convenes next year to allocate the funds. There’s also a danger that providing States with aid during challenging economic times will encourage states to spend irresponsibly during boom years, counting on Federal bailouts when times are tough.
You can make other arguments for spending more taxpayer funds on roads and bridges, but it’s a highly inefficient tool to stimulate immediate economic growth. Many of the advocates for a so-called “second stimulus” know that spending taxpayer funds on roads and bridges is popular with voting constituents.
There’s an important philosophical difference between the first stimulus (which was overwhelmingly bipartisan) and current Congressional attempts to increase government spending. The first stimulus proposed by the President looked at the economy as a whole, and tried to design a package that would help spur growth across the entire economy. Ideas being bandied about for a so-called “second stimulus” tend instead to take a constituency-based approach: they try to identify who is hurting, or who is politically powerful, and funnel government funding to them. Advocates then claim that these funds will stimulate broad-based economic growth.
We think that the first stimulus was both more fair and more effective by providing taxpayer rebates to more than 100 million Americans and broad-based business investment incentives to thousands of firms. And we think that there’s more economic bang still left from those recently implemented policies.
- We think the stimulus is working and increased Q2 consumption and GDP.
- The effects of the first stimulus are not yet complete. Most of the cash is out the door, but we think there will be increased consumption effects this quarter, and a diminishing amount in Q4.
- For many, “second stimulus” is code for “allow Congress to increase politically popular government spending shortly before Election Day, and call it macroeconomic stimulus.”
- Increased government spending is slow and ineffective macroeconomic stimulus.
Thanks to Donald Marron, the newest Member of the Council of Economic Advisers, and to the CEA team for their help with his note.