I am going to try to group the different fiscal stimulus arguments into camps:
- Rules over discretion — Stanford economist John Taylor argues that discretionary monetary and fiscal policy have been counterproductive. He argues that monetary policy should follow a rule (like the Taylor rule). He further argues that both the 2008 (Bush/Pelosi/Boehner) fiscal stimulus and the 2009 (Obama/Pelosi/Reid) fiscal stimulus were ineffective at best and counterproductive at worst.
- Yes on monetary discretion, no on fiscal stimulus — Many conservatives like to complain about the Fed’s recent actions but would not advocate a wholesale change in how we approach monetary policy. They are basically OK with the Fed Chair and the Federal Open Market Committee using their best judgment, although they wish the recent financial crisis didn’t necessitate such aggressive use of that judgment. Members of this camp argue against all forms of fiscal stimulus. They think the 2008 and 2009 fiscal stimulus laws were both mistakes. Their arguments fall into three categories: (a) fiscal stimulus doesn’t work; (b) even if in theory it could work, it’s almost impossible in a real world of legislation to get the timing right; and (c) the deficit increase isn’t worth the possible short-term growth benefit. Membership in this camp means you oppose both increasing spending and cutting taxes to accelerate short-term GDP growth. Most Congressional Republicans would tell you they are in this camp.
- It depends on the kind of fiscal stimulus (R) — OK with discretionary monetary policy, OK with tax cuts as short-term fiscal stimulus (but would prefer permanent tax cuts offset by spending cuts), but opposed to increased government spending as short-term fiscal stimulus. This is where President Bush was in 2008, leading to the 2008 stimulus law. I think Greg Mankiw falls here in his article on fiscal stimulus, “Crisis Economics” in the excellent policy journal National Affairs.
- For two-sided fiscal stimulus — This was the President’s logic behind the February 2009 stimulus, which increased spending a lot and cut taxes a little. Team Obama mislabeled tens of billions of dollars of transfer payments as “tax cuts” but the bill did cut other taxes. In this camp you’re OK increasing the deficit for short-term spending increases and for short-term tax cuts if those policies will increase short-term economic growth.
- It depends on the kind of fiscal stimulus (D) — OK with discretionary monetary policy, OK with increased government spending as short-term stimulus, but opposed to cutting taxes even in the short run unless they are offset with other tax increases. This is where most of the Democratic Congressional Majority is at the moment.
- Fiscal stimulus works and we need a lot more of it through increased government spending — Dr. Krugman and Secretary Reich are here. Krugman is hammering the point repeatedly, and probably causing Team Obama heartburn by doing so.
- It’s different here in Europe — They aren’t opposed to fiscal stimulus in principle, but right now the Germans especially are far more concerned with deficits and debt than with short-term GDP growth.
The DC debate is a bit messy, but most of it lies between camps 2 and 5. Each camp has its challenges.
Camp 1, rules over discretion, is lonely and cannot practically achieve its primary goal. A noted economist like John Taylor can go toe-to-toe with Chairman Bernanke in a debate about the appropriate measure and use of a monetary policy rule, but most DC policymakers cannot. Membership in this camp requires you fundamentally disagree with how Chairman Greenspan made and Chairman Bernanke makes monetary policy decisions, and not just with the particular decisions they made. As a practical matter, a Member of Congress has next to zero ability to achieve John’s goal of rule-based monetary policy. The law establishes the Fed’s mandated goals of “maximum employment, stable prices, and moderate long-term interest rates?,” but gives the Fed Governors complete freedom on how best to pursue these goals. Also, while many conservatives cite John’s opposition to fiscal stimulus, it’s important to understand that his argument is primarily about monetary policy. If you favor discretionary monetary policy, you’re not in camp 1 even if you agree with Professor Taylor in opposing fiscal stimulus.
A lot of my DC Republican friends (especially in Congress) think they are in camp 2 opposing all fiscal stimulus, but I suspect they’d actually be in camp 3 if pressed. Over the past 18 months “fiscal stimulus” has been redefined to mean “the failed Obama/Pelosi/Reid stimulus,” and in a political context the easiest message for a Republican elected official is “The stimulus failed and I oppose more fiscal stimulus. In fact, I oppose all fiscal stimulus.” But 169 of 199 House Republicans voted for the tax-cuts-only 2008 fiscal stimulus law, as did 33 out of 49 Senate Republicans. And almost all House and Senate Republicans joined President Bush in arguing for the short-term macro growth benefits of both the 2001 and 2003 tax cuts. The 2001 and 2003 laws were designed to have both short-term and long-term benefits, but we Republicans were not shy of using traditional short-term growth arguments in a weak economy to justify support for these tax cuts. When you’re in the Congressional minority with a Democratic President and “fiscal stimulus” = “increased government spending,” it is easy to oppose “fiscal stimulus.” If, however, Republicans were in the majority, had a Republican President, and faced 10% unemployment, wouldn’t they be advocating immediate tax relief to “get the economy going again?” Would they really be advocating no fiscal policy action from Congress were they in charge? If they couldn’t get permanent tax relief, wouldn’t they again compromise and pass temporary tax relief? I think for many Congressional Republicans aversion to the Democratic majority’s proposed spending increases is shaping their stated positions on broader questions of fiscal stimulus. Republican Presidential hopefuls, in particular, may want to think twice before making definitive statements opposing fiscal stimulus as a general policy tool. They may need that tool someday.
I’m in camp 3, OK with cutting taxes to accelerate short-term economic growth. I feel a responsibility to say what I’m for and not just what I’m against. Rather than just complaining about where we are or proposing to repeal the Feb 09 stimulus and reduce the deficit, I would instead support converting all the remaining spending in that law into immediate and temporary tax relief to individuals. This would accelerate but not increase the budget deficit relative to where it is projected to be, and would result in front-loading whatever growth benefit we’ll get from those deficit increases. I would prefer permanent tax relief to temporary, combined with aggressive medium- and long-term spending reductions. Most Democrats and many economists (including CBO) would argue my short-term conversion policy would sacrifice growth because much of the tax relief would be saved rather than spent. I have two responses: (a) the debate about spending vs. tax multipliers is wide open, as Greg Mankiw points out in his article; and (b) even if much of it is saved, as a long-run matter, I’d rather have individuals save these funds than Congress allocate them for slow-spending pork projects. The downside of camp 3 is that few elected Republicans will admit they’re in it so I’m mostly alone. Also, with Democratic Congressional majorities my preferred policy won’t happen.
Camp 4, for two-sided fiscal stimulus, is where the President began 2009. Team Obama (i) missed the baseline forecast, (ii) let a Democratic Congress turn their proposal into an unfocused spending spree, and (iii) repeatedly botched the post-enactment communications, undermining their credibility. The February 2009 stimulus might have accelerated GDP growth, but we’ll never know, and even if it did nobody will believe it. It’s also interesting to see the President and a Democratic Congress shift into Camp 5, where it’s OK to spend money without offsets, but not to cut taxes.
Camp 5, supporting spending increases but not tax cuts as stimulus is what Congress just tried and failed to do with the “extenders” bill. While I think many of my DC Republican friends are fooling themselves into thinking they oppose all fiscal stimulus, I think many DC Democrats are using a fiscal stimulus argument to justify avoiding making hard choices on spending. How can you claim a bill that increases the deficit by only $30 B is “fiscal stimulus?” It’s way too small to move the needle on a $14 trillion economy. If you believe that fiscal stimulus can increase short-term GDP growth, and if you believe we need to do more, then you belong in camp 5 with Dr. Krugman and Secretary Reich and should be advocating short-term deficit increases measured in the hundreds of billions. Instead we see a Congressional majority that is trying to mitigate the effects of a recession by funneling money to sympathetic constituencies, refusing to offset the resulting deficit increases, and rationalizing this by labeling it as fiscal stimulus. At the same time, they plan to allow a huge deficit-reducing contractionary tax increase to take effect January 1.
Members of camp 5 must simultaneously argue:
- The last stimulus worked but I support doing even more;
- I support doing a little more, but not too much more, even while the unemployment rate is higher than when we first began; and
- More stimulative government spending that increases the deficit is good, while contractionary tax increases that reduce the deficit are also good.
Camp 6, the “Third Depression” camp, is intellectually consistent but also quite lonely, because if you’re an elected official it puts you on the wrong side of popular concerns about the budget deficit. There’s an easy way for Dr. Krugman, Secretary Reich, and other outsiders to resolve this — they could fortify their advocacy for larger short-term deficit increases by specifying the particular policies they propose for medium-term and long-term deficit reduction. But since those specifics mean immediate political pain for he who proposes them, Democratic elected officials (including the President) are unlikely to venture here before the election.
Most people in Camp 7 are busy watching the World Cup.