Fallout: The Financial Crisis

Consider this: Stimulus plan won’t work

Marketplace Staff Feb 6, 2009
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Fallout: The Financial Crisis

Consider this: Stimulus plan won’t work

Marketplace Staff Feb 6, 2009
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TEXT OF STORY

Kai Ryssdal: Obviously there are different points of view about what kinds of spending make for good stimulus. There hasn’t been much talk yet though, about doing nothing. And that leaves plenty of room for commentator and economist Susan Lee.


Susan Lee: No doubt about it: Almost a trillion dollars is a huge number. And so it’s good that we’re having a huge debate over the stimulus package. Is it too big? Too small? Should it be mostly government spending? Or mostly tax cuts? We’re debating everything except for the most important question: Will it work?

There is a respectable body of opinion, held mostly by academic economists, that there’s no stimulus in a stimulus. This argument, called ‘ricardian equivalence’ after the British economist David Ricardo, goes like this: In an economic downturn, the government wants to boost demand by spending more money than it takes in taxes. But how will the government get that extra money? Not by raising taxes. That’s foolish in the middle of a recession. The only way for government to get extra billions of dollars is to borrow it.

But, as this over-leveraged country is beginning to understand, debt must be paid back. And how will the government pay back the debt? You guessed it. By raising taxes — later, when the economy is going gangbusters again.

The hooker is this. When people realize that their taxes will have to go up eventually, to pay off the debt, they’ll start saving today. And so the extra money motored out by the government will be off set by the money motored in by taxpayers. The net may very well be a checkmate. Government spending goes up and private spending goes down. And demand stays the same.

Although there’s some evidence that Ricardo himself didn’t believe in equivalence, academic economists have been debating it for decades. Some objections are theoretical. For example, not everyone can save today for an eventual tax hike down the road. And the empirical evidence is mixed.

Now, of course, one can always stand on the acceptable ground that academic economists wouldn’t know a payroll from a sesame-seed roll. But, before hitting the economy with a deficit that could top 10 percent of gross domestic product, shouldn’t Congress take a look at the argument that a stimulus won’t work? Shouldn’t it question whether the economy will get any bang for so many billions of bucks?

RYSSDAL: Economist Susan Lee lives in New York City.

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