Arnold Kling  

Feldstein for Fiscal Stimulus

The Language Barrier, II... Comment of the Week, 2003-03-0...

Martin Feldstein, writing in the Wall Street Journal (subscription required), makes the case for fiscal stimulus.

The shift of the cyclically adjusted federal budget from a $108 billion surplus in 2001 to a $117 billion deficit in 2002 added $225 billion to aggregate demand last year, helping to achieve the 2.7% GDP growth. The Congressional Budget Office now projects that the cyclically adjusted deficit will rise by only $32 billion in 2003 -- less than 0.3% of GDP -- and that this will be reversed by a $36 billion fall in 2004.

Feldstein is worried about the prospects for gridlock.

The negotiations between Congress and the administration could lead to a choice between enacting both the president's and the Democrats' plans or a stalemate in which both are rejected. To reduce the risk of a new downturn and increase the prospect for solid growth in the years ahead, it would be far better to accept some combination of both plans than to have no additional fiscal stimulus.

For Discussion. What are the pros and cons of relying solely on monetary policy to pull the economy out of recession?

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CATEGORIES: Macroeconomics

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Jim Glass writes:

"What are the pros and cons of relying solely on monetary policy to pull the economy out of recession?"

I dunno, and I don't think that's really a worry today. Here's Gene Steuerle, formerly of Treasury, now at the Urban Institute, writing at Tax Analysts,

As far as I can tell, never before in the nation's history has so much fiscal stimulus been provided relative to the size of a downturn.

While the typical change in fiscal position (or increase in deficit) might be 30 to 40 percent of the size of an economic downturn, this time it appears to be one to two times larger than the downturn itself! That is, the government has absorbed more than the entire loss of income to the population. And that doesn't count any new bill enacted this year.

According to the Congressional Budget Office figures (soon to be updated), in fiscal 2003 alone, recently enacted tax bills have reduced collections by $126 billion. Discretionary spending has been raised $72 billion, and other changes (largely interest costs on other tax and spending changes) will raise legislative changes to $238 billion.

In addition, we can approximate the direct impact of the economic slowdown on government activity simply by examining nonlegislative changes in estimates of the government's deficit position. Here we find another $286 billion, largely in lost revenues, due to reductions in such items as taxes on wages, capital gains realizations, and exercises of stock options. The natural reductions in the taxes people pay on their reduced income are the primary component of what is referred to as automatic fiscal policy, which is usually much larger than discretionary actions.

The total decline in fiscal posture for 2003 alone comes to around $500 billion. Compare this to the size of the economic decline ... the total decline from the beginning of 2001 to the end of 2002 might be about 2 to 3 percentage points of GDP. With an economy of a little more than $10 trillion, this implies that the nation's income is about $200 billion to $300 billion below potential in 2003 ...

It turns out that the combination of revenue shortfalls due to the recession, new tax bills, and new discretionary expenditures are on the order of one to two times the size of the decline so far...

Considering the time lag effect in both monetary and fiscal stimulus, and the amount of both in the pipeline, and the fact that the economy did grow over 2% this year, it's not a politically popular question to ask, but is it possible too much stimulus has been put in the works?

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