A Sign of the Times

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It is a sign of the polarized times in which we live that partisans of different stripes can look at the same objective indicators – persistent and increasing unemployment—and come to radically different conclusions about what is to be done.  The Republicans see proof in the unemployment numbers that the original stimulus package was ineffective and misguided.  The Democrats see it as a sign that the original package was not enough and that we need another one.
Because I like to cast myself as a moderate, let me split the difference.  I think the original stimulus package probably was beneficial.  It was always unrealistic to think that it would prevent unemployment from going above 8%, but it is equally unrealistic to believe things would be better now without it. 
 
Yet I do not believe another package is what we need for two reasons.  The first is that the problem with the original stimulus plan is that the money has not been spent fast enough (mainly because too much of it went for pent up Democratic spending priorities rather than “shovel-ready” projects).  So a much better plan would be to reprogram some of the original package toward projects that will spend money more quickly.  Helping state governments avoid layoffs might be a good place to start.  The second reason that I’d oppose another stimulus bill is that I think unemployment numbers may not be a good indicator of where the economy is going or whether the first package worked.  As we observed in last recession (for reasons we do not quite understand), employment and wages only started improving after the economy had recovered.  So throwing another batch of stimulus at an economy that may be already recovering would not be prudent.

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As an outsider (I am brazilian, living in Brazil), it is not surprising to see people's desagreement about economics plans. After all, there is almost as much (good) economic theories as there is good economists!

Actually tax cut is also an economic stimulus package, but the effect is quite limited .

Cutting taxes may not prevent recession because:

1. People may save tax cuts. The savings ratios is very low (close to 0%). Therefore, with low confidence, people may not spend a tax cut, but use it to pay off debts or increase their savings. Therefore, consumer spending may not increase.

2. Other Factors May Outweigh tax cuts. A cut in income tax may increase spending. However, this positive effect may be outweighed by the decline in house prices and the consequent negative wealth effect. Alternatively, the difficulties of borrowing in the credit crunch may keep investment low. To overcome the economic slowdown may require a very large fiscal stimulus.

3. Crowding Out. Expansionary fiscal policy leads to higher government borrowing. To finance the growing national debt, bond interest rates may be forced upwards. This can put upward pressure on interest rates and therefore reduce consumer spending. (This is known as financial crowding out)

4. Also government borrowing may cause resource crowding out. If the government borrows, it borrows from the private sector. Therefore, although the government spend more, the private sector have less to spend and invest.

5. Government borrowing is already understrain with high levels of National debt. Therefore, governments are limited in their ability to pursue expansionary fiscal policy. In the UK, the government have just broken their own rules on national debt. Expansionary fiscal policy would increase public debt even more.

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