Help me to understand the stimulus package

I'm trying to understand the economics related to the proposed stimulus package. I've seen the following claims made:

A. It isn't large enough to have a significant effect.

B. The legislative process takes so long that the stimulus package will arrive too late and thus fail to produce the desired effect.

C. Rather than spend the money, people will save the money, and thus negate some or all of the desired effect.

Is the argument for the stimulus package sound but for these objections?

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Alright, my viewpoint

I am not an economist, I have only a sketchy knowledge of that field, especially monetary economics which I find extremely hard to understand, but:

a. The stimulus size is in the hundreds of millions. It's a drop in the sea, unlikely to have any real effect. Losses are in the billions

EDIT: hum it's hundreds of billions, stupid miscalculation. With the correct figure, I'd say it will have a very positive effect.

b. The expectation that the money will arrive produces an effect by itself, people need to save less or can borrow for less as lenders know they'll have additional income.

c. If people save the money it's even better as it will mitigate the effects of the drop of interest rates. This argument relies on the fallacy that economy is driven by spending.

I've only studied the basic

I've only studied the basic models you get in intermediate macro, but I'll toss in my 2 cents.

a. This is probably right.

b. Arthur is probably right here- the fiscal stimulus will probably happen before the money makes into everyone's hands, but the effects of the stimulus will probably take longer to materialize. By this time, the recession may already be over. See, e.g., Milton Friedman.

c. Arthur is partly wrong here. Spending does drive the economy in the short run. The intended effect is to mitigate the incoming recession, so the short term is relevant here. By increasing spending now, the recession can be averted, at least in theory. The details are a bit too complicated to explain without some graphs, but if you pester me enough, I might try it.*

The question that not enough people are asking is whether we actually do want to avoid the recession. As far as we can tell, there were a ton of bad investments in the housing market, and they need to be liquidated. Preventing the recession postpones this correction, and creates a moral hazard in the mean time.

Also, preventing the recession comes at a long term price.Speaking just about the fiscal plan, if the intended effect is achieved- spending is increased in the economy, this means that savings is decreased. And savings is the engine of economic growth. So we get some short term stability at the expense of long run growth, which isn't necessarily a trade off we want to make.

So, yes the stimulus package could have the intended effect, if it was larger and most people spent the money, but that doesn't mean we desire the effect.

*To use a quick metaphor, spending and saving in the economy works much like it does for an individual. If you spend lots now, you can have tons of fun going out and having a good time, but wind up with little income in a few of years (days?). If, however, you invest in your education and save money by eating only ramen noodles, in a few years when your investments pay off, you can live at an even higher standard of living. If you are going through a rough time, you can spend some of your savings to ease the financial pain, but it comes at the expense of future gain. Replace you with the economy and the idea is essentially the same.

~Matt

I am not sure spending

I am not sure spending drives "the economy" in the short or long run, it may definitely drive some indicators, and of course, you can define recession relative to these economic indicators (say decline of GDP) but if you're considering a recession as a significant drop in productive activity, then I'd disagree, I think saving does not reduce productive activity which is driven by the supply of real capital and labor but merely shifts it to other types of production. At least this is - if I am not mistaken - the classical Austrian view.

eh...

@Arthur: In the long run, yes, but in the short run, sectoral shifts can be painful. Capital and labor aren't always very mobile or interchangeable, so changes, such as an increase in saving (or a technological innovation), can mean short term pain even if they also mean long term gain.

This doesn't really answer your objection about spending driving the economy, but I can't really recall why the fiscal stimulus works (theoretically) at the moment, and my macro book isn't here. The reasoning may be dubious- putting it in terms of the equation used in the model: y=C+I+G*, it is unclear how any variable can be increased without an equal decrease across the others. There was a crowding out effect noted in the model- deficit spending (which is what this package essentially is) crowds out private investment, so while G+C increases, I actually decreases. However, this effect never completely wiped out the increase in G+C and I'm not sure why. My intuition is with you, but I'm not sure. I'll try to steal my book back tomorrow and have a look.

@Curunir: No Ricardian equivalence is necessary. The question is empirical: what will people do with their rebate checks? The answer depends on their preferences. Many people are speculating that because many Americans are in a lot of debt right now, they will pay off that debt rather than buy new stuff. They may be wrong, but their view is plausible, I think.

*y=output, C=consumption, I=investment, G=government spending

~Matt

In the long run, yes, but

In the long run, yes, but in the short run, sectoral shifts can be painful.

What shif? Didn't low interest rate already enlarged the capital good sector. Increased savings would actually support that sector... in the middle of a credit crunch I hardly see how increased savings is bad, short or long term.

heterogeneous

Capital is not homogeneous. A lot of it is tied up in real estate markets, and it needs to move out. The same is the case for labor. Since this change can't happen instantaneously, there is short term pain.

~Matt

Ricardian Equivalence

Many people are speculating that because many Americans are in a lot of
debt right now, they will pay off that debt rather than buy new stuff.

I agree this sounds plausible and probably prudent. But my point is this: For large parts of the economy, the stimulus really is (almost) free money, because they're not in the brackets that pay a significant chunk of income taxes and so they don't have to pay the piper down the road. So for them, the stimulus is as if they just got a $600 bonus or raise from their employer. Now, it might make sense that they'd use that money to pay off debts, but a priori most people wouldn't assume that people would take all of a raise and put it to paying off debt, right?

Or maybe the psychology of big checks (stimulus, refunds, bonuses, etc.) is different from that of wages? That I'd buy.

Saving

Somewhat off topic, but regarding point (c), I'm actually confused why commentators think that families are just going to sock away their stimulus check. The reasoning behind it seems to be a Ricardian Equivalence one; that is, because the government will have to raise taxes in the future to pay off the deficit spending, rational families will save the money.

The problem with this is that large amounts of the nation pay basically nothing in income tax (they do pay payroll taxes though). Let's say just for argument's sake that it was 90% of income taxes are paid by the upper 50% (it's higher than that, but I'll be conservative). Well, the stimulus package is said, if I recall correctly, to cost $150 billion. OK, so only $15 billion needs to be paid back by, what, 120 million filers (one half of all filers)? That's $125/person.

So the story is the median taxpayer is going to save $600 because in the future his taxes will be $125 higher? I'm not buying it, and I'm wondering what I'm missing.

[edited to correct gross typo: I meant upper 1/2, not upper 1% paid 90%. ]

Here's what Jason Furlong

Here's what Jason Furlong and Steven Landsberg think. Landsberg thinks there are more objections than the ones you name.

Landsburg misses the boat.

Landsburg raises 3 arguments against the stimulus, but they're not very persuasive.

1. Since the stimulus is simply debt we owe ourselves, isn't it just a scheme to trick us into living beyond our means, as happened in the subprime crisis? The bill for subprime loans went mostly to the poor, who couldn't pay them. The bill for the stimulus, thanks to progressive taxation, will fall mostly to the rich. Thus the Richardian Equivalence argument doesn’t apply.

2. If the average American suddenly feels richer (for no incremental work), won't he work less? Yup. But the UNaverage American -- specifically, the guy who is unemployed -- won't work less; he’ll get a job in the leisure industry catering to all those average Americans who are working less, or in the temp industry filling in for all those vacationing Americans.

And yeah, the stimulus will probably stimulate foreign manufacturing sectors, too. So?

3. Finally: Yes, putting people back to work in dying sectors DOES make things less painful. Let those sectors die in a couple years when the economy – especially the labor market – has recovered. Honestly, doesn’t Landsburg have any unemployed friends? (Don’t laugh; there’s growing theoretical work suggesting the possibility of economists having friends....)

Thanks everybody for the

Thanks everybody for the input. I had been noticing that a lot of the prominant free market bloggers were focusing on these issues as a response to the stimulus package. The implication seemed to be that these are reasons why an otherwise sound theory won't work in reality. But I could have sworn the theory wasn't otherwise sound. I don't understand macroeconomics well enough to judge it for myself, but I've heard arguments before like some of the one mentioned here; spending doesn't drive the economy, recession is a healing process, etc. I don't see those types of arguments being made much in response to the stimulus package, but I might just be looking in the wrong places.

will the stimulus check be

will the stimulus check be deducted from 2008 tax? Foe example, if one received $600 and you file income tax 2008 and one is expected to get say, $2000 . does that mean 2000-600= $1400? just like cash advance?

Question

Ok, this is only my theory about this mess. If we save money dont you think that will hurt more the economy?. I mean, if we save now we will buy less, and sellers will sell less. So, if sellers sell less they will layoff more people, and it will cause in more unemployment. I don't know if Iam wrong with my theory. But in my common sense save now can be wrong. I dont saying that save money is a bad Idea of course is a good idea, but I think that now is not the perfect moment to do that. Because now we need to spend. People are afraid, and they need to feel more confident, and start to spend more. Thats what I am think about the stimulo package.the goverment wants to encourage people to spend more instead to save it.

What do you think?

Paradox of Thrift is a Fallacy

You have it all wrong actually. The paradox of thrift is a fallacy.

There is nothing wrong with people saving in hard times.

Are you in the mood?

Do you feel like presenting the case against the paradox of thrift in this entry which was created within the past day (as opposed to being a year old, as the current entry is)?

Ok I get it that the economy

Ok I get it that the economy needs to be stimulated, but if people are spending instead of saving, who's getting rich, the big retailers, automobile corporations, the list goes on and on, middle class Americans need to wake up, there's no stimulus package that's going to make YOU rich, just corporate America. I would rather take my chances and save what I can instead of relying on my government to make my life better. I do understand the layoffs and so forth but I still think Americans are being are being bullied into thinking they HAVE to spend, still in the end the rich get richer if we spend, poor and middle class spend there money for the rich and when things are not as good as there used to they layoff after they've made there millions and sales are down some, give me a break