Market Stimulus Gone Bad

PAUL KRUGMAN

Market Stimulus Gone Bad

If the money the government lays out doesn't get spent, the stimulus plan in the US will have failed.

AFP

A giant interactive screen displays a $10 bill at the Museum of American Finance in New York.

House Democrats and the White House have reached an agreement on an economic stimulus plan. Unfortunately, the plan -- which essentially consists of nothing but tax cuts and gives most of those tax cuts to people in fairly good financial shape -- looks like a lemon.
Specifically, the Democrats appear to have buckled in the face of the Bush administration's ideological rigidity, dropping demands for provisions that would have helped those most in need. And those happen to be the same provisions that might actually have made the stimulus plan effective.
Those are harsh words, so let me explain what's going on.
Aside from business tax breaks -- which are an unhappy story for another column -- the plan gives each worker making less than $75,000 a $300 check, plus additional amounts to people who make enough to pay substantial sums in income tax. This ensures that the bulk of the money would go to people who are doing OK financially -- which misses the whole point.
The goal of a stimulus plan should be to support overall spending, so as to avert or limit the depth of a recession. If the money the government lays out doesn't get spent -- if it just gets added to people's bank accounts or used to pay off debts -- the plan will have failed.

And sending checks to people in good financial shape does little or nothing to increase overall spending. People who have good incomes, good credit and secure employment make spending decisions based on their long-term earning power rather than the size of their latest paycheck. Give such people a few hundred extra dollars, and they'll just put it in the bank.
In fact, that appears to be what mainly happened to the tax rebates affluent Americans received during the last recession in 2001.
On the other hand, money delivered to people who aren't in good financial shape -- who are short on cash and living check to check -- does double duty: it alleviates hardship and also pumps up consumer spending.
That's why many of the stimulus proposals we were hearing just a few days ago focused in the first place on expanding programs that specifically help people who have fallen on hard times, especially unemployment insurance and food stamps. And these were the stimulus ideas that received the highest grades in a recent analysis by the nonpartisan Congressional Budget Office.
There was also some talk among Democrats about providing temporary aid to state and local governments, whose finances are being pummeled by the weakening economy. Like help for the unemployed, this would have done double duty, averting hardship and heading off spending cuts that could worsen the downturn.
But the Bush administration has apparently succeeded in killing all of these ideas, in favor of a plan that mainly gives money to those least likely to spend it.
Why would the administration want to do this? It has nothing to do with economic efficacy: no economic theory or evidence I know of says that upper-middle-class families are more likely to spend rebate checks than the poor and unemployed. Instead, what seems to be happening is that the Bush administration refuses to sign on to anything that it can't call a "tax cut."
Behind that refusal, in turn, lies the administration's commitment to slashing tax rates on the affluent while blocking aid for families in trouble -- a commitment that requires maintaining the pretense that government spending is always bad. And the result is a plan that not only fails to deliver help where it's most needed, but is likely to fail as an economic measure.

The words of Franklin Delano Roosevelt come to mind: "We have always known that heedless self-interest was bad morals; we know now that it is bad economics."
And the worst of it is that the Democrats, who should have been in a strong position -- does this administration have any credibility left on economic policy? -- appear to have caved in almost completely.
Yes, they extracted some concessions, increasing rebates for people with low income while reducing giveaways to the affluent. But basically they allowed themselves to be bullied into doing things the Bush administration's way.
And that could turn out to be a very bad thing.
We don't know for sure how deep the coming slump will be, or even whether it will meet the technical definition of a recession. But there's a real chance not just that it will be a major downturn, but that the usual response to recession -- interest rate cuts by the Federal Reserve -- won't be sufficient to turn the economy around.
And if that happens, we'll deeply regret the fact that the Bush administration insisted on, and Democrats accepted, a so-called stimulus plan that just won't do the job.