Will it work? Will the stimulus package now being yammered out by the House and the Senate actually pull the economy out of recession?
The good news is that stimulus packages can work. Even better, we've got lots of experience with what doesn't work.
The bad news is that we don't know very much about how much size matters. Huge packages clearly work. Small packages clearly fail. But we don't know much about where to draw the line.
And we don't know much about how to get the maximum bang for our buck. The truth is that just as what John Maynard Keynes called "animal spirits" play a huge roll in starting a recession, so, too, do emotions determine when a recession will peak and end. Most economic policy -- and most economic theory -- is built on an assumption that human beings behave rationally. Good luck with spending money effectively on that foundation.
What you need to know
So what do we know about whether the stimulus package will work? Here's my five-point guide to the good, the bad and the ugly of economic rescues:1. Economic stimulus packages can work -- if they're big enough.
The Great Depression proves that. Oh, I know that you've read or heard endlessly that the New Deal didn't end the Depression and that only World War II did. But let's get our facts and terminology straight, shall we? The New Deal, despite all its activist programs, was never very big on economic stimulus. And besides being a global war, World War II was the biggest stimulus package ever.
Let's look at some unemployment and budget numbers from the Depression years. In 1928, before the 1929 crash on Wall Street, U.S. unemployment was just 4.2%. In 1930, the rate was nearly twice that, at 8.2%, and by 1932 it had climbed to 23.6%.
The Hoover administration didn't believe in deficit spending as a way to stimulate the economy. The conventional economic wisdom of the day, to be fair, called for a balanced budget as a solution to a collapse in business demand because, it was theorized, that would demonstrate the soundness of government finances and restore confidence in the economy. In 1930, the federal government ran a budget surplus of almost 20%.
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Franklin Roosevelt's initial budgets for 1933-37 look like massive stimuli if you compare government receipts to government outlays. In 1933, the deficit was 128% of government receipts, and in 1934, 123%. But those numbers are deceptive because we're talking about a period when government tax receipts collapsed along with the economy. President Herbert Hoover's 1932 budget ran a deficit equal to 5.9% of gross domestic product because government receipts had collapsed to $2.8 billion from $4.2 billion in 1930. In 1934, in many ways the peak of New Deal stimulus spending, the deficit had climbed to 9.6% of GDP.
The unemployment rate dropped to a still-startling 16.9% in 1936, but that looked pretty good compared with the 25% peak rate during 1933, and that was enough for the Roosevelt administration to revert to economic orthodoxy. In 1937, the deficit fell to just 2.9% of GDP, and in 1938 the administration almost balanced the federal budget with a deficit of just $100 million. But in 1938, unemployment climbed again, to a shocking 19%. It stayed high through 1939, 1940 and 1941 even as deficits ran at less than 4% of GDP.
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It's this climb in the unemployment rate that justifies the claim that the New Deal didn't end the Great Depression. That's a fair conclusion, but it's also fair to say the rise in unemployment in Roosevelt's second term was a result of rolling back the economic stimulus of his first term. Government spending was lower in 1937, 1938, 1939 and 1940 than it had been in 1936. The New Deal's lack of success in reducing unemployment from 1936 to 1940 wasn't because deficit spending and economic stimulus had failed as policies but because the Roosevelt administration had rolled back its stimulus program.
If you want to see stimulus at work, I'd say look not at Roosevelt's second term but at World War II. Sure, comparing peacetime and wartime economies is extremely difficult -- the draft ended unemployment, for example -- but there's no denying that the war was economic stimulus on a huge scale. In 1942, for example, the government's budget deficit was 141% of receipts, and in 1943, 228%. The deficit hit 9.8% of a much bigger economy in 1942 and then climbed to 16.8% in 1943.
(Just for reference, if you add the remaining $350 billion from the Troubled Assets Relief Program, a $900 billion stimulus package and a projected budget deficit of $1.2 trillion, the deficit for fiscal 2009 comes to about 16.3% of U.S. GDP.)
The momentum built up in the war years carried the economy for decades. By 1960, unemployment was still only 5.5%, and GDP had climbed to $519 billion from $97 billion in 1930.
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2. When it comes to economic stimulus packages, failure is a relative term.
In trying to judge the current proposed stimulus package, it's important to discriminate between short-term boosts to the economy and long-term effects that set an economy on a new, more productive track.
No, the New Deal didn't end the Great Depression. It didn't manage to fix the problems of production and demand that had led to the crisis. And it didn't put the economy on a long-term track to recovery. So if that's your benchmark, then the New Deal was a failure.
But in the short term the New Deal did provide real stimulus to the economy. The New Deal did keep unemployment from increasing above 25% of the work force, and it did reduce the rate to 16.9% in 1936. That's an 8.1-point drop from the 1933 peak. For comparison, the official unemployment rate last month was 7.6%.
The effects didn't last when the stimulus was cut back after 1936, but even in the short run the New Deal's stimulus program did make life better for millions of people. It brought electricity to rural areas that had never had electric power. It gave millions of people jobs during a time when a job of any sort made a critical difference. (Full disclosure: My dad's first job was building a fish hatchery with the Civilian Conservation Corps.) It created hope at a time when hope was in short supply. And it put in place programs such as Social Security and bank deposit insurance that changed the country for the better.
The current stimulus package as passed by the House contains a shot of stimulus such as extended unemployment benefits and health insurance coverage through Medicaid that will boost the economy in the short run and diminish suffering during the downturn. These efforts aren't likely to have much long-term effect.
The package also includes money for long-term investment designed to increase the economy's productivity. In this part of the bill you'll find everything from money for extending the Internet to improving education and increasing energy efficiency.
You can argue, as the plan's opponents have, that the package spreads itself too thin by going after stimulus and investment, or you can argue that, by mixing the two, the plan tries to diminish short-term pain while setting the economy on a new, productive track. I'd go with the second argument myself.
Continued: Big, fast and consistent
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