Common sense on the proposed stimulus package

Harvard economist Robert Barro has a column explaining in a commonsense way the macroeconomics behind the proposed stimulus package and why it won't work. He has studied the economic growth during wartime and concluded that federal dollars spent during our 20th century wars led to a multiplier of 0.8 dollars worth of growth. But the results are different from spending on peacetime projects.

here are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases. For one thing, people would expect the added wartime outlays to be partly temporary (so that consumer demand would not fall a lot). Second, the use of the military draft in wartime has a direct, coercive effect on total employment. Finally, the U.S. economy was already growing rapidly after 1933 (aside from the 1938 recession), and it is probably unfair to ascribe all of the rapid GDP growth from 1941 to 1945 to the added military outlays. In any event, when I attempted to estimate directly the multiplier associated with peacetime government purchases, I got a number insignificantly different from zero.

Instead, Barro recommends a stimulus that would target true economic growth.

But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936.

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

When you add in the fact that over a third of the proposed $825 billion won't even get spent this year or even next year, there is very little indication that spending all those billions would do anything to help us now to get out of the recession. Really what we're seeing is the spending that the Democrats would like to do anyway dressed up in language of a stimulus package. As Rahm Emanuel has said, he doesn't want to let a crisis go to waste. Seeing opportunity in a crisis may be good leadership advice, but it isn't good fiscal advice for federal government spending.

And remember that the House version was put together outside the normal committee process without any hearings on the necessity of these projects and without any real study of the likelihood that all this spending will do anything in its proposed task of stimulating the economy. As Emanuel would say, they're not wasting a crisis on all those normal procedures for deciding how to spend our money.