CRFB UPDATE -- Fiscal Stimulus: Do It Right or Don't Do it at All

Congress appears poised to move forward with a fiscal stimulus package. In theory, a mixture of monetary and fiscal policy is generally most appropriate to help a slowing economy; in practice however, fiscal policy becomes politicized so easily that it is often ineffective, and is sometimes even counterproductive. Too often in the past, stimulus bills have been poorly timed, poorly targeted, and larded up with unrelated items.

If Congress moves forward with a stimulus package, the Committee for Responsible Federal Budget believes that:

Stimulus should be simple. Short-term stimulus should be the lone focus of any bill. Other economic agendas including making the tax cuts permanent, reforming unemployment insurance, expanding health insurance, increasing infrastructure spending, or altering Medicaid, should take a back seat to the goal of quickly crafting an effective stimulus that is unencumbered by unrelated agendas.

Stimulus should be targeted. To be effective, stimulus should maximize the size and speed of its effect on GDP. Stimulus should increase aggregate demand by encouraging spending by individuals, businesses, or government. The Congressional Budget Office has found some of the most cost-effective policies to include:

• Temporary tax cuts and rebates
• Temporarily extending or expanding unemployment benefits
• Temporarily increasing foods stamps

The Committee also urges that fiscal stimulus policies not be targeted towards particular industries, including those that are hardest hit in the recession. Although the challenges in the housing industry are serious, for instance, these problems should be addressed separately, not as part of a stimulus package.

Stimulus should be timely and temporary. Mistimed fiscal policy can do more harm than good by adding to the national debt. Fiscal stimulus should be crafted to precede a sustained downturn, take effect as quickly as possible, and be temporary. If Congress waits too long to pass a plan, the economy could be growing just when the stimulus is passed, leading to an overheating of the economy rather than propping it up. We recommend that the stimulus take effect in calendar year 2008 and that none of it be permitted to significantly increase the deficit beyond a one-year window (barring other unforeseen deteriorations in the economy.)

Stimulus does not have to be paid for. We know, we know—as strong advocates of PAYGO, it might be expected that we would argue that all stimulus should be paid for. While we commend those who are concerned with creating a fiscally responsible stimulus package, the very point of stimulus is that it not be paid for so that it injects extra money into the economy and helps to drive higher levels of consumption. If a stimulus package were paid for in the out-years, we would certainly be pleased. However, we believe that such a requirement is likely to derail the process of trying to assemble an effective stimulus package. We would prefer to see stimulus separated from more generally fiscally responsible measures and treated as a one-time emergency measure that does not require offsets. If, however, there are any measures that extend beyond 2008, they should not be exempt from PAYGO.

The need for fiscal stimulus is a reminder of why we should keep our fiscal house in order. Although the Committee would accept using increased deficits as a tool to spur the economy in the short-run, we urge the President and the Congress to take the next important step: A long-term budget plan that addresses entitlements, tax reform, and spending restraint. The most important signal to send the economy is that the government intends to tighten fiscal policy, and run surpluses when the economy is doing well. Failure to deal with our dismal long-term fiscal outlook will eventually undermine the government’s ability to use fiscal policy as a means to manage the economy or help protect Americans from recession.

At this point, a stimulus bill seems likely. We believe that a bad stimulus bill—one that comes too late, or contains special-interest, unrelated, or ineffective provisions—is worse than no stimulus at all, given the high costs of a bill (a cost that seems to be growing by tens of billions of dollars a day) and given the fiscal challenges already facing the country. If Congress fails to keep a bill simple, targeted, timely, and temporary, we would prefer to leave managing the economy to the Federal Reserve Board.

Major Stimulus Enacted in Past Recessions

Source:  Christina D. Romer and David H. Romer 1994, NBER Macroeconomics Annual, Vol. 9 (1994) pp 13-57 (paper drew on historical government documents such as the Economic Report of the President); Budgets of the United States Government FY 2002-04; Douglas Elmendort and Jason Furman, “If, When, How: A Primer on Fiscal Stimulus,” The Hamilton Project, Washington, DC:  The Brookings Institution, January 2008

Learn More About: Maya MacGuineas
Related Programs: Committee for a Responsible Federal Budget, Fiscal Policy Program
Topics: Fiscal Policy