Stimulus -- you can pay me now or you can pay me later

This post is stimulated by comments I received on the issue of unemployment in the USA. Many of the arguments against further economic stimulus today are phrased in terms of such issues as rising inflation, budget deficits, national debt, and so on. It is easy to ignore these arguments since they sound much less imminent and alarming than a 9.5% unemployment date. It is easy to imagine the horrible plights of unemployed persons and their families. National Debt and rising inflation seem much less important. But it simply isn’t true. What I try to show below is that a fix that leads to an enduring impact on employment and unemployment is what we want. Stimulus packages and extensions of unemployment insurance may not be the best way to get what we want. If stimulus helps a worker keep his or her job for another couple of months but then leads to a time of rising unemployment after that then you might not vote for it. The issue, then, is about unemployment now and later.

The first thing to emphasize is that while government could conceivably hire all or most of the unemployed persons – not many people really want that as the permanent solution. We recognize that firms always have been and probably always will be the main driver of job growth in the USA. Yes, there are plenty of people who believe that government could hire more people or keep them on unemployment insurance longer as a short-term stimulant, so I will turn to that below. But that is, at best, a temporary fix and not the real solution.

Stimulus seems obvious. Since the unemployment rate remains high, the stimulus argument asks that government add more stimulus – or at least not withdraw or reduce the present level of stimulus. Private spending is lacking. Replace the private spending with public spending. This puts income in people’s pockets and replaces the missing demand for goods and services. The increased demand has a multiplier impact as firms hire workers to do jobs, pay them income which they spend, and spreads the benefits to other firms. In the meantime, uncertainty or lack of confidence disappears and firms are more willing to spend on plant, equipment, and capital items. Not only is this intuitive but it is humane. All those unemployed people regain not only jobs but dignity. I may have missed some of the points but I hope I have reproduced the essence of the stimulus argument.

Intuition helps us solve a lot of problems – but it isn’t always right. The world is complicated enough to facilitate difference of opinion. We used to think blood sucking leeches would solve a variety of human health ills. No I am not talking about any of my relatives. Physicians who voiced objections about blood sucking remedies cared about their patients even though they might have been out of step with traditional practice. Economists and others who argue against continued stimulus care about unemployed people. What matters is not the name or party of the arguers – what matters is what really works.

Since I am one who believes continued stimulus is not the best approach right now, it behooves me to focus on the issue of unemployment – and that’s what I have done in past posts. So let me bring together here what I tried to do in the past messages.

The challenge here is that while the pro-stimulus argument is intuitive, the con-stimulus arguments are not. For example, the Cons are usually phrased using an expectations-augmented shifting Phillips curve. Ohhhh crap – not that one again! J Or the Cons get hung up trying to explain future discounted capital budgeting issues. Or they might worry about disincentive effects of higher tax rates. Arrgghhh

I used past posts to get into the nitty gritty of all that technical stuff. Often I lost the forest (unemployment) for the complicated trees. So let me just try to summarize some of the points here with a stronger focus on unemployment.

First is “you can pay me now or you can pay me later.” A stimulus policy might reduce the unemployment rate now but it won’t last. This is exactly what we saw with the expiration of the massive subsidies to buy cars and houses. We mostly shifted future buying into the present. I wrote one post to explain why the USA and the world economy might not be as far as we think from reducing excess capacity. A huge dose of stimulus on top of the past stimulus could lead to a rise in inflationary expectations, increased input costs, a profit squeeze and a higher unemployment rate. We call this phenomenon stagflation. Some folks say we are a long way away from this. But the facts suggest otherwise. Expectations are sensitive and can move in upward direction quickly.

A second part of “pay me now…..” is what the Fed does. If excess capacity starts declining the Fed will start to remove the monetary stimulus and interest rates will rise. The chances are that the Fed might not remove this stimulus on a perfect time table. In addition to stagflation we could have the Fed moving too slowly then tightening demand too much and this could lead to higher unemployment.

Third, in a previous post I documented the size of changes in the federal debt. But the debt is not the ultimate problem – it is just the symptom. If the USA is alone in its ignorance of the implications of high debt and if the USA adds even more to the bloody debt numbers – it will have an impact on people who participate in the credit markets. But it doesn’t stop there. If domestic and foreign participants lose faith in American financial assets and move their money abroad, this will show up as a reduction in the demand for US goods and services and a rise in the unemployment rate. Some economists argue that this could never happen to the US. But their arguments are not based on current realities. Already we see global investors shifting out of dollars into euros and yen.

Fourth, I wrote a silly analogy about Mary and her Twinkies. But the point is that government spending is habit-forming. Once you get the government spending train going – it isn’t easy to slow it down. After the mid-term elections in November, a bipartisan committee will begin to work on a program to address my third point above. An extension of the stimulus program into the rest of 2010 and beyond makes the job of that special commission even harder. This is partly because the past and future stimulus mixes spending whose intent was to quickly increase spending with other spending that’s aimed at America’s special long-term policies with respect o defense, energy, health care, and more. With partisanship so vivid and strong I pity the members of that commission. If we cannot bend the spending line I doubt we will have any better luck with restructuring taxes. This let down in budget courage will simply add to worries about a financial outflow and will increase the unemployment rate. This makes me really hungry for a Twinkie. Do Twinkies go well with Jack Daniels at 10 am?

Fifth are current expectations of the future health of US business. It matters when people discuss whether or not President Obama is pro business or not. Consider all the spending and taxing and regulation policies that will negatively impact business. It doesn’t matter whether you love business or not. If business is going to hire all those folks then you better not throw away the baby with the dirty bathwater. Many of you have been waiting for years or decades for a president who would solve our long run problems in healthcare, energy, global warming, immigration, social security, financial market problems, poverty, and more. But as James Brown would say – Please Please Please – have we thought about the impacts on business hiring decisions as we try to implement all this legislation quickly (before Obama loses his majority in both houses)? If businesses are to create the jobs in the future, one must not rush to judgment and we must answer this question thoughtfully.

Sixth is basic intuition. If the unemployment rate went up because of too much debt and bad debt – it is hard to imagine that the solution to the problem would be even more debt.

Finally, while the intuition is that stimulus could and should work again, there is no real consensus that it will. As I said above, much of what was called a stimulus package was simply an excuse to attack a myriad of problems – whether or not the spending would quickly impact the economy. If Congress could not be trusted to enact real stimulus at the onset of recession, why should they do any better at a time when the economy has been growing by approximately 3% for as much as a year?

In summary, the prospects do not look very good for improving the unemployment situation with more stimulus. We really should be looking elsewhere.