A Curious Conservative Reaction to the Democrats' Economic Stimulus Plan

Writing an analysis in the Los Angeles Times, on the Democrats' legislative package for an economic stimulus plan, Maura Reynolds makes a striking observation that: "The $825-billion stimulus proposal that Democrats unveiled this week may encounter stiff opposition from conservatives on Capitol Hill. But it isn't meeting significant resistance from conservative economists." Ms. Reynolds admits that: "Though economists might quibble with specifics or express concerns about longer-term effects, the vast majority agree that some kind of massive government spending plan is necessary." Ms. Reynolds quotes: "Mark Zandi, a founder of Moody's Economy.com who advised GOP presidential candidate Sen. John McCain of Arizona" for admitting that: "Most conservative economists are all for it." Ms. Reynolds explains the interplay of the forces behind this apparent paradox taking place between conservative politicians and conservative economists from an economic perspective: "The reason is fairly straightforward. A recession is a prolonged drop in demand for goods and services. Both consumers and businesses have cut back hard on spending. With economic insecurity higher than at any time since the Great Depression, consumers and businesses are more reluctant to resume spending than in previous downturns. Reluctance to spend can set off a vicious economic cycle, with dropping demand leading to layoffs, further stifling demand. Many economists believe such a cycle may already be underway. Conventional economic theory holds that the only institution that can halt that cycle is the federal government, which does so by substituting its demand for goods and services for the diminished appetite of the private sector." Ms. Reynolds adds that: "Even Martin Feldstein, a professor of economics at Harvard University who served as chief economic advisor to President Reagan and is considered the dean of the country's conservative economists, has expressed support for a stimulus plan." Ms. Reynolds quotes Feldstein's reasoning behind his support for the Democrats' plan: "Countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment that is now underway," Feldstein wrote in the Wall Street Journal last month. "Without that rise in government spending, the economic downturn would be deeper and longer." On the other hand, in an attempt to explain the beliefs of elected GOP officials, Ms. Reynolds interjects that: "Republican lawmakers are often uncomfortable with government spending programs, usually preferring tax cuts. House Republican leader John A. Boehner of Ohio said Thursday that the Democrats' plan "appears grounded in the flawed notion that we can simply borrow and spend our way back to prosperity." Ms. Reynolds acknowledges the Republican officials' position and observes: "But so far, Republicans have not demanded new tax cuts." Ms. Reynolds returns to her observations of conservative economic dogma to explain: "For one thing, although permanent tax cuts can foster long-term growth, in the short term most economists agree they create less economic demand -- that is, they are less "stimulative" -- than direct government spending." Its an all together different matter for: "Economists" who Ms. Reynolds says have a tendency to "explain the spending-versus-tax-cut debate this way: When the government spends $1 to buy an item or a service, economic output (or gross domestic product) goes up by $1. Then it goes up a bit more because whoever gets that $1 spends at least part of it buying supplies or paying workers, who in turn use it for food, gas or medical care. So $1 of direct government spending becomes roughly $1.57 of GDP, according to projections by economic advisors to President-elect Barack Obama." And according to economists: "Tax cuts work differently. If a person gets a tax cut of $1, there is no guarantee he or she will spend it, so it has no immediate effect on GDP. And the worse the economy and the greater the fear of bad times ahead, the more likely they are to hold on to that dollar." This distinction, allows "Obama's advisors (to) assume that the $275 billion in tax cuts in the stimulus proposal would have no effect on GDP for the first quarter after the plan is passed. After that, they expect taxpayers and businesses would begin to spend the money they save from taxes. Their models suggest that a $1 tax cut would eventually produce 99 cents worth of demand within two years." In addition, Ms. Reynolds explains: "Analyses of how last year's tax rebate checks were spent have convinced economists that taxpayers and businesses are not in a "stimulative" mood. Joel Prakken, chairman of Macroeconomic Advisers, a St. Louis-based economic forecasting firm, estimates that taxpayers spent only 30% of the rebate checks they received. That meant $100 billion in tax reductions bought just $30 billion in demand for goods and services." And as UC San Diego economist Valerie Ramey explains: "What happened was exactly what economic theory says should happen,.. People knew the tax rebate was temporary, so it didn't make sense for them to go out and splurge. Rebates are not the best way to stimulate spending." Ms. Reynolds draws an important distinction to consider, however; "But tax cuts for businesses can be useful in creating the conditions for capital spending and job creation once an economic recovery begins. And a tax cut that ordinary taxpayers perceive as permanent can lead them to increase their consumption once a crisis passes." Reynolds completes her point by explaining: "That's one reason Obama has tried to send the message that the $500-per-worker ($1,000 per couple) tax cut that is part of the stimulus package will be followed by a permanent change in the tax structure." As far as Ms. Reynolds economic analysis is concerned: "All of these economic pros and cons help make the $825-billion blueprint resemble a hodgepodge of programs. Some commentators have ridiculed elements of the plan as masquerading as "stimulus" -- such as the $20 billion to computerize medical records or $6 billion to bring broadband Internet access to rural areas." And there's also several caveats that Ms. Reynolds does not forget to mention: "But economists say the package is designed to do several things at once, some short-term, some long-term." Which means that: "First, the package aims to soften the brunt of the recession by increasing government purchases of goods and services. Public agencies can put contractors to work building schools, or they can spend to upgrade their vehicle fleets, thus creating jobs for autoworkers." To which Ms. Reynolds mentions the other point: "Second, the plan seeks to ensure that the economy has the most productive resources and infrastructure in place to make the U.S. economy as competitive as possible. Hence the spending on such physical resources as roads and broadband connections and "intellectual resources" like computer programmers and new technology. " Adding further viability to the Democrats' plan is a comment made by Joel Prakken, the economic forecaster, who Ms. Reynolds credits for having "said computerizing medical records was a good example of the dual goals of a stimulus program." Prakken continues by explaining that: "You are going to have to pay programmers to do the work. That's GDP, by definition. And if it increases the efficiency of healthcare, that delivers a long-term benefit." Ms. Reynolds reports that: "Prakken and his team ran a simulation of the effects of the Democratic program. Without it, unemployment would rise from the current 7.2% to 9.1%, Prakken estimated. With it, the jobless rate will peak at 8.3% at the end of this year. As for GDP growth, it is likely to turn positive in the middle of this year, and actual GDP would be 3.2 percentage points higher at the end of 2010 than it would be without the stimulus, according to the projection." Ms. Reynolds wraps up her analysis by stating that: "The stimulus package has a third objective, one that is harder to measure but also crucial: It must ease the fear gripping the economy." To which UC San Diego's Valerie Ramey explains the all important psychological portion of the plan by saying: "If people and businesses believe the stimulus will work, they become less afraid and will begin to spend,.. Just that psychic effect could pull the economy out of the doldrums." Once again proving the high degree of correlation that exists between the psychological mood that can be reflected by economic policy and the ability of the economic plan; whether through success or failure that the economic policy can effectively establish through it's psychological impact. Let us all hope that we will soon have an economic plan in place that elevates the psychological mood of the nation and brings tremendous economic recovery and spurs a period of sustained, beneficial economic growth.