An 8.3% Deficit Is Plenty of Stimulus

Proponents of a new fiscal stimulus package discount the unprecedented fiscal boost that is already in the works. But there is little economic basis for arguing that $1.2 trillion in annual deficit spending will lead to despair while $1.6 trillion will lead to prosperity.

Resident Scholar Philip I. Levy

Hey everybody, I found the stimulus. And we're in luck--it requires no additional action on Congress's part. It's already in the works.

The Congressional Budget Office projected last week that even without a stimulus package, the federal budget deficit will hit $1.2 trillion this year. That's 8.3% of gross domestic product. Followers of the late John Maynard Keynes should be thrilled. Such a gap between government spending and taxes was just what he prescribed to stimulate a slumping economy.

And yet the stimulus enthusiasts seem unsatisfied. President-elect Barack Obama argues that this level of stimulus would leave us with shattered dreams and long-lasting torpor. Our only chance is to adopt his plan of $800 billion in additional stimulus spending over the next two years. So $1.2 trillion in deficit spending leaves us in despair, but $1.6 trillion in deficit spending brings prosperity.

Fiscal stimulus is among the weakest tools available to counteract a contraction.

The basis for this reasoning is unclear. Keynesian macroeconomics argues for deficit spending. We've got lots of that. We also know there are costs to overdoing it. Ultimately, government borrowing must be paid back. And if government borrowing is excessive, at some point we will have some combination of inflation, higher interest rates and higher taxes. The danger now of excessive borrowing is exacerbated by the impending retirement of the baby boomers and the resulting strain on public finances.

So how does Mr. Obama come to the conclusion that we need more stimulus spending now?

Perhaps he's shooting for shock and awe. The current deficit estimate was somewhat predictable with falling tax revenues and rising spending. Therefore, the thinking goes, to fix the economy we need a policy that moves us beyond the bounds of the ordinary.

But even if that were true, an 8.3% federal budget deficit ought to do it. The previous post-war record was 6%, set in 1983. And what's more, the idea that pushing surprising policies is the best way to kick-start the economy is itself flawed. As we learned in the 1970s, people base their economic actions on beliefs about the future. Attempting to game those expectations about the future with policy surprises is usually fruitless.

Inevitably, bold government actions introduce greater uncertainty into an already uncertain marketplace. We have seen the malign effects of this with our latest experiment in urgent, dramatic action, the Troubled Asset Relief Program (TARP) of last fall.

Consider the perspective of someone contemplating an investment in a beaten-down U.S. bank. Is that investment a good idea? Yes, if the government is going to take the troubled assets off your hands; no, if the government is going to demand a dilutive equity stake and impose onerous conditions.

Our government announced one plan and implemented the other. When it added this uncertainty to the unpredictability of the broader economic environment, it was hardly a recipe for encouraging private activity. An $800 billion tax-and-spending package would likely rework incentives in many parts of the economy.

In other words, there is very little science behind arguments that an additional $800 billion stimulus should do the trick.

A pragmatist might contend that this is no time to quibble about economic theories. We need measures that get proven results. If so, the record of discretionary fiscal spending--the stimulus spending beyond the deficits we naturally get in a falling economy--is pretty weak.

Despite all the recent cries of "Shovels at the ready!" it is very difficult to agree on and disburse emergency spending quickly and effectively. Fiscal stimulus is among the weakest tools available to counteract a contraction. Japan's failed attempt to spend itself out of recession in the 1990s and the U.S.'s futile stimulus of last year underscore the point.

None of this is to dispute the gravity of the present economic situation. But the nation's long-term fiscal challenges are grave as well. No one is arguing for a return to the 1930s, with proposals for balanced budgets and tight money in the face of depression. The argument is over the magnitude of the stimulus. We have an unprecedented deficit already in the works. How far beyond unprecedented do we need to go?

Philip I. Levy is a resident scholar at AEI.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Philip I.
Levy

What's new on AEI

Defeating ISIS: AEI experts weigh-in before the president’s address on Wednesday
image Degrading, defeating, and destroying the Islamic State
image Wealth Building Home Loan: Building wealth through homeownership and retirement savings
image The $3 iPhone
AEI on Facebook
Events Calendar
  • 15
    MON
  • 16
    TUE
  • 17
    WED
  • 18
    THU
  • 19
    FRI
Tuesday, September 16, 2014 | 5:00 p.m. – 6:00 p.m.
The Constitution as political theory

Please join us for the third-annual Walter Berns Constitution Day Lecture as James Ceasar, Harry F. Byrd Professor of Politics at the University of Virginia, explores some of the Constitution’s most significant contributions to political theory, focusing on themes that have been largely unexamined in current scholarship.

Wednesday, September 17, 2014 | 8:10 a.m. – Thursday, September 18, 2014 | 1:30 p.m.
Third international conference on housing risk: New risk measures and their applications

We invite you to join us for this year’s international conference on housing risk — cosponsored by the Collateral Risk Network and AEI International Center on Housing Risk — which will focus on new mortgage and collateral risk measures and their applications.

Event Registration is Closed
Thursday, September 18, 2014 | 2:15 p.m. – 3:00 p.m.
Speaker of the House John Boehner on resetting America’s economic foundation

Please join us as Speaker John Boehner (R-OH) delivers his five-point policy vision to reset America’s economy.

Event Registration is Closed
Friday, September 19, 2014 | 9:15 a.m. – 11:00 a.m.
Reforming Medicare: What does the public think?

Please join us as a panel of distinguished experts explore the implications of the report and the consumer role in shaping the future of Medicare.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.