Why the Federal Stimulus?

Martin Feldstein and Paul Krugman have teamed up, calling for increased government programs and more policy proposals to help avert a new nadir in the recent economic crisis. The former’s recent column in the Washington Post claims:

With the Fed’s benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand. Another round of one-time tax rebates won’t do the job. The rebates that Congress enacted this spring failed to stimulate consumer spending: More than 80% of tax rebate dollars were saved or used to pay down existing debt. The only way to prevent a deepening recession will be a temporary program of increased government spending.

As much as Feldstein thinks that tax rebates did little to stimulate consumer spending, he seems to be in a camp of his own. Parker’s findings indicate that household spending increased when consumers received their stimulus payments. Parker’s report goes on to say:

With the Economic Stimulus Act of 2008, policymakers tried to increase disposable income temporarily through tax rebates in the hopes that households would increase or maintain their spending levels and so end or at least mitigate the severity of a U.S. economic slowdown. We find some success: the stimulus payments are initially being spent at significant times.

Feldstein, it seems, does have one other bedfellow. Paul Krugman’s most recent “work” reads:

Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap—a situation in which the Federal Reserve has lost its grip on the economy…In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away, yet mortgage rates and the interest rates many businesses pay are higher than they were earlier this year. The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.

Although Krugman and Feldstein may disagree with me, consumers should cut their spending now. Everyone knows that consumers have been living beyond their means. If, hypothetically, consumers decide to maintain their spending (whether through a cut in sales tax or a Krugman-esque fiscal stimulus), but everyone knows consumer spending will decline in 18 months. While the so-called “liquidity trap” will be finished by then, investment commitments will be mediocre in the meantime, since people will be waiting for the economy to process change. Perhaps we need to spend less now and get the adjustment over with faster, even though that will be painful. Or say we don’t know when the spending decline will come—markets dislike uncertainty most of all.

I view the goal as expediting necessary sectoral adjustments and minimizing unnecessary (i.e., temporary) ones. Any of Krugman’s “stimulus” funds should go to preserving expenditure patterns of state and local governments. This ensures that the money is spent, if that is indeed the goal. Greg Mankiw offers a related solution. Indeed, the columns of Krugman and Feldstein are stark commentaries on how much of a fiscal “quick-fix” society we have become.