The Wall Street Journal-20080118-Fiscal Stimulus Is Good for the Short Run
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Fiscal Stimulus Is Good for the Short Run
As the organizer of what you portrayed as a funeral for Rubinomics ("Rubinomics R.I.P.," Review & Outlook, Jan. 15), I feel compelled to set the record straight (for full disclosure, the event was organized by the Hamilton Project at Brookings, an initiative co-founded by Bob Rubin). While how best to increase the economy's productive capacity and thus long-run growth is a hotly debated topic, what is not in much dispute is what to do about an economic slowdown when the economy is not fully utilizing its current capacity, as evidenced by the broad agreement at our recent forum.
In a slowdown or recession the immediate task for macroeconomic policy is to boost aggregate demand, that is spending by consumers, businesses or the government, so that the economy can more fully utilize its capacity. If Congress and the president are able to act in a timely and effective manner, fiscal stimulus can play a helpful, complementary role to monetary policy. Although any increases in government spending or reductions in taxes could be classified as "fiscal stimulus," the evidence shows that the most effectively targeted policies put cash in the pockets of those households most likely to spend it through tax rebates or temporary increases in transfers such as food stamps and unemployment insurance benefits.
Both monetary and fiscal stimulus are temporary policies designed to boost a flagging economy, but neither is a sustainable way to grow the economy over the longer run. That's why economists from Martin Feldstein to Lawrence Summers agree that any fiscal stimulus should be temporary and timed specifically for when aggregate demand needs the most support.
In addition to being ineffective, permanently cutting taxes or raising spending would be counterproductive. All else equal, increases in expected long-run deficits would raise current interest rates, crowding out short-term investment and undermining some of the stimulus policymakers are trying to achieve. This interest rate effect, which you term "Rubinomics" (and I would call "textbook economics"), is borne out by 50 years of macroeconomic data, including the experience in 1994 when deficit reduction enabled real interest rates to remain surprisingly low despite a large increase in investment. Increasing the long-run deficit would also reduce national saving, leading to lower investment, more foreign borrowing, and ultimately lower national income.
The lesson for fiscal policymakers is simple: If you want to conduct fiscal stimulus to help the economy in the short run, make sure it does not increase the long-run deficit. But ultimately policymakers will need to bring down the long-run deficit to foster strong and sustainable growth.
Jason Furman
Senior Fellow and Director
of the Hamilton Project
The Brookings Institution
Washington
