Richard Posner, "Stimulus and Deficit"

Stimulus and Deficit
Richard A. Posner
The Atlantic
February 21, 2010

My last post elicited a number of very interesting comments. Some very intelligent-seeming commenters insist that the $787 billion stimulus program enacted last February has had no effect on unemployment. I think this is wrong, but I understand the underlying concern, which is with the impact of the program on the federal deficit.

The stimulus program was months late in being enacted, was poorly designed, and has been lackadaisically executed. And critics are right that the claims made by the administration, and for that matter by private economists (both academic and business) and economic journalists, concerning the number of jobs saved by the stimulus are arbitrary. Economic science has not advanced to the point at which the effect on unemployment of a given increase in deficit spending can be estimated. Take the claim that the stimulus saved the jobs of hundreds of thousands of public school teachers. It is said that but for the stimulus moneys that were allotted to state governments, the teachers would have been laid off. But would they have been? Might not the states have cut other funding, or increased taxes, to keep teachers and other public employees on the payroll? Or reduced wages in lieu of layoffs? Such cuts, whether of other funding or of teachers' wages, could, by reducing money in circulation, have led to layoffs elsewhere, but no one knows how many of those other layoffs there would have been and therefore how many jobs the stimulus money allotted to the states saved. And the money that was distributed to individuals in the form of tax credits or other benefits--how much of that money was saved rather than spent, and saved in forms that do not stimulate economic activity?

Still, something like $300 billion was injected into the economy in the last three quarters of 2009, increasing GDP by about 3 percent, and that is not a negligible amount and must have been a factor in keeping consumption growing (albeit modestly) though incomes were falling, and the more consumption, the more production and hence jobs. More important is the psychological effect of the stimulus--not today, when the effect has turned negative as I'm about to argue--but back in February 2009 when the stimulus program was enacted. The public mood was very bleak then; deflation was in the air; there was a lot of scary talk about an impending repetition of the Great Depression--and indeed the economic indicators were falling faster than they had fallen in the corresponding period of that depression. The bank bailouts and the expansion of the money supply and the other restorative measures that had been taken seemed not to be working. It was psychologically important for the new administration to move resolutely to spur recovery rather than to throw up its hands and tell the people to let nature take its course. Psychology is a key factor in the decision of businesses to invest and consumers to spend. The government had to do something to prevent producers and consumers from freezing and hoarding rather than investing and spending.

Richard A. Posner