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September 25, 2012
The Dismal Science
Getting Stimulated
by Adam Smith

Back when President Obama was first elected, the “Stimulus Package” was passed by Congress and signed into law by President Obama in February 2009. At the time, unemployment was at 8% and the passage of the $800 billion stimulus was promised to keep the unemployment rate from rising.

By October of 2009, the unemployment rate was at 10% and did not drop below 9% until October of 2011.

The question that has been asked over and over and discussed till everyone’s eyes glaze over when the subject is brought up is, “Did the stimulus package work?”

The Republicans say the administration promised the unemployment rate would not rise above 8% if the stimulus was passed, so the fact that unemployment went to 10% is proof that it did not work.

The Democrats will say that the recession was worse than they anticipated and even though unemployment increased to 10% it would have been much worse, maybe even a depression, if the stimulus was not passed. Millions of jobs were either created or saved due to the stimulus package.

Who is right and who is wrong? A simple, brief explanation of the theory behind the stimulus package would be helpful.

The size of our economy (GDP) is made up of consumption by households; investments by businesses such as new buildings, equipment, factories, and so on; government spending, and the difference between what we export and import.

During times of economic distress, households restrict their consumption and increase savings, and businesses react to the decrease in demand and stop investing in expansion. This leaves government spending as the crutch that keeps the economy from shrinking.

The hope is that with increased spending by the government, the economy will not shrink, or may even cause it to grow, giving consumers more confidence to spend. This increase in consumer spending will signal to businesses that the economy is recovering, and they will begin to invest again and start hiring new employees. With increased consumer spending and investment by business the economy will start expanding. This is the theory.

Not to get all Bill Clinton on you, but who is right on the question, “Did the stimulus package work?” depends on how you define “work.”

There is no doubt that the stimulus did create and help save jobs. It would literally be impossible to spend $800,000,000,000 over eighteen months and not have some impact on employment. So if that is how you define success for the stimulus, then, yes, it did work. The supporters claim anywhere between 3 and 4 million jobs were created or saved.

This sounds like a lot, but that would mean that each job cost between $200,000 and $250,000 to create. The cost is incredibly high and indicates a lot of inefficiency. So if your definition of whether the stimulus worked is a matter of efficient use of money, then the answer is no.

The claim that it helped keep us from a depression is just silly and deserves no response.

But why did the stimulus not give us the boost promised?

Early in 2009, I was at a conference and was listening to an economist talking about the recession, the stimulus, and how the economy was likely to respond. The consensus of economists was that the economy would expand when the stimulus was being spent, but there was no way to know what the economy would do after the stimulus was done.

At the company I work for, we did see some expansion of demand when the stimulus was being spent, but because the stimulus in no way changed the uncertainty of the future when the stimulus money ran out we did not respond with any investment or expansion. In fact almost all businesses just sat and waited to see what would happen.

Consumers were still in shock and not ready to spend, so the economy has basically stayed flat. Really flat.

I emailed a noted economist and asked him, “I have a quick question about Keynesian stimulus spending. If businesses know that economic expansion for a 6-month or 12-period of time is only due to expanded government spending, why do economists think that business will react to the expansion when there remains so much uncertainty about the economy when the expanded government spending stops? Businesses are not irrational. We just sit and do nothing to see what is going to happen to the economy after the stimulus. Doesn't this make the stimulus moot?”

His response was “I agree with you.”

I think the better or more pertinent question about the effectiveness of the stimulus is whether it created the confidence in the consumer and businesses to increase their willingness to take on more risk.

The obvious answer to this question is no. And more government spending will not solve our current “stubborn unemployment” (as the President likes to say).

If you want to change how the economy is functioning, then you change the underlying fundamentals. There are three things the government could do to invigorate our economy and none of them will cost the taxpayer a dime. I will discuss them in the next column.


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