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January 12, 2009

What sort of stimulus?

You have probably heard that Obama wants to borrow money to create a government stimulus of about a trillion dollars.I'm of the mind that it will contain too much meddlesome and expensive waste to be worth it. However, a lot of policy makers and economists have been discussing the relative merits of a tax cut and government spending as a Lafferian/Keynesian stimulus to get us out of the recession. The idea here is in the multiplier effect. The hope is that when the government refunds you a dollar of taxes or pays you to build a road, you invest and consume your new income, creating jobs in the industries you consume and invested in. Of course, when the government spends money it doesn't have it does so by printing money or borrowing, both of which raise interest rates throughout the economy, making it a bit more difficult for every borrower in the economy. When you add up the total economic consequences, they could be greater than the original dollar (we call the ratio of the benefits to the costs the multiplier) indicating that the government can powerfully stimulate the economy or less than one, indicating that such a stimulus is unlikely to succeed. Krugman believes that government spending has the higher of the two multipliers (tax cuts with a multiplier of 1, government spending of 1.5) , while Mankiw believes that tax cuts have the higher multiplier (tax cuts of 3, government spends of 1.4).

The way I see it, if we have to have one, we should have tax cuts. The worst that can happen with the tax cuts is that people spend and save money that the federal government borrowed cheaply, and the best would be that people used that money to make intelligent savings decisions for retirement and emergencies. As Bryan Caplan says, this would provide the psychology of the stimulus with far less opportunity for the negative consequences of all the new government intervention to rear its ugly head. I guess said another way, the worst the multiplier of of tax cuts could be is 1, while the worst the government spending multiplier could be is negative. When it comes to the perils of government action, I am risk averse.

Posted by OneEyedMan at January 12, 2009 7:41 AM

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