The following is in response to "They'll Need That Money Back" by Steven E. Landsburg in the Los Angeles Times.
How about I respond to your questions with a multiple-choice question. The estimated number of unemployed increased by 474,000 in the month of December, bringing the total 12-month increase in the number of unemployed to 895,000. Is this because:
A. People are feeling so much richer that they have decided to cut back on their work? B. The economy needs to be cleansed of its bad industries? C. The economy has hit a weak patch and needs to be stimulated?
Your posts have some flavor of "A" in them. You are quite concerned that giving people extra money will discourage them from working — and instead you would like to find a solution that encourages work. While potentially true in normal times, this is not high up on the list of my worries for the economy in 2008. Your posts also seem to have a large dose of "B" — a thinly veiled distaste for any attempt at countercyclical policy.
My answer is "C." Downturns are painful. In the relatively mild 2001 recession and the aftermath that followed, the number of unemployed increased by 4 million. In a recession and its immediate aftermath, the typical family of four can see its income go down by about $5,000. The evidence suggests that far from the hopeful scenario of "creative destruction," these economic losses are persistent and not necessarily ever recovered.
If we both agreed on "C," then we could get down to more technocratic questions like how best to combat a potential recession. Do you think interest rate cuts are more effective than fiscal stimulus? And if we are doing fiscal stimulus, are the best policies to build infrastructure, put rebates in the pockets of working families, give money to states or give tax cuts to businesses? How should we balance the concerns about excessively low interest rates fueling another credit bubble (the downside of using monetary policy by itself) with the concern that a stronger dollar would lead to a larger trade deficit (the downside of using fiscal policy by itself)?
Elsewhere I have summarized (PDF) the evidence on the effectiveness of these different policies. But my bottom line is that well-designed fiscal stimulus appears to act more quickly than lower interest rates. This fact, together with my uncertainty about the precise effects of either policy course, lead me to favor a diversified approach that relies on both fiscal stimulus and interest rate cuts.
Your proposal to use tax changes to encourage people to work is not high up on my list of considerations for the simple reason that I do not agree with your diagnosis that changes in the unemployment rate reflect people's desire to work. Moreover, it is incompatible with the more important goal of getting the stimulus into the economy in a timely manner. As Federal Reserve Chairman Ben Bernanke testified last week, "To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so." For the Internal Revenue Service to be able to mail out more than 100 million checks soon, it must look at taxpayer earnings from 2007. And even you would admit that changing tax rates on decisions made in 2007 couldn't cause those decisions to be unmade. But it is not too late to change people's spending decisions in 2008.
Will the economy get a much-needed boost from a stilmulus package? In a week long Los Angeles Times 'Dust Up' series, Jason Furman, a Brookings scholar and an advisor to President Clinton, and author-economist Steven E. Landsburg discuss the U.S. economy and the recently announced stimulus package.