Senate Committee on Finance

Options for Fiscal Stimulus

Mr. Chairman and other members of the Committee, thank you for inviting me to testify at this hearing on a stimulus plan that makes sense. A spate of bad news, including a jump in the unemployment rate, a decline in consumer spending and a continued plunge in housing starts, leave little doubt that the economy is weakening. Well-designed fiscal stimulus, in the form of increased government spending or tax reductions, has the potential to help cushion the economic blow.

The key to well-designed stimulus is to ensure that it is timely, temporary and targeted – the "three T" principles enunciated by economists as diverse as Harvard Professors Lawrence Summers and Martin Feldstein, Federal Reserve Chairman Ben Bernanke and Congressional Budget Office Director Peter Orszag. Three of the options that best meet this test are (1) a refundable tax rebate that is adjusted for family size and phased out for high-income households; (2) a temporary extension and possibly expansion in unemployment insurance benefits; and (3) a temporary increase in food stamps. Policymakers should also consider state fiscal relief implemented as a temporary increase in the federal share of Medicaid costs.

My testimony today has three parts. First it discusses the underlying economic logic that motivates the three principles of fiscal stimulus. Second, it applies these principles to analyze a range of stimulus options. Finally, it includes a more detailed discussion of the design of an individual rebate.

The Economic Logic Underlying Fiscal Stimulus

How best to increase the economy’s productive capacity and thus long-run growth is the most important long-term task for policymakers. But it is also complicated and subject to debate. What is not in real dispute is what to do about an economic slowdown when the economy is not fully utilizing its current capacity. Economists broadly agree that, in principle, both monetary and fiscal policy can increase consumption, investment, government spending, or net exports—thus boosting aggregate demand, which translates into higher GDP and more job growth. To the degree economists sometimes disagree in practice, their differences largely stem from uncertainty about economic prospects and the likelihood that the political system will deliver fiscal stimulus in an effective manner.