Is More Fiscal Stimulus Needed?

The following is reposted from The Council on Foreign Relations website.

There is little doubt the stimulus measures taken by the Bush and Obama administrations in 2008 and 2009 were effective in preventing a worse slump. Automatic stabilization programs and the two stimulus packages helped limit the drop in disposable household incomes to just 1 or 2 percent. As a result, household consumption fell substantially less than it would have without any stimulus.

The long-term danger of fiscal stimulus is loss of confidence in government debt and sharply higher public and private borrowing costs. But the notion that we cannot increase the deficit in the short run while simultaneously reducing the long-term debt is dubious. Taking both kinds of actions would improve both the short-term and long-term economic outlook. The question is whether these actions together are politically achievable.

In the near term, the government should boost spending or keep taxes down in order to spur faster economic growth. While private sources of demand are very weak, judging by current interest rates on Treasury debt, both U.S. and overseas investors believe the U.S. government is highly creditworthy. This means there is still room for the government to borrow funds to relieve the unemployed and state governments, and invest in public infrastructure.

The U.S. government would strengthen its creditworthiness by simultaneously taking credible steps to reduce the long-term deficit. Most of that deficit growth is traceable to a single, widely recognized development: federal healthcare spending is growing much faster than the overall economy. To keep healthcare affordable long term, the country must reorganize insurance and care provision to reduce wasteful administrative spending and cost-ineffective care. The health reform law will curb some future cost growth, but Congress can and should take additional steps to cut future costs.

The situation in Europe is different. Many small countries with dubious credit records cannot add significantly to their public debt. But that is hardly the case for big countries with good borrowing records, including France, Germany, and Britain. If monetary policy alone does not push Europe toward faster economic growth, more stimulative fiscal policy may be needed.