The Post-Stimulus Economy: Stimulate, Then Be Patient

The following is in response to “Nothing Extraordinary About Housing” by Steven E. Landsburg in the Los Angeles Times.

Steve,

It has been an eventful week in the economy. While we have been writing back and forth, the House of Representatives and the Senate Finance Committee both passed fiscal stimulus bills in the neighborhood of $150 billion and the Federal Reserve cut rates by another half-point, bringing the total rate cut since September to 2.25% — the largest such reduction in more than two decades. At the same time, the economic news has fallen short of even the pessimistic predictions. On Wednesday, we learned that GDP growth in the fourth quarter of last year was a disappointing 0.6%. On Thursday, we learned that real per capita personal income has fallen since August (yes, Steve, the same day you wrote that personal income was at an all-time high — it seems you forgot to adjust for inflation). And today we find out that the payroll survey shows the economy lost 17,000 jobs in January (although the unemployment rate, calculated by a different and less reliable survey, ticked down slightly).

Although predicting the future is notoriously difficult, it is hard not to be much more worried about the economic outlook than we were six months ago. The good news is that the rate cuts will have a big effect on the economy — leading economic forecasters are predicting that the rebate checks and other stimulus measures will add about 0.7% to real GDP. The bad news is that most of the benefits will not be felt until the second half of this year.

That has an important implication for policymakers trying to answer today’s question: “What if the stimulus package does not work?” The biggest implication is that we will need to be patient. Even reams of bad economic data over the next six months would have little bearing in trying to understand the efficacy of the stimulus package or the need for another one. We would not want to be like the person who turns up the thermostat and then, without waiting for the temperature to rise, turns it up even further until eventually her home is overheated.

The second-biggest implication is that policymakers need to be vigilant about responding to rapidly evolving conditions. The Federal Reserve, with its technical expertise, political independence and flexible policy instrument, is the entity most capable of monitoring and flexibly responding to rapidly evolving developments. Although fiscal policymakers appear to have gotten it right this time, in some ways it was a fluke that cannot be counted on to happen again. The Federal Reserve, for example, can make large preemptive rate cuts and then tighten if needed. It is impossible to imagine fiscal policymakers taking back fiscal stimulus if it is no longer needed.

Finally, if the economy is still weak toward the end of this year and the Federal Reserve has run through most of its ammunition by cutting the federal funds rate to something like the 1%, then we should think about another round of fiscal stimulus. But I am hopeful it will not come to that.

When the economy does start growing more strongly again, we should use that as an opportunity to focus on some of the long-run growth issues you raised in previous posts. We should also focus on reforming unemployment insurance, health insurance and taxation in ways that automatically reduce the severity of business cycles and, more important, cushion families from some of the worst downsides of those business cycles.

Jason

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.