Economic Calculations

There is a broad consensus that when the economy is in a downturn, the government can mitigate the effects by stimulating the economy. There are at least three ways to stimulate the economy: (1) the Federal Reserve can increase the money supply reducing interest rates to encourage economic activity, (2) the government can reduce taxes in the hopes that this will spur economic activity, and (3) the government can increase spending to pump up economic demand.

In general, option (1) is preferable. The Federal Reserve can act quickly and potentially nip incipient downturns early. Admittedly, the money supply is a blunt instrument, but compared to tax decreases or spending increases variations in the money supply can act as a scalpel excising he effects of downturn. Sometimes, actions by the Federal Reserve may not be sufficient and one of the other two alternatives are necessary.

In general, Conservatives prefer tax decreases, in part because of their stimulative effect and in part because of the conviction that money in the private sector is more efficiently spent and is a greater spur for economic activity. Liberals believe that the government can act as an engine for economic growth, helping those at the bottom of the economic ladder, and that sometimes the government can allocate resources more equitably than the private sector.

However, discussions about a long-term strategy for growth are less important in dealing with the immediate impact of a severe downturn. The urgency has long been recognized.¬† Last winter, even before inaugurated, President Barack Obama was emphasizing (and thus perhaps contributing to) the severity of the downturn. In arguing for his stimulus package which passed in record time in February, Obama “wanted to shine a spotlight on how severe this downturn is all across the country, and to make sure that members of Congress understand the sense of urgency that I feel in getting something done.”

There was a common understanding that something should be done quickly and the Obama Administration took advantage of the “crisis” and decided that spending increases were the best approach. Conservatives argued that tax increases, by contrast, could be felt in pay checks almost immediately. The Obama Administration responded that there were “shovel ready” projects that could inject money in the economy. Indeed, the Administration predicted in January that if nothing was done, the unemployment rate would peak at 9% and with their stimulus package unemployment would reach no more than 8%. It is now only several months after the prediction, employment has reached¬† 9.5% and is still increasing. Just given economic momentum and the current derivative of employment with respect to time, it is not unreasonable to expect double-digit inflation values. Those shovel-ready projects are, as anticipated by Conservatives, taking longer to implement than expected.

Stimulus packages of whatever variety are meant to be temporary expediencies.¬† The large deficits created should be alleviated when unemployment abates and economic growth accelerates. However, given the slowness of the economy to respond, certainly slower than promised by the Administration, the current deficit hole being excavated will be far deeper and require exceptionally large growth rates to overcome. It also calls into question the ability to afford Administration health care initiatives and to economically accommodate the climate proposals. The Administration’s response that the inherited economy was worst than they anticipated does not ring true given the alarmist arguments they were making both during the election and the rush to pass their stimulus package. If they can be so wrong so quickly about the economy, how can their judgments about the health care and the environment be trusted?

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