Christina Romer, the chair of the Council of Economic Advisors, gave a pretty good defense yesterday of the administration’s stimulus plan. Romer, speaking at the University of Chicago, responded to some conservative criticisms of the plan. One of these concerns how to calculate the “multiplier”--the degree to which a dollar in spending or tax increases will lead to more than a dollar in output and effective demand.
The administration’s estimate that its plan would create about 3.5 million jobs was based on using a multiplier of 1.6 for spending and 1.0 for tax cuts. Some economists have cast doubt upon this estimate. One figure often cited is economist Robert Barro’s calculation that during the Korean War the spending multiplier was less than one, which would mean that spending was a very inefficient way to stimulate the economy. But Romer points out that during the Korean war, increases in spending were accompanied by tax increases intended to pay for the spending. It’s a simple point, but seems to elude not only Republican conservative, but also Democrats like North Dakota Senator Kent Conrad: To work effectively, a stimulus has to increase the government’s deficit to make up for lagging demand and investment in the private sector. If it is counteracted, it won’t work, or won’t work effectively.
Romer also deals with the argument that the stimulus package won’t work because the “financial markets are operating poorly and lending is not flowing.” She doesn’t mean to say that the collapse of the financial sector won’t undermine the stimulus; surely, it will. But what she does argue, and which is a good point, is that the stimulus is just about as important to reviving the financial sector as any rescue plan aimed specifically at banks. In so far as banks are threatened by loan defaults, these are likely to decline if income goes up because of the stimulus. “In the Depression, the end of deflation, renew optimism, and increased employment and output were as crucial to the recovery of the financial system as the more direct actions taken to stabilize banks.”
The point can be made in a more general way. The strategy in counteracting a severe downturn is to replace mountains of private debt, which are threatening banks and discouraging consumers from buying and businesses from investing, with mountains of public debt. It doesn’t necessarily happen through the kind of one-to-one swap that some of the bank rescue plans contemplate, but through a process by which deficits created by public investment and transfer payments increase income, which reduces the amount and proportion of debt in the private sector, allowing both businesses and banks to revive.
Finally, Romer takes on those critics who argue that the stimulus package includes too many items that won’t immediately create jobs. She makes two important observations: First that many of these objections stem from a bygone view of industry, which only can only imagine jobs in construction. An education grant or healthcare spending might easily create as many jobs as a highway project. The second is that the current downturn, when interest rates are very low, provides an important opportunity to stimulate the economy while making investments that will raise productivity in the long run. There is quite of bit of this kind of spending in the stimulus bill--for instance spending for rural broadband, a new electrical grid, and high speed rail. And it's a good thing there is.
The one argument she doesn’t deal with, and that critics on the left have made, is that the stimulus is too small--that 3.5 million jobs will still leave the economy in recession. That’s probably right, but in the administration’s defense, it probably couldn’t have gotten more than $800 bill from Congress--with Democrats deficit hawks joining forces with Republican Hooverites against a bigger bill. Still, as Barack Obama has already hinted, the administration will probably have to go back for another stimulus. The problem will be that by then the economy will have deteriorated to the point that the total government spending and deficits will have to be even larger than they would have been if Congress had a OK-ed a trillion plus bill now.
--John B. Judis