Economic Stimulus ?
This morning Martin Feldstein, who chaired President Reagan's Council of Economic Advisors, weighs in on the version of the stimulus package the House passed yesterday. Among other things, Feldstein argues that some of the debt-financed federal spending will simply displace debt-financed spending at the state level, an argument I made in my previous post. He also argues that spending on infrastructure projects, e.g., roads and bridges, won't take place until it is too late to counteract the current downturn. Moreover, he contends that temporary tax cuts will provide little stimulus, since consumers will simply save the cuts, knowing that they will have to pay higher taxes two years from now. While savings is generally a good thing, Keynesians at least believe in the "paradox of thrift," i.e., if everyone saves too much, aggregate demand will suffer, and the economy will spiral into recession, unless the government borrows the savings and spends it. By contrast, it is said, so-called Classical economists believed that "too much" savings would reduce interest rates and therefore increase investment and long term economic growth, pursuant to "Say's Law."
How, then, would Feldstein stimulate the economy ? He proposes rapid increases in military procurement and construction of military bases. The F-22 Raptor, pictured above, costs over $100 million apiece. Instead of spending billions on mass transit programs, perhaps we can buy another 50 Raptors? Feldstein does not mention Raptors; he may have in mind more mundane items such as ammunition and spare parts depleted during the wars in Iraq and Afghanistan.
Note that Feldstein's conclusion regarding the non-efficacy of temporary tax cuts follows naturally from Milton Friedman's "Permanent Income Theory of Consumption." See Milton Friedman, A Theory of the Consumption Function (Princeton 1957). According to Friedman, individuals make their consumption decision based upon their expectation of their long term "permanent income" and not simply the income they expect in a particular year. Hence, a temporary cut in tax rates, for instance, will have only a modest impact upon consumption, because the cut will have only a modest impact on the consumer's expected income over time. By contrast, a permanent reduction in tax rates will, other things being equal have a larger impact on consumption.
Here is Feldstein's op-ed, from the Washington Post, entitled: "The $800 Billion mistake."
Query whether Feldstein's implicit adoption of Friedman's hypothesis undermines part of his argument. For instance, while infrastructure projects might not literally create jobs within, say, the next six months, they may create the expectation of jobs (and profits for the firms that perform them) and thus increase the permanent income for thousands of individuals, thus increasing consumption expenditures sooner than one might otherwise think.