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Less Than Stimulated by Idea of Stimulus

by Travis Pantin
Wed, 23 Jan 2008 at 10:49 AM

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On Cafe Hayek, a George Mason University professor of economics, Russell Roberts, explains in layman's terms why he thinks that an economic stimulus package will not cause the wider economy to grow.

"Let us begin with the most basic question. If you received a windfall, that is, an unexpected increase in your income, what would you do with it? The right answer is that it depends," he writes.

One of the determining factors is where the money comes from. "It would seem to be irrelevant, but it's not," Mr. Roberts writes. "If you are the only person receiving the money, say from an unexpected inheritance, you might respond differently than you would if you knew that everyone was getting a tax reduction."

The recipient of a tax rebate is less likely to spend his newfound cash than is the recipient of an inheritance, because the rebate is financed by government borrowing, which will eventually have to be paid back, he writes.

Imagine, Mr. Roberts writes, that the government makes enormous tax cuts, and that a family receives $16,000 in rebates. He writes: "The husband might say to his wife: 'Honey, great news. The government isn't going to collect any taxes this year. We have an extra $16,000 to spend. Now we can finally (choose one: take that cruise, replace the minivan, renovate the bathroom).'"

However, he says the wife, who is more financially prudent, would probably respond: "Well, if the government isn't going to cut spending (and they're not, because that would offset the stimulus of the tax cut, wouldn't it?), then it's going to have to borrow all the money to cover its spending for this year. The bonds the government sells are going to have to be repaid. We're going to have higher taxes next year and the year after. I think we better put that $16,000 aside to pay for those taxes."

According to Mr. Roberts, the wife clearly wins the argument: Even if the tax rebate is $16,000, not $1,600, people will still realize that they are going to have higher taxes in the future, and will therefore be less likely to spend their rebates. And when people save their rebates rather than spend them, Mr. Roberts explains, fiscal stimulus plans lose effectiveness.

On Overly Bearish Bloggers
A strategist with Ten Asset Management, Paul Kedrosky, responds to his fellow bloggers' extreme pessimism about the current economy.

"I have no problem with bearishness, and a good deal of it is warranted right now, with an economy in recession, markets tanking, the Fed's riding in for the rescue, and so on. But most financial blogs – and their commenters, in particular – are bearish way past that point, with they and their commenters in an echo chamber muttering darkly about canned food, plunge protection teams, a bullet-less Fed, and on and on," Mr. Kedrosky writes.

He calls their worries "a relentless and somewhat bizarre mixture of Calvinist moralizing and noisy negative-triumphalism."

Mr. Kedrosky is equally critical of the overly bullish bloggers. "Their indefatigable and illogical boosterism in the face of contrary economic evidence is merely wealth-deflating. But that said, I don't get the same conspiracy-minded moralizing from them, more just fuzzy-headed cheerleading," he writes.

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