Stimulus II: How (And How Not) To Do It

The European economy continues through its “Perils of Pauline” drama.  The latest positive news, European Central Bank chair Mario Draghi’s “whatever it takes” statement last week, afforded the U.S. stock market its customary 48 hours of euphoria.  Whether the market will continue walking on air this week – or more importantly, will have good reason to in the weeks and months to come – is uncertain.

However, other economic news is less than favorable.  The economy has apparently lost the momentum that it showed last winter and early spring.  Growth in the second quarter has clocked in at only 1.5 percent, which does not meet Federal Reserve chair Ben Bernanke’s criterion of supporting improvement in the labor market.  Even if the good news from Europe should stand up, the U.S. economy may already have drifted below stall speed, and be heading for an outright downturn.  If we are anywhere close to that point, the economy may soon need a boost.

For economists, one of the most unfortunate pieces of fallout from recent political developments has been the demonization of the word “stimulus.”  It always is difficult to communicate to the public that, yes, things have improved at a frustratingly slow pace, but were it not for a particular policy intervention, things would have been worse still.  A policy that makes things less bad should be called a success, but to the non-specialist public, because things are worse than they once were, or worse than expectations, that policy usually is deemed a failure.

So it has been with macroeconomic stimulus since the American Recovery and Reinvestment Act (ARRA) of 2009.  That bill absolutely was flawed (as I wrote at the time, and will discuss later).  However, it is the most basic economics that when demand is off sharply in the private sector, and state and local governments are cutting back as well, either the federal government does something to add to total spending or the economy will fall even more.  In a much-less-than-prefect way, the 2009 law did backstop the economy in that fashion.

Some Washington wags have criticized the 2009 economic stimulus as a “sugar high” that provided nothing for long-term strength and growth.  I believe that this analogy was poorly chosen.  The stimulus was more an adrenaline shot for a critically ill patient’s stumbling heart.  No, the adrenaline was not a long-term strength program.  But a recommendation of diet control and exercise for a patient on the verge of flat-lining would be no more useful than a tall sugared soft drink for an obese person sitting on the examining table.

But from some hard-earned experience from my years on the White House economic team, it would be impossible for an administration to make that case effectively.  Members of any administration must speak in carefully muted tones, because the public assumes that the federal government has special knowledge of the state of the economy, even though it doesn’t.  (As one example, the then-Secretary of Labor once publicly speculated about the employment numbers that would be released the following Friday.  The financial markets went nuts, assuming that the Secretary must have known what the numbers would be.  He did not; in fact he had no more knowledge than the markets already did – which is to say, mere speculation.)  So if an administration actually ever talked about an adrenaline shot for a failing economy, even if that analogy were apt, it quickly would become a self-fulfilling prophecy – and the patient (the economy) would fail.

Alan Blinder made these points about a month ago in a Wall Street Journal column, “Stimulus Isn’t a Dirty Word.”  I believe that Alan (a brilliant economist, a former colleague, and I hope a friend – at least until now) was spot-on with respect to the conceptual issues.  Unfortunately, in my opinion, he fell into the same trap that caught the ARRA in 2009.  And because the Journal chose to make the lead out of that very trap, and because this issue might prove to be crucial if we need to debate economic stimulus in the coming months, it is worth some thought.

Here is the part of the column that the Journal highlighted in its promotion:

…inadequate public investment is part of the problem. America’s infrastructure needs are so huge, and so painfully obvious, that it’s mind-boggling we’re not investing more. The U.S. government can now borrow for five years at about 0.75% and for 10 years at about 1.7%. Both rates are far below expected inflation, making real interest rates sharply negative. Yet legions of skilled construction workers remain unemployed while we drive our cars over pothole-laden roads and creaky bridges. Does this make sense?

Let me raise three problems with this particular flavor of the stimulus argument – the argument for “public investment” in infrastructure as a twofer, increasing overall demand and getting “public capital” at the same time as a bonus.

First, the economy is weak now.  It needs stimulus yesterday, if not sooner.  However, public investment projects are notoriously slow.  This is because of the time needed to plan numerous large and important projects – we are talking about filling a sizeable demand hole, after all – and protections for issues such as environmental impact, which are important to many advocates of public investment.  The so-called shovel-ready projects that fill PR catalogs tend not to be quite so shovel-ready, and also small and much less consequential to economic growth than the idealized vision of public capital would assume.

To get a sense of just what this means in practice, go back to the 2009 law.  When it was signed into law, on February 17, 2009, the economy was declining at a frightening rate, and the need to move the stimulus money was widely appreciated.  But of the funds that were appropriated for public investment (and all other appropriations, to be sure – but non-construction projects, though not separately measured, were probably quicker), only 17 percent were spent as of September 2009, 53 percent as of September 2010, and 66 percent as of March 2011.  In contrast, 85 percent of all tax cut funds was out the door as of September 2009, and 90 percent by March 2010.  The latest data show that as of July 20 of this year, funds for tax benefits and entitlement programs (both of which are open-ended) have very slightly exceeded their original estimates.  Spending of appropriated contracts, grants and loans other than for the Department of Transportation has reached 91 percent of the appropriated amounts.  But spending of appropriations for the Department of Transportation, which probably serves as the closest approximation of public investment in these terms, still is barely over three-quarters of the amount funded.  (See table below.)

This problem of the slow spend-out rate of public investment was raised in the debate over the 2009 law.  One defense of public investment then was that the economic downturn, because it was caused by a financial crisis, would last for some time.  Therefore, even if funds spent on public investment moved slowly, the economy still would be weak when they hit the street, and so they would not be too late in the sense that they would overheat an already recovering economy.  That much proved true.  However, because the extraordinarily weak 2009 economy needed absolutely all the help it could get, the stimulus public investment funds that dribbled out in 2010 and subsequent years were in fact too late in a more important sense.  If those funds had been delivered through faster-moving programs in 2009, the continuing economic downturn might have been less painful, and the economy might be much closer to recovery by now.

The fastest-moving programs in the 2009 law were temporary tax cuts, but some criticized the tax cuts on the ground that the federal government did not “get anything” for those dollars, and so they were in some sense “wasted.”  However, this criticism misses the larger point that what the federal government wanted to buy with those dollars was an economic recovery.  If the infrastructure money in the 2009 law achieved a secondary objective of adding to public capital, but missed the primary objective of stimulating the economy in a timely way, then that hardly was a good bargain.

On a second point – the “legions of skilled construction workers” who are in need of jobs, and who presumably are waiting to swing into action at a moment’s notice:  Unfortunately, “construction” is too large of an umbrella concept.  The legions of skilled and unemployed construction workers are not so much those who build highways, bridges, and water and sewer systems.  Rather, they are residential construction workers who hang drywall, string electrical wiring, and put shingles on roofs.  (See accompanying chart.  Note that one subcategory of “heavy construction employment” is land subdivision, which is dependent for the most part upon housing construction rather than public infrastructure.  Much of the employment decline in the broad heavy construction category is due to land subdivision, and the chart shows that the rest of the category is much closer to the level of the economy as a whole.  Legislation to reauthorize the stalled highway program for a full five years surely would help that sector.)  Residential construction and heavy construction skills are not totally unrelated, but they are not necessarily closer than, say, those of public capital workers and unemployed factory workers.  The unemployment of people formerly in housing construction, as heartbreaking as it truly is, therefore does not present any opportunity for rapid building of public capital, and does less to make a case for investment in public infrastructure than it does for anything that might more effectively cause a broadly based increase in economic growth.

Both of these two arguments – the speed of economic response and the level of employment and unemployment in public capital versus housing construction – make the case for an alternative stimulus policy (which Blinder also advocates) of aid to state and local governments to prevent layoffs of teachers, police and firemen (and also to protect state and local infrastructure spending).  Such funding was included in the 2009 law and also saved jobs, but it did so much more quickly and therefore effectively.  This is not to say that public-capital-construction jobs don’t matter but state-and-local-government jobs do; it is, rather, that public policy has a firm handle on one problem but not on the other.  And again, broad-based economic recovery will help all people, and the sooner, the better.

Finally, Blinder’s argument about the low cost of financing today, because interest rates on Treasury securities are so low, is a bit more complicated than it appears on the surface.  The Treasury follows the principle of “unitary financing” – that is, virtually all Treasury borrowing is through undifferentiated general-obligation bonds, rather than through small classes of bonds tied to individual programs or projects.  In the long run and taking all borrowing into account, this principle minimizes the debt-service cost to the taxpayer by maximizing the liquidity and the depth of markets for Treasury securities.  However, that means that the Treasury borrows by selling securities all along the maturity structure.  If it needs to sell an additional $100 billion or $200 billion to finance a stimulus program, those bonds will include not only five-year or 10-year notes (and 30-year bonds), but also three- and six-month bills.  Thus, the nation cannot lock in low rates for the long term for the entirety of the cost of a stimulus program of public investment.

To be precise:  The nation needs public investment.  There is no reason to leave construction resources idle, especially when the economy as a whole needs the demand.  However, there also is no reason to believe that a crash national infrastructure program (pardon the apt pun) will stimulate the economy as quickly as other alternatives, such as temporary tax cuts or aid to state and local governments (which itself will finance some infrastructure investment).  A large increment to infrastructure spending at this time, beyond merely full long-term funding, is more likely to deepen the order books of the heavy construction industry than it is to add significant new economic activity now.  And the federal government cannot fully exploit today’s low interest rates to reduce the long-term cost of such a program.

“Stimulus” should not be a dirty word.  We may need to use it sometime soon.  But if that time arrives, we should use it in the most effective way.  There is plenty of difference of opinion, but the evidence says that public investment is more a long-term priority than a short-term stimulus.



  1. There are some interesting points in time in this article but I dont know if I see all of them center to heart. There is some validity but I will take hold opinion until I look into it further. Good article , thanks and we want more! Added to FeedBurner as well

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