How do you stimulate a stumbling economy? For decades, the consensus among economists was that this was a job best left to the Federal Reserve and to such automatic fiscal stabilizers as unemployment insurance. Passing laws in Congress to cut taxes or boost spending to stave off a downturn was seen as pointless at best. Such help would arrive too late or in the wrong place, the thinking went, or would have no impact at all. (See TIME's "Bailout Report Card.")
That consensus has unraveled in the face of the current recession, which appears likely to be the worst in the U.S. in three-quarters of a century. When President-elect Barack Obama arrived in Washington at the beginning of the week and began lobbying for $775 billion in stimulus spending over the next two years, the nation's economists at least the ones who are listened to in Washington expressed near unanimous support. This support showed no signs of wavering when the Congressional Budget Office projected Wednesday that even before any new spending, the federal deficit will top $1.2 trillion this year. As Obama summed it up in a speech at George Mason University on Thursday, "There is no doubt that the cost of this plan will be considerable. It will certainly add to the budget deficit in the short term. But equally certain are the consequences of doing too little or nothing at all." (Read Obama's full remarks.)
Yet this pro-stimulus consensus "élite groupthink," as libertarian econo-blogger Arnold Kling, one of the dissenting minority, puts it has its limits. Economists have neglected the subject for so long that their theories of how stimulus works are shockingly underdeveloped. Many of the arguments they make for one proposal or another are the product not so much of economics as of common sense, guesswork and ideology. The motley mix of tax cuts for families and business, aid to states, infrastructure spending, health-care spending and alternative-energy investment that constitutes Obama's stimulus plan is partly the product of campaign promises and political compromises. But it's also a good reflection of the current muddled state of economic thinking on stimulus.
The biggest split is over whether stimulus should take the form of tax cuts or government spending. The main argument for spending over taxes is that at a time when American consumers have turned suddenly frugal, they're more likely to save any extra cash they get than spend it. This may be the right thing for most people to do, but it won't stimulate the economy. Meanwhile, if consumers do spend the money on TVs and cars and such, much of the impact will leak out overseas to pay for imports.
Tax cuts have the advantage, though, that they can be put in place quickly. There's also the more ideological, if still possibly valid, argument that they don't encourage the growth of bureaucracy. And recent empirical research some of it by Christina Romer, the University of California, Berkeley, economist who will be chairwoman of Obama's Council of Economic Advisers indicates that tax cuts have been quite effective as stimulus in the past. All of which helps explain why 40% of the Obama stimulus consists of tax reductions.
Then there's government spending. One argument is that if you're going to stick future generations with added debt, you might as well put the money into something that will leave them better off infrastructure, alternative energy, etc. But these projects take time to get up and running. If they're rushed, they're likely to be botched. That's where the case comes in for simply backstopping existing state- and local-government spending that would otherwise have to be cut back sharply. The Obama plan includes elements of both.
Is it the right mix? Who knows? But if it's any solace, the intellectual godfather of all economic-stimulus plans, economist John Maynard Keynes, didn't think the specific content mattered all that much. It would be better to do something "sensible" with the money, he wrote in the 1930s. But the economy would still be helped if government simply chose to "fill old bottles with banknotes, bury them at suitable depths in disused coal mines, which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again." So far, bottle-burying isn't an element of the Obama stimulus plan. But just wait till next week.