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Is stimulus costly?

Summary:
With the seemingly endless stimulus now coming out of Washington, it’s time to revisit the question of whether deficits matter. In recent weeks, I’ve seen lots of pundits say that government spending is virtually costless, as interest rates are close to zero. There are two flaws with this argument. Before getting into these flaws, let me acknowledge than many concerns regarding budget deficits are overstated. These big deficits are not likely to lead to high inflation, and they are not likely to lead to default on the debt. So what are the actual concerns? 1. Deficit spending always involves opportunity costs. That’s even true in a Keynesian model where deficit spending magically boosts output so much that it’s self-financing. Whenever you spend money on X, there’s

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With the seemingly endless stimulus now coming out of Washington, it’s time to revisit the question of whether deficits matter. In recent weeks, I’ve seen lots of pundits say that government spending is virtually costless, as interest rates are close to zero. There are two flaws with this argument.

Before getting into these flaws, let me acknowledge than many concerns regarding budget deficits are overstated. These big deficits are not likely to lead to high inflation, and they are not likely to lead to default on the debt. So what are the actual concerns?

1. Deficit spending always involves opportunity costs. That’s even true in a Keynesian model where deficit spending magically boosts output so much that it’s self-financing. Whenever you spend money on X, there’s always the opportunity cost of not spending it on Y.

Is the government’s best use of money to send people like me a check for $1200? It’s hard to imagine that the answer is yes, even if you believe (like me) that the government is not very good at wisely spending money. Consider this analogy. Imagine you are Ms. Bezos, and you’ve just come into a windfall of $50 billion. You decide to give a big chuck of the money to charity. Where do you donate the money?

It’s probably true that the average middle class resident of Seattle would benefit more from a $1200 check than Ms. Bezos, but is that really the best use of the money? I don’t know of any charity that randomly hands out checks to average people.

Even if you favor tax cuts as the preferred way of returning money to the public, giving almost everyone a $1200 check is not really a tax cut, it’s a (welfare) spending increase. A tax cut is when you lower the tax rates from which you derive the money in the first place.  Taxing people and giving part of the money back is a tax program combined with a spending program.  To argue otherwise is to argue that AFDC welfare and Social Security are “tax cuts”.

If we must run deficits, then they should be either in the form of cuts in tax rates or spending in areas where it has the greatest impact on human wellbeing.  And that’s probably not a huge bailout of the Post Office.

2. The second cost of budget deficits is the future tax burden they impose. Public finance theory suggests that the most efficient policy is one that smooths tax rates over time. Notice that even this criterion suggests that we should dramatically increase the budget deficit during wars and depressions. So right now it is appropriate to increase the budget deficit somewhat. (And we should have run a budget surplus in 2019, when the actual deficit was exploding upward.)

Nonetheless, it’s highly likely that the deficit this year will be too large, even from an optimal public finance perspective. I expect we’ll have to pay a price in terms of higher future taxes, perhaps not too far out in the future. Yes, higher future taxes were already on the way, for various reasons, but the current deficits will make the tax increases even greater than otherwise.

PS. I’m also seeing pundits suddenly claiming that unemployment insurance doesn’t discourage people from working. And yet even progressive bloggers like Brad DeLong and progressive textbook writers like Paul Krugman suggest just the opposite. If you make something more lucrative, you will get more of the activity that you are subsidizing.

I happen to believe that some expansion of unemployment insurance was appropriate during this pandemic, especially the provisions that covered a wider range of workers. But we shouldn’t pretend that this does not increase joblessness. And I don’t understand why unemployment was made so generous that it replaced more than 100% of lost wages. Can someone explain the logic of that to me?

The science of economics always regresses during a depression.  We saw that in the 1930s, in the 2010s, and we are seeing it again today.

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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