Will Federal Spending Boost the Economy?

Here we are, with an economic downturn that is resulting in high unemployment--likely to persist for a long time. There is some hope on the horizon, with projections that economic growth may become positive sometime this year and some upticks in the stock market. But the unemployment numbers are daunting. America lost another 663,000 jobs last month to bring non-farm unemployment to 8.5 percent Although that is still well under the post- Depression high unemployment of 10.8 percent reached in 1982, our current unemployment rate represents a 3.7 percent drop from the December 2007 employment peak. This means our current crisis has caused a greater percentage increase in unemployment than in any downturn since the Depression.

So what are we to do? The government's primary tool to fight economic doldrums, monetary policy and the lowering of interest rates, has been exhausted. Real interest rates are as low as they can go, and the Federal Reserve has even resorted to its most extreme measure, so called "quantitative easing" where the Fed spent 1 trillion dollars on treasury bonds and other securities to pump more money into the moribund financial system.

Since monetary policy has been exhausted, it's only natural to turn to fiscal policy, or more simply, government spending. The case for the government running deficits by increasing spending and cutting taxes in an effort to stimulate economic activity is this: In recessionary conditions, there is less output than there "ought" to be. There is idle labor and people are afraid to invest and spend.

So, how do we get money into people's pockets to stimulate spending and reduce unemployment? There are three basic approaches. One is to give people that money through tax breaks and refunds. This can be accomplished by reducing the amount of money withheld from paychecks or even by spending out tax refund checks.

Another is to ramp up government spending on programs like food stamps, welfare and unemployment benefits. The reasoning behind this is that the requirement for these programs increase as the economy turns south, so they need additional funding. Also, these cash transfers are the most likely to be spent immediately on consumer goods, as opposed to tax rebates and checks, which are often saved, or used for paying down debt.

The third action the government can take is to directly employ people through public works projects. Although this measure is slower acting than aid to states or tax breaks, it directly increases employment, and if the program of spending is designed properly, can leave behind real public goods that increase economic growth in the long run. Beside the immediate effects on economic output, now is an ideal time to embark on an aggressive infrastructure investment program. Since the yield on treasury bills are at historic lows, there has never been a cheaper time for the government to spend money, especially with commodity prices also exceptionally low.

In early February, President Obama signed a massive piece of legislation, the American Recovery and Reinvestment Act of 2009, adding up to some $819 billion in tax cuts and government spending. While some bits of the bill could make no claim to be truly stimulative, it was still broadly well-designed. The Congressional Budget Office estimated that the stimulus bill would increase short term economic output and decrease unemployment because the government spending would utilize capital and labor that would otherwise go dormant. In other words, it will lead to employment of those workers would otherwise be unemployed and, since it's financed through the selling of government bonds, lead to investment that would otherwise not happen.

Just because stimulus spending is a good idea now does not mean that the government should always pursue an aggressive policy of stimulating demand. There are legitimate worries about deficits and about crowding out private investment. But stimulus spending is short term, and if it can meaningfully increase economic output and growth, then the future deficits will be more manageable. At this point, faced with the exhaustion of monetary policy and the prospect of tremendously high unemployment, the question is not whether stimulus spending is a good idea, but how soon we can get more of it.

Matt Zeitlin is a contributor to Campus Progress, a project of the Center for American Progress. His work has been featured in The American Prospect. His commentaries can be found at whippersnapper.wordpress.com.