Stop Saying the Stimulus Didn't Work

The tag-line of many hard-line conservatives this year, as the economy continues to struggle, is that the stimulus package was a failure.  They say "the Democrats promised that this stimulus spending would bring the unemployment rate down to 8%."  Since this did not come to pass, they say that it was "a colossal waste of money."  While the democrats may be guilty of bad forecasting, to say that the stimulus did not work shows a complete lack of basic economic understanding.  You will also notice, if you pay attention, that none of these tag-line parroting hard-liners ever follow up this claim with what they feel would have been a better solution.

For those of you out there brave enough to take an economics course in college, and unfortunate enough to not have been able to sell back your textbook at the end of the semester, you can look back at a couple of equations that represent the most fundamental relationships for an economy.  The first is as follows:

GDP = private consumption + gross investment + government spending + (exports − imports)

Ok, so now lets take a look at what happened in 2008.  A recession of massive proportions drove down consumption and investment to the point where GDP was shrinking by 6% at its worst point.  So when you have a total absence of consumption and investment, and we all know that the U.S. has imported far more than we have exported (aka running a negative trade balance), then the only hope to get an economy to stop shrinking is to increase the government spending variable.  We have to increase spending and increase the overall debt level in order to prevent the recession from worsening.  If the economy continued to fall at a 6% clip, what would have happened to employment levels?  What would have happened to tax revenues and unemployment and social entitlement costs, if the economy continued to shrink?  Steadily falling revenues and continually increasing costs would have been worse for the debt situation than a one time shot aimed at preventing those effects.

The other important equation to consider is the following:

M * V = P * Q

What does this translate into?  Money * Velocity = Price * Quantity, or even more simply, the supply of money in the system times the speed at which it turns over, is equal to price times quantity, aka GDP.  While this is a little more convoluted for a non-economist, here is how it breaks down in real terms.  In 2008 the credit markets froze up as banks were afraid of lending any money out.  The supply of money was shrinking (which is actually a pretty rare occurrence for the US).  The money that was in the system was not being turned over as fast because consumers were not spending it.  So banks not lending, consumers not spending, will lead to a lower GDP as well.  What the government hopes to do by increasing their spending is to increase the supply of money and credit, and hope that the extra supply will turn-over (read, get spent) at a fairly rapid clip.  The absence of government spending in that situation could lead to a continuing decrease in both and thus, continuing decrease of GDP.

The choice that the government has is to allow the country to spiral dangerously close to a depression type scenario, or to add another slug of money to our debt level in order to float the economy, and also then "stimulate" the private economy back into a growth mode.  The question is not whether or not we have recovered from recession, but rather where would we be absent this critical level of government spending?

The second argument is that this money was "wasted" on bad projects that did not have the pay-off they should have.  The most famous tag-line for opponents of stimulus in this argument is pointing out a line from President Obama where he said "maybe some of these shovel-ready projects were not as shovel-ready as we thought."  Now we can argue all day and night about the stimulative effects of one congressman's pet projects vs. the others, but the bottom-line is that the difference between the two is nowhere near as important as the actual level of the funds being spent.  Further more, if you log onto to recovery.gov you can actually see what the break-down of the spending really is.  Curiously, well over a third is represented in by tax-cuts, which I thought many conservatives tend to favor.

I realize that politicians never let facts get in the way of a good argument so, with this next election season coming up, I am bound to suffer through all of the republican candidates regurgitating the stimulus package argument.  I just hope that we can make our decisions based on facts and figures instead of convenient sound-bites.  The worst mistake the democrats could have made was trying to tag a target rate of 8% unemployment to this bill.  Their big underestimation was on the productivity of Americans who are nervous about the possibility of losing their job.  Companies have not hired more workers because they have been able to get more and more out of their current skeleton staffs.  In my January prediction piece I also quoted a forecast of 7.5% unemployment by the end of the year because of the same mistake.  Today we are still seeing a 9.1% rate and this is not expected to drop much further by year end.

Bottom-line is that the stimulus was a necessary step from the government to prevent our recession from devolving into a full blown depression.  Am I satisfied with where we are in terms of our recovery?  Of course not.  It will take time to work through our malaise, and unfortunately require some action from our action-phobic congress.  In the end, I am optimistic that our country will continue to prosper... it just might not be at the level many of us were used to in the last two bubble economies of the 90's and early 2000's.