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A Better Way to Deal With Downturns

By Andrew A. Samwick
Sunday, January 27, 2008

Shortly after House leaders and the White House reached a tentative deal Thursday to stimulate the economy, President Bush hailed the agreement as the result of "patience, determination and good will on all sides." While politically expedient, the stimulus package is unjustified in the short run and harmful in the longer term. We would be better off if "forethought" had figured into Bush's description.

The $150 billion agreement calls for tax rebates to low- and middle-income households as well as business incentives. Doubtless, this will boost economic activity. If you pull levers, you get movement. Personal consumption and business investment will increase relative to what they might otherwise have been. But there is no discussion of repaying the money through higher taxes in the near term. Let's drop the euphemism of "stimulus package" and call this agreement by its proper name: "deficit spending."

It is ironic that additional borrowing is prescribed as the remedy for a malady that arose from unwise borrowing. In recent years, cheap credit and some imprudent lending policies generated excessive consumption and investment in the real estate sector. This boosted economic activity beyond the level that would have prevailed with more sensible policies. That level of economic activity is the starting point for discussion of a recession. If we acknowledge that bad loans fueled the activity, why is it now a widely shared policy objective to maintain that level of activity?

The answer is a combination of three factors. The first is elected officials' fear that they will be punished in November for an economic downturn unless they do "something" to avoid it. Few things precipitate bipartisan agreement so quickly. Using the incomes of future taxpayers to purchase reelection today is irresponsible but common public policy.

The second factor is policymakers' fear that unless "something" is done, a temporary economic downturn could become more protracted. This fear, to the extent that it is justified, is better addressed by the Federal Reserve lowering short-term interest rates, which would stimulate the economy more quickly and comprehensively than would fiscal policy. The Fed did just this on Tuesday. Yet the fiscal-policy lever has been yanked before any data have indicated whether the Fed's stimulus has had its intended effect.

The third factor is the recognition that some households will bear a disproportionate burden of an economic downturn, combined with a belief that "something" should be done to help them. Government has a choice in whom it taxes to finance this relief -- other taxpayers today or all taxpayers in the future. That the agreement holds the former group harmless was also praised by Bush. This "stimulus bill" is really $150 billion worth of some future generation's resources appropriated to finance our own consumption. Why are we entitled to pass on this additional debt?

The imperative to do "something" is all the entitlement politicians need. In political arguments, you can't beat something with nothing. But we can learn from this experience to have a better menu of fiscal policy options the next time around. Two changes to our budget policy would go a long way toward that goal.

First, we should rule out deficit spending to finance a consumption binge. As the economy slows, the deficit will widen even without changes in fiscal policy. But an honest budget policy would be calibrated to balance the budget over a complete business cycle. Years of cyclical deficits will be offset by years of cyclical surpluses. As a corollary, we must not waive pay-as-you-go rules that require spending that increases the current deficit to be offset later, when the economy is stronger.

Second, we can plan well in advance. The federal government has a critical role in maintaining and developing public infrastructure, whether in transportation, telecommunications or energy transmission projects. A sensible capital budget would include a prioritized list of projects that need attention. Some would be slated for this year, some for 2009 and so on, over the useful lives of the projects. When economic growth falters, the government would be in a position to move some of the projects from later years into the present year.

This approach to counter-cyclical fiscal policy has several advantages. Perhaps most obvious is that it forces the government to establish priorities for capital projects. It reduces overall expenditures by doing more of the work in times of economic slack, when costs are lower. It also abides by pay-go rules, since projects moved up to 2008 need not be done in 2009. With a little forethought, short-term economic concerns and long-term budget goals need not be in conflict.

Andrew Samwick, an economics professor, directs the Nelson A. Rockefeller Center at Dartmouth College. He served as chief economist on the staff of President Bush's Council of Economic Advisers in 2003-04. He blogs about economics and other issues athttp://voxbaby.blogspot.com.

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