Stimulus without long-term balancing does not help

PBN Staff

09/24/2011

Joblessness and sluggish growth are hampering the economic recovery and President Barack Obama’s political standing. Raising taxes on the rich, as the president called for last week, isn’t going to turn things around.
What sort of fiscal policy can turn things around?
The president’s announced jobs plan centers on the need for additional short-term stimulus designed to boost aggregate demand and jump-start economic growth. In some recession scenarios, such action, if timely, can indeed raise output and employment.
In our current state, however, calling for additional spending and temporary tax relief without addressing longer-term economic challenges may exacerbate the likelihood of another recession.
This is because the U.S. economy suffers from structural problems predating the financial crisis. This observation points out two problems with the case for stimulus being made by the president. The first is that near-term and temporary support for household incomes does little to counterbalance the chilling effect of announced future policies.
A second problem with the president’s plan is that repeated efforts to use stimulus to revive the economy increase the federal debt. Without addressing longer-term fiscal concerns, new stimulus is likely to lead to a loss of investor confidence.
The key, then, to any effort to boost the economy is to craft a short-term “stimulus” in the context of a longer-term structural reform plan that clarifies the deficit and debt path for the United States. This can be accomplished in four steps.
• The first is to outline a plan to bring down the federal debt-to-GDP ratio toward its pre-financial-crisis level. This decline can be accomplished by economic growth and spending restraint. • The second is to acknowledge, as the Congressional Budget Office’s projections do, that the nation’s long-term fiscal problem relates principally to spending, with a gradually rising share of federal revenue relative to GDP dwarfed by rapidly rising federal spending relative to GDP.
• The third is to clarify how future deficits will be reduced. Recent economic research argues that deficit reduction through reducing transfer spending is more likely to promote economic growth and stabilize the debt-to-GDP ratio than by raising tax rates.
• The fourth is to understand the centrality of tax reform to any structural reform of the U.S. economy. Fundamental tax reform – broadening the tax base and reducing marginal tax rates – promotes saving, investment and economic growth.
Much of the debate over the stimulus paints economists and officials like myself as favoring inaction for pressing short-run problems. This is a false choice: Enhancing a recovery in productivity and employment is a pressing policy need. Yet turning around the economy now also depends on grasping our structural problems and defining a policy for long-term reform and growth. •

Glenn Hubbard, a former chairman of President George W. Bush’s Council of Economic Advisers, is the dean of Columbia Business School. He is an adviser to Mitt Romney’s presidential campaign.

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