An Economic Perspective: The need for further stimulus

The National Bureau of Economic Research, the organization charged with dating when economic downturns begin and end, has officially declared that the Great Recession ended in June 2009.

Unfortunately, unemployment remains high and the prospect for future economic growth remains uncertain. America needs further fiscal stimulus.

According to Mark Zandi, chief economist at Moody's Analytics and former economic advisor to Sen. John McCain, further stimulus is necessary to maintain a strong economic recovery. Past stimulus spending, including The American Recovery Act, Cash for Clunkers and housing tax credits, has boosted aggregate demand in a time of weak private investment and widespread uncertainty.

While growth is slowly recovering, the labor market has remained stagnant. The official unemployment rate has hovered near 10 percent for 18 months. A possibly more realistic measurement of unemployment, the U6 rate, shows unemployment at 17 percent during the same period. The Obama administration predicts that the official unemployment rate will remain above 6 percent until 2015.

The Federal Reserve System has continued to stimulate the economy with a 0 percent interest rate policy and quantitative easing (printing money). Easy monetary policy is traditionally sufficient to stabilize an economy. The Great Recession, however, was unusually severe. Banks don't want to lend and people don't want to borrow. Monetary policy is not enough.

What's needed is further fiscal spending by either increasing government spending or tax cuts. Government spending is preferential because it has a larger bang-for-your-buck - what economists call the "multiplier effect." Essentially, for every dollar the government spends an additional $1.80 is created. The other method would be to use tax cuts. For every dollar the government cuts taxes 80 cents is created. Tax cuts tend to be less effective because people, especially the rich, save rather than spend in a recession.

Critics of stimulus generally oppose it on two grounds. First, they claim that any spending now will simply increase our future debt obligations. This is not true. Increases in government spending, due to the multiplier effect, may actually decrease our future debt. Cutting taxes will slightly increase our future debt but is still worthwhile to prevent a "double-dip" recession.

Second, critics maintain that unemployment is caused by structural problems. They claim that people don't have jobs because of rigid labor markets and that stimulus won't help. There is some truth to that claim, but the main culprit of unemployment continues to be weak aggregate demand.

From a theoretical perspective, America needs another multi-billion dollar stimulus act focusing on government spending and state aid. Realistically this will not happen.

Yet, small plans for stimulus still exist. President Barack Obama recently proposed a $50 billion transport bill and a significant tax reduction on research and development. The George W. Bush tax cuts are set to expire and could be extended for the middle class.

America does not have the political will to bring the economy back to potential employment. Continued economic growth, however, may hinge on future stimulus.u

This is a work of the Economics Society, and does not necessarily represent their aggregate views.

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