The Economic Neocons

This stimulus debate has gotten a little out of hand.  Among other things, this is a disgrace for macroeconomists.  Figuring out how to solve problems of this magnitude ought to be the central empirical concern for researchers, rather than cause for ideological trench warfare.  

My own biases are evident here, but I find John Cochrane's writing to be both the best ongoing commentary as well as the best case for relying on monetary policy.  

The arguments on the other side all seem to revolve around fear.  Because of "animal spirits" and fear, drastic measures need to be taken.  The basic model connecting individual fear to the macro level is left uncertain, as is the explanation for why scaring people and spending lots of government money is the best remedy.  If this is your worldview, as Will Wilkinson points out, the best way to achieve your ends is to institute propaganda on a wide scale.

Really though, people are cutting back for perfectly reasonable reasons; that is, their fears are based on accurate expectations about the economy.  A classical Keynsian stimulus doesn't make quite as much sense, as we're coming off a long period of wasteful investment.  It's not as if people suddenly stopped buying things; it's more like the scale of previous growth was unsustainable and people are cutting back.  Propping up demand isn't going to help as much as fixing the problems in the banking and housing sectors that created the problem to begin with. 

Imagine that a group of people has favored a particular set of policies for a very long time, but found it difficult to get their extremist ideas a fair hearing.  Now, suppose something very bad happens, and people become very scared.  This group comes along and claims that their favored positions are best suited to solve the current problem, and the other group is un-American.  That's basically what happened with Iraq, and that's what's going on with the stimulus bill.  It's basically a wish-list of Democratic priorities over the last ten years.  Not to say they all shouldn't happen, but this is not the type of environment to put them in place.

Even from the standpoint of a Democrat policy-maker, this bill is hard to justify.  If they took a bit longer with the fiscal policy/spending side of things, they could actually find some useful projects and invest in some great things.  But the time constraints of the stimulus are forcing a decision now, even though we'll see little of the spending immediately.  Meanwhile, the legacy of spending on this nature will present a significant hurdle to achieving other items on the Democrat agenda, namely Universal Healthcare.  

In the spirit of compromise, I'm willing to support some sort of tax breaks.  The big counter-argument is that people will save rather than spend the money, which has support from classic economic concepts like Friedman's Permanent Income Hypothesis and Ricardian Equivalence.  There's some evidence, however, that even one-time tax cuts can encourage quite a bit of spending from households--it looks like that was the case for the 2001 and 2008 stimulus packages.  

Tax cuts also have a lot going for them once you move away from the "More unsustainable spending will solve the problem" stance.  The government can basically borrow money for nothing, while many families are paying off loans at much higher rates.  Tax cuts used to pay off these loans can serve as a massive interest rate arbitrage, which can create substantial real wealth (The federal government could also loan to the states, which generally don't do deficit spending and cut services during recessions.  It looks like the Senate is cutting State Aid due to Republican pressures; just replace that with a loan and the budget problems disappear).  Also, savings can recapitalize the broken banking system while improving financial security for households heavily in debt.  When the recession is over, tax Carbon and consumption and you're back to normal with no crazy unsustainable government programs.

All of this happens, very quickly, when you shower people with money.  But if you tie tax cuts with permanent decreases in the tax code, you get all of this plus the fact that people have greater incentives to work and invest.  Kill the payroll tax--many people have a bizarre belief that only rich people pay tax, when FICA is killing everybody.  Do Tabarrok's plan of cutting marginal income taxes for incomes in excess of those earned the previous year.  Plenty of people won't take part, but many professionals, entrepreneurs, and part-timers can increase work if they really wanted.  More so than fear-mongering and spending, this would actually generate incentives to work more.  There are plenty of ways to game the system, sure, but how many people are going to hold off getting a job in order to vie for a stimulus job?

Add to all of this that there is virtually no evidence that fiscal policy of this sort can meaningfully improve the economy.  Whatever you think about the merits of government policy or stimulus plans, there's no reason to do all of this in a state of fear--just spend whatever you want on the criteria of rates of return.  Despite all our wealth and prosperity, it looks like a little shock in income drives people as crazy now as it did in the 1930s.