Will the Stimulus Become a $3 Trillion Nightmare?

Feb.13.09 | About: SPDR S&P (SPY)

From comments in the Reason.com Stimulus Symposium:

Like all fiscal stimulus packages in the past, the current one will not impact the economy at the right time for the intended stimulus effect, due to the inevitable problems of long lags. Much of the intended expansionary fiscal effects won't happen until next year and even 2011, and it's likely the economy will have recovered sufficiently by then so that the fiscal stimulus will be unnecessary, and might actually be destabilizing.

The graph below from the Cato Institute (using CBO data) illustrates the problem of long lags for expansionary fiscal policy. Only about 21% of the increased spending would take place in 2009, and 38% would be spent in 2010 and 41% in 2011 and after. Let's be optimistic and assume an economic recovery sometime in 2009. There are two conclusions from that outlook:

  1. The stimulus package would not be responsible for much of the economic recovery because almost 80% of the spending would take place after the economy has recovered.
  2. The majority of the fiscal stimulus would impact the economy in 2010 and after, at a time when the economy no longer needs a stimulus. Stimulating an economy already in recovery would be potentially destablizing.

Chris Edwards at Cato suggests an alternative and even more pessimistic outcome:

What if special interest groups successfully lobby to extend all the new benefits and subsidies? One possibility would be that the 2010 funding level of $206 billion is extended permanently, as shown in the chart below. Rather than the stimulus bill costing $546 billion through 2019, it would trigger spending totaling $2.2 trillion over the period.

In sum, here are the budget effects through 2019 of the stimulus nightmare scenario:

Temporary tax cuts in the Senate bill: $292 billion
+ Spending continued permanently at 2010 level: $2.2 trillion
+ Estimated additional federal interest costs: $500 billion
= Total increase in federal debt under nightmare scenario: $3 trillion

Extending the (mainly useless) tax cuts in the stimulus package would make deficits even larger. And, of course, all this increase in debt would come on top of the debt piling up from financial industry bailouts and regular budget spending. It’s madness.

Thanks to Paul Sebastian for the Cato tip