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Stimulating spending and manufacturing optimism

Congress recently passed a stimulus package -- which has become one of those weird set phrases in the recent news cycle, like "rogue trader" Jerome Kerviel, or the subprime meltdown or the "credit crunch." The demands of internet search engines seem to encourage the formation of such news nuggets. These set phrases become what Marx (according to literary critic Michael McKeon) called simple abstractions, holding together and stabilizing a collection of related ideas that are actually in tension. Thereby simplified, they circulate like currency and can be deployed in lieu of a richer understanding or a more comprehensive explanation of the forces at work. The main thing I know about the stimulus package is that it means the government will send me $600 simply for being a taxpayer.

You would that would be delightful, but it seems more frightening, like something a banana republic would do. It seems akin to giving hobos booze on election day as a reward for their vote. Also, the economic problems seem to be derived from too much irresponsible borrowing and spending, so it seems peculiar that the solution would be to give consumers more money and tell them to spend it freely. It's like giving kids pudding when they haven't eaten their meat.

Built into the phrase stimulus package are assumptions about what fiscal policy (aka money spent by the government) can accomplish. The main assumption is that the economy is moving into a recession because of a failure of aggregate demand, which is a consequence of credit suddenly becoming unavailable for risky and non-risky borrowers alike. Therefore the government borrows from the future (by increasing the deficit) and hands out checks to regular folks and encourages them to spend it. You don't have to revile Keynes to be skeptical of this. Tyler Cowen makes a good case against it here:

Most fundamentally, more aggregate demand is not the answer because insufficient aggregate demand was not the problem in the first place. Just as a social framing effect (and lots of fraud) led subprime loans to be perceived as "not very risky," right now social framing effects -- call them collective fear -- are causing lower asset prices, some degree of credit constipation, and higher risk premia. The economy is undergoing a sectoral shift toward less risky assets and that can bring an economic downturn. The shift itself is costly, it brings thorny coordination problems (e.g., sudden insolvencies, overturning of credit expectations), and lower-yielding assets also mean less wealth. Lack of liquidity simply is not the fundamental problem.

But then logic of the stimulus package may be less economical than political, as is usually the case when it comes to fiscal policy -- who should get the fruits of government spending is always a political question. This package is not likely to have much direct effect on the economy, but it will certainly affect voters' attitudes. The stimulus seems a matter of preventing a hiatus in standards of living -- of habitual shopping, that is -- and forestalling the unrest this would cause. So instead of helping adapt consumers to more "realistic" limitations on their consumption, we will do what we can to encourage them that no limits exist. This is called bolstering consumer confidence, and seems likely enough to work. America is an optimistic place, after all.

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