With the first two fiscal stimulus packages winding down, having failed to produce the promised "lift-off" with self-sustaining growth and improving employment, stimulus advocates are now pointing to upcoming "fiscal drag" when the measures are withdrawn as a reason for still more stimulus. These calls, namely for further additions to debt and deficits, are being heard in the midst talks aimed at major deficit reduction.
Consider the disappointing impact of last December's stimulus package. Passed just after the Federal Reserve's November QE2 balance sheet expansion, most forecasters were expecting a growth rate close to 4 per cent during the first half of this year. The outcome will probably be below 2 per cent. Many are blaming the negative effects of higher fuel prices and Japan's earthquake for slower-than-expected growth.
"Fiscal stimulus produces a temporary positive impact on growth and perhaps on employment after it is enacted."
But part of the disappointing outcome is due to the waning impact of the first stimulus package and a related collapse in construction spending. That the June employment report showed an increase of only 18,000 additional jobs surely falls short of the promises made by advocates fiscal stimulus. The list of disappointments goes on. When the last December's stimulus is withdrawn at the end of the year, it is estimated to reduce next year's growth by 1.5 percentage points - and all we have to show for it is a larger national debt mountain, coupled with the need for greater future deficit reduction.
We are learning a basic truth. Fiscal stimulus produces a temporary positive impact on growth and perhaps on employment after it is enacted. This is followed by a drag on growth when it is withdrawn. The net effect over time is highly uncertain but disappointing overall. The stimulus-on, stimulus-off sequence reflects the fact that the spending must be financed by an increase in debt that carries with it the prospect of higher expected future taxes and/or spending cuts. This is especially true as the US debt to gross domestic product ratio approaches level associated with fiscal crises.
With the president and some policy makers calling for $2,000bn to $4,000bn in defect reduction over the next decade - another stimulus package of, say $500bn would only leave us looking for $2,500bn to $4,500bn of defect reduction over the next nine years. That is unless we want to put off deficit reduction steps - again. But that is how we got into this deficit box in the first place.
John H. Makin is a resident scholar at AEI.