What Should We Stimulate, Exactly?

I'm dreaming of holiday goodies.

It's now clear that plans are well underway for a big stimulus package for the U.S. economy. There will be similar programs announced elsewhere, just as happened in China this past week. The numbers being discussed are of the magnitude of $300 billion for the U.S., although Paul Krugman proposed as much as $600 billion. We are getting so accustomed to sums of this order that it is hard to get a sense of their importance in the scheme of things.

U.S. gross domestic product is $14.4 trillion, so $300 billion is about 2.1% of GDP. That's a lot of stimulus, coming on top of the commitments that have already been made via the Paulson bailout plan (4.8 % of GDP) and the other commitments of the Fed and the Treasury (another 4% of GDP) to rescued institutions. On top of that, we have the ongoing fiscal stimulus of the wars in Iran and Afghanistan. Government spending in total is roughly $2.4 trillion (after transfer payments), so $300 billion would be an additional 12.4% of government spending.

For comparison purposes, China's proposed stimulus package is $586 billion over two years, or roughly 7% of their GDP each year. There is some skepticism about what those numbers mean exactly, but it will be serious stimulus. European governments are talking this weekend about co-ordinated fiscal actions to stimulate their economies.

How will we pay for this? We shall borrow, which means it will probably be our children who pay, and they won't thank us for the burdens that we've left them. There's no point in hand-wringing. That's the way it has to be, and so an apology to future generations is in order. This is the only way to pay for wars and national exigencies--as the British taught us during the Napoleonic Wars.

If we aren't worrying about spending, we ought to be very worried about whether the stimulus is going to do what it's supposed to do. Not how much we have to borrow, but how we spend it. As the TARP bailout experience has underscored so well, when you put out a big trough, lots of oinkers show up for a taste.

Not all stimuli are the same, and we have plenty of past and recent experience to learn from. A number of people have argued for a stimulus that will get people back in the stores shopping--a tax cut or rebate. We might want to ask two questions: Is further stimulating consumption desirable, and would a further tax rebate or cut be effective?