Economic Stimulus

With all the troubling economic news, it was only a matter of time before the economy took center stage in the Presidential election. Last night, the Republican candidates spent a good deal of time during their debate talking about whether we were headed for a recession. And today, Senator Clinton released her plan for a $70 billion economic stimulus package.

What is an economic stimulus package?

Essentially, a stimulus package is a combination of policies that are designed to spark increased economic activity in the hopes of avoiding a negative economic spiral.

Why do we need one?

It looks increasingly as if the effects from the mortgage crisis have spread into other sectors of the economy. When it became clear that millions of home-loan borrowers were going to be unable to make payments on their suddenly skyrocketing mortgages, it caused a huge squeeze in the credit market. Lending money became much riskier and therefore borrowing has become more expensive. The American economy runs, in large part, on the credit. There is a huge amount of consumer debt in the economy and as long as credit is still easy to come by, people will still buy stuff. With the credit crunch, consumers have been a lot less inclined to go out and purchase goods and services. That's led to weak retail sales as well as a slumping stock market. Now the worry is that diminishing demand for goods and services will spur employers to make cutbacks (read: layoffs). When people lose their jobs, they are especially unwilling to spend money. So layoffs lead to even less demand which leads to layoffs, and that's your downward economic spiral. Until last month, unemployment had been holding steady (at a relatively low 4.7%). In December, it jumped to 5% (a huge increase). That has spooked a lot of people and that's why we're hearing talk of economic stimulus now.

How does an economic stimulus package work?

There are basically two ways that the federal government can seek to stimulate economic activity. First, it could increase spending on domestic programs. Second, it could send increased financial resources to directly to the consumer.

The first method rests on the fact that the government is itself a massive consumer. We can raise demand for goods and services merely by having the 800 lb gorilla eat more.

The second method assumes that if each individual consumer has more money, they will be more willing to spend more in the marketplace, thus keeping demand nice and high. Recently, the main vehicle for this has been tax cuts. But other policies would work too (and some would actually work a whole lot better). For example, increased unemployment benefits would probably be the most effective and efficient way to reverse falling demand. If the recently unemployed have a safety net, they are much more likely to continue spending in a manner similar to when they had their job. Without that safety net, they are likely to cut back.

Is Senator Clinton's plan any good?

Its not bad. Senator Clinton focuses on the first method, increasing spending. She proposes:

• setting up a $30 billion fund to help defaulting homeowners pay their mortgage
• allocating $25 billion to help people pay for home-heating
• $10 billion to extend unemployment insurance
• $5 billion in alternative energy programs

As mentioned, the unemployment benefit is especially good. The $25 billion for home-heating would be very good as long as it gets passed quickly. Obviously increasing spending in that area won't do much if it comes in July. I'm less enthusiastic about the $30 billion. While I think that would likely go a long way toward easing the mortgage crisis, it may take a while for those effects to be felt in the wider economy. Stimulus packages should seek to have much more immediate impacts.

It will be interesting to see if the other candidates come out with plans of their own. For now, score one for Senator Clinton for releasing a thoughtful, fleshed-out plan.