These words from AEI's Kevin Hassett in today's WSJ are worth highlighting:
Every stimulus effort has not two but three stages.
- When the stimulus is imposed, there is some positive short-run increase in GDP.
- When the stimulus is removed, there is an approximately equal and opposite reduction in GDP.
- But after that, the stimulus must be paid for with higher taxes or ongoing borrowing—causing a further reduction in GDP.
Thus the total impact of the Keynesian policy is negative over its life. This fact is visible even in the fine print of Congressional Budget Office analyses so often cited by stimulus apologists, such as its 2009 finding that the Obama stimulus would reduce output in the long run. (numeration added)
What this means for us, then, is this:
In the lengthy, slow‐slog out of a financial crisis, the stimulus hangover arrives before the recovery has taken off. Temporary stimulus therefore hurts the economy when it is removed and again when it is paid for. The hangover is virtually guaranteed to arrive at a moment when it can push us back into recession.
The two options he says we should pursue are perhaps not surprising but that doesn't make them any less important:
The first is tax reform that broadens the tax base, lowers rates, and reduces taxes on capital income. Over a decade, fundamental tax reform can deliver enduring benefits large enough to offset the residual negative effects of the financial crisis.
Second is entitlement reform. Given the massive imbalances that exist today, consumers likely have little faith that current programs will remain in place throughout their lifetimes. Accordingly, cuts to entitlements that phase in gradually will likely have little impact on consumers' perceived lifetime wealth, as the benefit cuts are already factored into their thinking. If so, government can reduce promised benefits without causing consumption to go down. Such a reduction would restore market confidence and create the budget space to ensure successful tax reform.
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