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The Science of Stimulus

By Russ Roberts

This commentary aired on National Public Radio's All Things Considered on January 16, 2008 in response to much talk about the the need to create a stimulus package to avert a recession. Audio is here.

Love that word—stimulus. It sounds so scientific. With the right stimulus, you can even make the leg of a dead frog twitch. A heart attack victim gets the stimulus from those chest paddles and bam. Back to life. My online dictionary defines stimulus as something that "rouses or incites to activity." Sounds like the perfect prescription for an ailing economy.

But if politicians know how to stimulate the economy, why wait for a recession? If you can make the economy grow, why wait for bad times?

One answer is that a healthy patient doesn't need medicine. But the other possibility is that it's all hot air. Maybe we don't know how to make a $14 trillion economy move very quickly. And if we did, it would take a lot more than an injection of even 125 billion dollars.

There's that scientific language again—an injection. The politicians are always going to inject some amount of money into the hands of consumers and into the economy, like a doctor giving a lifesaving blood transfusion. But where does the economic injection come from? It has to come from inside the system. It's not an outside stimulus like the chest paddles or the transfusion. It means taking money from someone or somewhere inside the system and giving it to someone else.

The standard stimulus package doesn't change incentives. It's a check from the government. The hope is that the receiver will spend it. But when you just send out checks from the government, whoever gets stimulated is likely to be offset by someone who gets unstimulated.

The money has to come from somewhere. If you raise taxes to fund the plan, the people who are taxed are poorer and they'll spend less. If you borrow money to fund the plan, the people who buy the government bonds have less money to spend and that offsets the stimulus. It's like taking a bucket of water from the deep end of a pool and dumping it into the shallow end. Funny thing—the water in the shallow end doesn't get any deeper.

And even the people who get the money often save more of it than they spend.

That's why stimulus schemes based on giving people money have a poor track record of energizing the economy. Usually, the only thing that gets stimulated is a politician's approval rating.

I'm not saying that economy policy is irrelevant. Economic policy matters because it affects the long-run growth of the economy. I'm all for policies that make us more productive or innovative by changing incentives. But those policies take time. There's little any economic doctor can do to move our $14 trillion organism of an economy in the next few months.

Politicians who work in the Oval Office—or those who seek to work there—would be wise to remember that patience is a virtue. Focus on the policies that lead to growth over time. Expecting results overnight is bound to lead to disappointment.

January 17, 2008 • National Public RadioThe Economy


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Comments (13)


C'mon Russ. We can just print money.

Seriously though, tax cuts could help. However, given the nature of our federal government's fiscal status, that would require either spending cuts (gasp!) thus taking money from someone else (who, admittedly received it by plunder) or printing up more bonds to sell.

My main concern in this whole situation is that the government will act and create a new bubble somewhere else and 5 years from now we'll all be fretting over that one.

That they are either unable or unwilling to recognize how their actions are causing these swings causes me dismay.

Like I've always wondered - if fiscal stimulation is such a great idea, we don't just stimulate the economy all the time?

I love the analogies as well.

Money from one end of the pool to another--priceless.


That was very well done.

Bailey Norwood:

Isn't the theory behind a stimulus package based on money demand? The way I remember learning it, is that some people have money "just sitting there," like stuff under a mattress but more likely just sitting in their wallets. They aren't spending it because they are fearful of bad economic times approaching. If you can get that money out into the economy, let that money be lent to someone to spend, then the injection of money is not offset by a removal of money somewhere else. Somoeone borrows that money and spends it, and pays it back later to the person who wasn't going to spend it anyhow.


Great one Russ! Excellent analogies! Can I use the pool one, please? I'll give you credit!


To get capital from outside our system, incent all foreign government funds to re-capitalize the financial instutions with a break on their capital gains tax treatment upon sale of their shares. This could be a "Special Share" with certain priviledges denied such as voting and/or Board mambership. The shares would have other conditions to include the purchase must be made within 3 months of the new law being passed. The long-term holding period should be lengthen to 3 years or to any length of time to correspond with the financial institutions' write-down period.

The percentage of the break should be based upon current cap gains qualifications/rates, not what the Dems will do to that qualifications/rate next year. This will assure the investors their gains are not subject to the socialists bent currently present in this country.

This could help the current credit situation and its expected length of time to work through the system. Most importantly, it relieves the taxpayers from future taxes to cover direct payments and borrowing costs incurred by responsibility agencies/units who will have to cover the credit transition costs shortfalls. Increasing the money supply would not be as much either which would help not only the additional debt carrying cost, but future inflation pressures.


What if the government borrows the money for the "stimulus" by selling bonds to, say, China? Then we'd be borrowing from the future, presumably when the economy was healthier because it had already been "stimulated", to fund the current stimulus plan, whatever that may be.

I thought that the main reason why sending one-time tax rebate checks to taxpayers didn't work very well to stimulate spending or boost the economy was that people don't tend to change their behavior very much based on small one-time windfalls. But people do tend to change their behavior more in response to tax cuts, because tax cuts seem more permanent (though one big hole in that theory is that tax rates change so often that you can't really count on them when planning your spending).

Philip Segal:


How could anyone disagree with the swimming pool analogy?

It's just as if I take my wallet from my hip pocket and put it in my jacket pocket. I'm not any richer, though I may be more comfortable when I sit down. Likewise, transferring $1000 from Bank A to Bank B does not change my net worth, unless bank B gives me "free" toaster.

Another way to look at a "stimulus package" though might be to think of it as a rebate of an overpayment of taxes. Most economists I think would agree that individuals and business owner are more likely to make better decisions about how to spend or invest money than bureaucrats.

Or, think of it as a partial refund of all the extra costs we incur because of rent seekers such as peanut farmers, sugar cane farmers, corn farmers, etc.

Or, look at the "stimulus" the way my daughter would. To her if I give her an extra $50, it's free money, and she'll spend it faster than I can get it from that wallet in my hip pocket. Now our family isn't any richer when she gets the money, and may be poorer or at most even once she spends it. But she'll feel better, I'll get some pleasure form seeing her enjoy the money, and in the end we may end up slightly better. Clearly there are a lot of if's here, but you get the point. If people who are worried about a slowing economy think the "stimulus" will work. It just might. Sort of a $75 billion placebo.


Money is debt, and is created out of thin air by banks.

Flash Gordon:

But if politicians know how to stimulate the economy, why wait for a recession? If you can make the economy grow, why wait for bad times?

Rush Limbaugh said essentially the same thing on his radio show Thursday or Friday. Maybe he stole it from Russ Roberts, or maybe Russ Roberts stole it from him. Or maybe neither one stole it from the other. Maybe it's just such a logical conclusion that anyone who thinks seriously about it and is not biased in their thinking would come up with it. Anyway, I wish a few more people, like maybe a few journalists, could ask the politicians about this. I'd love to hear their response. Or maybe I wouldn't.

Jake Peachey:

"The money has to come from somewhere. If you raise taxes to fund the plan, the people who are taxed are poorer and they'll spend less. If you borrow money to fund the plan, the people who buy the government bonds have less money to spend and that offsets the stimulus. It's like taking a bucket of water from the deep end of a pool and dumping it into the shallow end. Funny thing—the water in the shallow end doesn't get any deeper."

Well above quotation represents a "closed system" viewpoint. I would like to see if I can persuasively present the viewpoint that macroeconomics is in fact "open system." You can add liquidity to the pool from an external source.

Value is fundamental to all things economic. Value is the sub-atomic particle without mass, upon which everything in economics is built. Value exists only in the imagination. It can be easily destroyed or created. It is value that defines assets. Assets are only carriers of value and do not define value.

The historical development of economic thought includes automatic and instinctive assumption that value is inherent in assets. This always leads to "closed system thinking."

Since value is fundamental to everything economic and assets are only carriers of value, this means that value is value is value. It is an ephemeral thin air essence that will never allow you to classify economics as one of the hard sciences. It can only be an inquiry is part of human culture.

All of this means that value is the same value regardless of which asset is ascribed to: including the dollar bill. If value is ascribed to this newly created money, it adds real value to the economy, just the same as when value is ascribed to gold after it is made available to the market as the result of mining.

Our traditional monetary policy through fractional reserve banking multiplies money during credit expansion. During credit contraction it will annihilate this money. Through this process massive amounts of value can appear and then disappear within an economy. The water level in the swimming pool rises and falls. During the disappearing phase it leaves behind a lot of nonperforming debt that can seriously threatened the financial system and subsequent economic performance.

The solution is quite simple. You raise the level of the swimming pool by straightforwardly creating money and injecting this liquidity to the swimming pool.

Properly managed, it is possible to tap the vast pool of the imagination of mind from whence all value is derived to counter the effects of credit contractions. The treasury can sell bonds, with the Federal Reserve buying it. For the Federal Reserve this is not real debt --- as if it had gotten money elsewhere that needs to be repaid. Once its storage rooms are full of treasury bonds, it can either build additional storage area or get big paper shredders. This can go on until the sun burns out. But one caveat; care must be taken to maintain scarcity integrity to maintain stable value in the dollar. This can be done by maintaining discipline in the credit market. Fiscal policy, with created money, can introduce cash flow into the economy to replace debt which will enhance the balance sheet of the private economy.

Jake Peachey

Philip Segal:

If the government borrows at 2.5% (five year note rate today) and gives it to me as a rebate, and I pay off a credit card debt at 18%, doesn't this arbitrage help me out. Yes, I'll eventually have to pay higher taxes to repay the "rebate" and the interest thereon, but I still should be net ahead by 15.5% from this arbitrage. Who loses? Maybe the Chinese or the Europeans who are buying the Treasury bonds. But, once I've paid down high interest debt, I can use current income to purchase more. I realize that what works for an individual doesn't always work for aggregates. On the other hand, why were Democrats wrong with their "paygo" requirements for any tax cuts, but now they and the President and Republicans are wrong to argue for a tax cut/rebate, that doesn't require any immediate spending offset?

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