americanprogress.org/issues/2009/01/recovery_reinvestment101.html

Heather Boushey of the Center for American Progress debunks some of the myths and falsehoods making the rounds of talk radio & the cable news programs on the stimulus bill.

This recession has the potential to be deeper and more protracted than most other recessions. The Federal Reserve can normally encourage economic activity by lowering the cost of borrowing, but these tools are not as effective as they are in more typical recessions because of the crisis facing the financial sector.

The Federal Reserve has already used up its most common ammunition to boost the economy—the Federal Funds Rate. It lowered the Federal Funds Rate to about zero percent in December 2008 from 5.25 percent in August 2007. Even so, economists are forecasting that economic growth will continue to be negative in 2009, and the end of the economic downturn is nowhere in sight.

What’s more, U.S. families began this recession with less to fall back on than in prior recessions because of existing economic weaknesses. Income growth had been weak, and Americans had more debt and fewer assets than at the beginning of prior recessions. Since consumers make up over 70 percent of the U.S. economy, the weakness of family finances will likely hamper the economy’s ability to recover quickly.
Why does a stimulus and recovery plan help?

The recovery and reinvestment package is designed to break the cycle of job loss and economic decline. An economy suffering from lack of demand needs a jump-start. The stimulus allows the government to step in and create demand by making purchases itself; it directly puts people back to work and gets money into people’s pockets so they can spend again. Businesses begin, in turn, to hire and make investments as they regain confidence that there is a market for what they produce. The downward spiral becomes an upward spiral.
What are the criteria for an effective stimulus?

An economic recovery package should be large enough to address the problem, timely, targeted to cost-effective uses, and use taxpayer dollars responsibly.

Large enough to address the problem

Economists are now generally convinced that the stimulus package must be equal to at least 2 to 4 percent of gross domestic product, which is about $300 to $600 billion annually.

Timely

Head of President Obama’s National Economic Council Lawrence Summers suggested in early 2008 that any stimulus package must be “timely, targeted, and temporary.” This logic was applied to the stimulus package passed in March 2008, which provided $160 billion of tax rebate checks. Yet economic conditions have continued to worsen and it is clear that it will take more than a few months to solve the problems facing our economy. A “timely” recovery package should therefore be focused on the next 18 to 24 months.

Targeted

Investments should increase demand and generate jobs. If the problem is that firms are not seeing demand for goods and services, the most effective package will create demand. The best demand and job creators are investments in infrastructure and green jobs, as well as aid to the states. Such investments will also indirectly increase demand because every dollar spent is spent again by whomever receives the funds.

The government can only spend so much responsibly in a short period of time, however. Tax cuts are therefore a useful addition to the package—although they would otherwise be a second-best approach—because they put money into people’s pockets that, if spent, will spur demand. The most effective tax cuts are those that go to lower- and middle-income families that need the money most and are thus most likely to spend it. (See Krugman, Romer, and Bernstein, and Zandi.)

Responsible

The government is committing trillions of dollars to the economic recovery through a stimulus package and by shoring up the financial sector. It is imperative that the public knows this money is being well spent. This can be accomplished both by having appropriate supervision of the spending and by keeping the public and media well informed about where the money goes.

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