January 31, 2007


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An economist explains
What is a “stimulus package,” anyway?
By Brian Early bearly@hippopress.com

Q:With many economists worried about an impending recession, there’s much discussion about stimulus packages. What exactly is a stimulus package? How is it supposed to work?
A stimulus package is meant to stimulate activities in the economy. ... For example, consumer spending tends to be a strong driver of the economy. Consumer spending for goods and services generate a demand for those services and goods. They have to be produced, which leads to greater business activity — employment and so on. While we don’t know the details of the stimulus package that’s being discussed, it would appear that the basis of that package is a way to get more money in the hands of consumers and business. It’s probably going to take the form of a tax rebate of some sort, the idea being that the consumer gets a tax rebate or effectively pays less taxes — that is more money in the consumer pockets that the consumer would have available to spend, and the spending by the consumer stimulates activity in the marketplace.

Where does the money come from for these stimulus packages? Doesn’t that mean it’s coming from somewhere else?
This is presumably money that the U.S. government would have received in taxes and that is going to have to be offset somewhere. It may well be that the U.S. government has to borrow more than it otherwise would have. There may have to be a reduction in government services. This is not coming out from thin air.

If that’s the case, won’t that affect the economy in another way?
In any social science, we’re not dealing with fully controlled experiments. Nothing can be really be analyzed in isolation. There are what economists would call confounding effects....

What’s the issue in the economy today, and how much of that affects New Hampshire?
It’s a credit crunch. We had the sub-prime problem, and it has led to a general concern ... which has made it more difficult to qualify for credit borrowing .... If consumers see this and perceive that things could get worse and are worried about their job, they may cut back on spending.

This idea of getting consumers money to spend — our nation is not well known for having a good savings rate?
Yes, I think it’s close to zero now.

Is that good economic policy to have consumers just spend money?
These are difficult decisions ... amongst professional economists there are differences of opinion, so there is no magic bullet here.

When you look at the world economy, it seems that all the world markets are focused on the United States even though our dollar is down.
Commentators are on all sides of this issue as well. Many have argued that linkage worldwide to what’s going on in the U.S. isn’t as tight as it’s previously been, but we saw worldwide reaction. We’re in a global economy, and the markets are interlinked.

Do you have any advice for consumers?
My sense is that panic is not the way to proceed. I suspect when consumers hear the word “slowdown” or “recession” the first thing that comes to mind is job security. I would sense that we’re not facing a situation where we would expect to see widespread firings or unemployment. A consumer would want to ... build an emergency fund. We know how things work — the week you lose your overtime, it’s probably going to be the same week that your transmission goes and your washer or dryer breaks.

One of the pillars of economics is that humans make rational decisions. Are we rational?
The hottest branch of economics and finance is called behavioral economics, studying whether actors in the economy do or do not make rational decisions. Much of theoretical economics and finance is based on that consumers and business operators are making rational decisions. The empirical evidence continues to mount that that is not the case. For example, take the case of workers contributing to 401k plans. Generally that rate of doing that has been very low. There is a move afoot to set those programs [so] the consumer has to opt out instead of opting in. Preliminary evidence shows that if the consumer has to opt out, more of those consumers stay in the 401k plan. I think it would be easy to argue that for most people that it would be rational to enter into a retirement program, like a 401k. It’s probably not effective to assume that agents in the marketplace are consistently making rational decisions. .

—Brian Early