4 Ways the Stimulus Plan Could Flop

Despite assurances by politicians, the government has limited ability to fix the economy.

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So the government is on the case. Washington's going to rescue the economy. Sending $150 billion worth of checks to consumers will be just the pick-me-up we need to stay out of recession and continue our free-spending ways.

Uh, maybe. The politicians might already be congratulating themselves for a bipartisan economic bailout, but the notion that the government can push a few buttons and turn around a $14 trillion economy is a dangerous myth. Sure, the government has some control over economic factors, like short-term interest rates and federal spending. But the U.S. economy is vast and complex, and government "stimulus" doesn't always work. Sometimes it even damages the economy. Here's what could go wrong:

The stimulus comes too late. As in business or real estate deals, timing is everything. Many economists agree that a government injection equal to about 1 percent of gross domestic product, or roughly $150 billion, can be helpful—but only if it comes when the economy is at its weakest and needs the boost the most. And when will that be? Well, we'll know in about a year. It might have been in November, or it might be next month. Forecasters can guess, but they're hamstrung by a "recognition lag": It takes months to determine when a downturn actually begins and the economy bottoms out, and by the time they know for sure, the economy is usually growing again.

The Federal Reserve can act in real time when it raises or lowers interest rates, but the kind of spending in the stimulus plan takes months to legislate and put into effect. "By the time tax rebates are in place, we may already be coming out of recession," says MIT economist Kristin Forbes. That can pose risks of its own: Goosing the economy when it doesn't need it can worsen inflation and crimp a nascent recovery.

Government intervention during recessions in the 1960s and 1970s generally came too late and did more harm than good. The government acted more quickly and did a better job during recessions that began in 1990 and 2001, so maybe we're smarter these days. Like, we'd never be foolish enough to plunge into a nationwide housing meltdown.

Consumers don't do what they're supposed to. Giving consumers extra money to spend works only if they, well, spend it. Yes, Americans need to save more, in the long term. But a short-term stimulus is all about spending to boost economic growth—now. During the 2001 recession, the government sent consumers checks ranging from $300 to $600. Spending did rise after that, but surveys also showed that many consumers—perhaps more than half—used the money to pay down debt or boost their savings. That's a smart money move, but it doesn't generate short-term economic growth.

One way to make sure consumers spend the money is to give it to those who need it most—namely, those hardest hit by a downturn. The current stimulus proposal would target the neediest consumers somewhat, by giving $300 checks to low-income earners, for instance. But wealthier consumers would get bigger checks, and the return on that, in terms of economic growth, could be much lower.

It could be the wrong kind of stimulus. Just because it's politically popular doesn't mean a government bailout is economically wise. The current proposal to give businesses $50 billion worth of tax breaks, for instance, is a big winner with politically active corporations and small-business owners. But it will boost the economy only if those businesses use the savings to buy more equipment and hire more workers. During recessions they often do the opposite, since demand for goods and services declines. And if businesses just pocket the government's largess, the benefit to the rest of us can be minimal.

Targeting aid to the neediest consumers tends to work well, because they spend the money to cover basic expenses and it ends up right back in the economy. But needy consumers aren't exactly the most powerful voting block, one reason proposals like extending food-stamp or unemployment benefits haven't caught on.

Other problems get worse. There are many things the U.S. government can do little about, like rising oil prices, currency speculation that drives down the dollar, and overseas demand for American goods. All of those things directly affect the U.S. economy, and if China cut back on purchases of U.S. government securities, for instance, or foreigners bought fewer U.S. goods, it could overwhelm a mere $150 billion worth of stimulus. But if that happens, rest assured, the politicians will come up with another plan.