Economic Stimulus: How It Works (or Fails)

The pros and cons of six different approaches to perking up a slowing economy.

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It might sound like a good idea, but there's no guarantee that the proposed $150 billion government stimulus plan will succeed. Here are the pros and cons of government intervention:

Tax rebates

What's the plan? Will it work? Whom will it help most? What's the downside?
Give money directly to consumers, to spend as they wish. Under the House-approved plan, millions of individuals would get a $600 check; couples filing jointly, $1,200. Certain low-earners would get half as much. Depends. If consumers spend it all, it could boost growth by half a percentage point or more. But after similar rebates in 2001, many people used the money to pay off debt or boost their savings, which muted the effect. Lower-income workers most likely to need the money more for routine expenses, and actually spend it. In wealthier hands, the money would benefit the economy less. It adds to the budget deficit and the federal debt. And timing is critical. If the economy has already bottomed out and begun to recover by the time checks go out in May or June, the extra money could drive up inflation.

Tax breaks for business

What's the plan? Will it work? Whom will it help most? What's the downside?
The House plan includes $50 billion worth of incentives that would increase tax deductions and otherwise offset business expenses. Unclear. To boost the economy, businesses would have to invest the savings in new equipment or workers. But in a downturn, the demand for goods and services typically falls, leading companies to cut back--not expand. Small businesses and other companies. It will help consumers in general only if those companies use the savings to invest more and hire new workers, or at least keep the ones they have. Business incentives take longer to affect the economy than a direct injection of cash to consumers. And like rebates, they add to the deficit.

Interest rate cuts

What's the plan? Will it work? Whom will it help most? What's the downside?
Federal Reserve rate cuts make loans cheaper for businesses and consumers, broadly stimulating the economy. One reason such "monetary policy" is a powerful tool is thatthe Fed can act quickly, without political dickering. They're often the most effective economic lever the government can pull--unless there's a credit crunch, with banks cutting back on loans for other reasons. That happened in Japan in the '90s and could be happening in the United States now. Banks and big institutions that borrow large sums at or near the prime rate, and consumers getting lower rates on mortgages and other loans. Plus, companies with low borrowing costs are more likely to invest and hire new workers. If rates go too low, spending can shoot up, triggering inflation or fueling another bubble. Remedial rate cuts could also convince investors the Fed will bail them out, encouraging riskier behavior.

Government spending

What's the plan? Will it work? Whom will it help most? What's the downside?
Increased spending on infrastructure projects or goods the government buys can add to growth, but few policymakers are proposing a spending hike as part of the stimulus plan. This is no time for New Deal II. Government spending typically takes place over years--a period too drawn out to help when a quick, targeted stimulus is needed. Workers employed on infrastructure projects or at companies that make what the government buys. The money ultimately comes from taxpayers, and the government generally spends money less efficiently than consumers: The Sen. Millard F. Blowhard Memorial Bridge to Nowhere isn't going to save the economy.

Tax cuts

What's the plan? Will it work? Whom will it help most? What's the downside?
President Bush and others have lobbied for them, but it appears that tax cuts will not be part of a final stimulus plan. Tax cuts that left consumers with a bit more cash in their paycheck would boost spending but not as quickly or effectively as lump-sum rebates to targeted groups of people. Many consumers would benefit from having extra money in their pockets. But tax cuts tend to favor people with higher incomes, since they pay more taxes, and the cuts take a while to affect the economy. Some of the most bitter beltway battles erupt over the fairness of tax policy, which makes quick action unlikely. And tax cuts add to the deficit unless offset by spending cuts.

Expanding food stamp and unemployment-benefit programs

What's the plan? Will it work? Whom will it help most? What's the downside?
These aren't part of the proposed plan, but government spending on these programs goes up automatically as more people hit hard times and become eligible. Congress could increase benefits at any point. Increased aid to distressed consumers is an effective way to boost the economy and help those who need it most. Hard-hit consumers tend to spend most of the aid they receive, providing a direct boost to the economy. People eligible for the benefits, which includes workers who have lost their jobs recently and people with household incomes close to or below the poverty line. Extended benefits can dissuade laid-off workers from looking for new jobs or moving to areas with more jobs. And they'd add modestly to the federal deficit.

Sources: National Bureau of Economic Research; University of Michigan; Kristin Forbes of MIT; Center on Budget and Policy Priorities; Congressional Budget Office; OMB Watch

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  • Rick Newman

    Rick Newman is the author of Rebounders: How Winners Pivot From Setback to Success and the co-author of two other books. Follow him on Twitter or e-mail him at