Fiscal Stimulus: The CEA Report and Beyond

Is the largest fiscal stimulus package adopted in U.S. history working? Is it worth the high fiscal cost in the future? With these questions in mind, our Fiscal Roadmap Project looks at the first quarterly report on the stimulus package by the President’s Council of Economic Advisers and beyond.

Six months into the life of the stimulus package, evidence on whether the stimulus package is working is limited. However, based on the available data, it is reasonable to conclude that growth in the second quarter was not as weak as it would have been otherwise. Moreover, the trajectory of the economy looks a lot better now than it did at the end of last year and early this year. As of August, employment is also higher than it would have been otherwise. The private sector is clearly adjusting to the new economic and financial landscape to insure firm survival (signaled by strong productivity growth related to cost cutting); but, in the meantime, demand is being supported largely by government spending and tax cuts.

But it’s too soon to declare victory. While growth is expected to be turning positive now (the 3rd quarter is widely expected to rebound with GDP growing somewhere around a 3% annual rate), next year’s outlook remains an open question. While economic activity will probably look better for the next few months, the economy and financial sector remain weak and the risks of a double dip recession continue to be high. It is still far from clear whether the stimulus will successfully jump-start the economy so that the growth will be self-sustaining. Recoveries from recessions induced by financial crises tend to be slower than typical recoveries. Our economy is tremendously resilient, but economic headwinds are strong and the situation complex.

Moreover, the recovery in employment is likely to lag and (unsurprisingly) we have just learned that the poverty rate has worsened.

At the same time, looking ahead, we have entered a very dangerous period, and the administration faces a delicate balancing act – to say the least. We must prepare for an unusually wide range of possibilities, keeping in mind that the risks still remain on the weak side. At one end of the spectrum, a double dip recession would bring with it additional costs (including fiscal) and risks. At the other end of the spectrum, with the enormous resources poured into the economy, growth could take off once economic and financial adjustment is over. The pace of adjustment is always difficult to predict, and the costs in the form of accelerating inflation could be high if we get it wrong.

The other challenge in the mix is that we are getting closer to the arrival of the budget tsunami from the retirement of the Baby Boomers. Ten years is not a long time when it comes to fiscal planning.

Given the typical leads and lags involved, the administration must also start making plans now to get its fiscal house in order once recovery takes firm hold – without prematurely withdrawing stimulus. To reassure taxpayers and other creditors that U.S. fiscal management is alive and well, it is all the more important that we have a Fiscal Recovery Plan in place soon.