The classic argument against fiscal stimulus is that it crowds out spending. As I noted on a prior post, Paul Krugman has objected that he’s only proposing that government borrow businesses excess cash reserves, which, he says, won’t crowd out because that money’s not being used anyway. A source I found somewhere recently (and don’t feel like searching for at the moment) suggests those current excess reserves are around $1 trillion, which presumably would be a meaningful amount of stimulus.
Does that suggest Krugman is right? It sounds compelling. Two possible criticism have been rolling around in my head. One is that businesses might be waiting while they search out good investment opportunities, and borrowing that money might make it impossible for us to ever know what they would have done with that money six months or a year from now. I’m not sure how strong that criticism is, though, precisely because borrowing the money would make it impossible for us to ever know what businesses would have done. The other is that it assumes a multiplier of greater than 1 (which Krugman and others believes is the case, while Robert Barro and others dissent). But again I’m not sure about the strength of the argument because I don’t think anyone can state with certainty what the multiplier for government stimulus spending is.
But what about this argument from Steve Sexton at Freakonomics, written in the context of Obama suspending the new EPA rules?
cash reserves are not “idle” for most businesses; they are providing a hedge during uncertain economic times. If owners of such businesses have decided that their current reserve is optimal, then surely they will seek to maintain that hedge even with the requirement of new pollution-abatement expenditures. In that case, they must reduce other expenditures today in order to retain the hedge. The new expenditures and jobs for pollution abatement, then, are partially or fully offset by reduced expenditures and job losses elsewhere.
Would the same logic, if correct, would hold true for borrowing for stimulus? Would businesses would offset their diminished cash reserves by decreasing investments elsewhere? Or is this different because in the case of borrowing they’re voluntarily investing their money with the government, demonstrating by revealed preferences that such a use of their cash is more valuable than keeping it in reserve, whereas the same can’t be said for involuntarily investments in pollution control measures?
And, a technical question, if the government borrows a trillion (or some portion of that), how does it ensure that the borrowing is drawn from those cash reserves, rather than drawing it away from other investments, so that it continues to crowd out? Or does that not matter? I would think it has to, since in that case the net cash reserves would remain the same. Does this argue for a stimulus policy of “drafting” cash reserves involuntarily, rather than selling government securities to voluntary bidders?
My inclination, clearly, is against stimulus, but I remain uncertain. I’m not going to indulge in an ideological stance against it, but while I remain unconvinced by Krugman and company, I’m not yet fully persuaded that their critics have satisfactorily demonstrated anything more than doubts about stimulus.
Addendum: I’m not persuaded that the short-term effect on the economy is the relevant question in regards to whether Obama should delay pollution controls or not. If the amount of pollution the new requirements would prevent is significant, he’s just perpetuating an externality, so any economic benefit is largely illusory, created by allowing businesses to continue forcing others to involuntarily cover their expenses. I have no doubt that the local factory in my town might add jobs if the government required my neighbors and me to pay their utility bills, but I don’t see how that helps the local economy on net.