A few thoughts on how the federal government might best implement a fiscal stimulus.
The first goal I’d encourage us to keep in mind is preserving flexibility. The U.S. faces very daunting long-run challenges in terms of the federal deficit, and these could easily turn into a serious immediate problem if we were to see a sudden shift in foreign demand for U.S. assets. I would not want to see us begin “temporary” stimulus efforts which we lack the political will to undo once they’re put in place.
Moreover, to be effective, quick action is called for. Grandiose new federal programs necessarily involve a long start-up process, which I do not believe we can afford.
The final core principle should be to prevent further economic damage. State and local governments are on the verge of implementing significant contractions in spending as they try to stay within their budgets. Unlike the federal government, state and local authorities often lack the flexibility for deficit spending.
For example, on Thursday the San Diego Union-Tribune reported:
Raising another alarm in California’s budget crisis, a state panel that oversees loans for public works voted Wednesday to stop financing nearly all infrastructure projects in the state, halting nearly $4 billion in loans for everything from freeway interchanges and carpool lanes to classrooms.
Nor should we suppose that additional federal spending is the ideal response to a cut in state and local spending. If federal spending increases by the same amount that state and local spending decreases, it is not a pure wash as far as the economy is concerned. This is because there are multiplier consequences from local layoffs, and the resulting unemployed resources should not be assumed to costlessly relocate to wherever the new federal money might go. Better to keep the original person employed in the first place.
For these reasons, my preferred fiscal stimulus would take the form of temporary unrestricted block grants to state and local governments.
UPDATE: Mish has more on the situation in California.