module 21 Fiscal Policy and the Multiplier 213
About That Stimulus Package...
In early 2008, there was broad bipartisan
agreement that the U.S. economy needed a fis-
cal stimulus. There was, however, sharp parti-
san disagreement about what form that
stimulus should take. The eventual bill was a
compromise that left both sides unhappy and
arguably made the stimulus less effective than
it could have been.
Initially, there was little support for an in-
crease in government purchases of goods and
services—that is, neither party wanted to build
bridges and roads to stimulate the economy.
Both parties believed that the economy needed
a quick boost, and ramping up spending would
take too long. But there was a fierce debate
over whether the stimulus should take the form
of a tax cut, which would deliver its biggest
benefits to those who paid the most taxes, or an
increase in transfer payments targeted at Amer-
icans most in economic distress.
The eventual compromise gave most taxpayers
a flat $600 rebate, $1,200 for married couples.
Very high -income taxpayers were not entitled to a
rebate; low earners who didn’t make enough to
pay income taxes, but did pay other taxes, re-ceived $300. In effect, the plan was a combina-
tion of tax cuts for most Americans and transfer
payments to Americans with low incomes.
How well designed was the stimulus plan?
Many economists believed that only a fraction
of the rebate checks would actually be spent, so
that the eventual multiplier would be fairly low.
White House economists appeared to agree:
they estimated that the stimulus would raise
employment by half a million jobs above what it
would have been otherwise, the same number
offered by independent economists who be-
lieved that the multiplier on the plan would be
around 0.75. (Remember, the multiplier on
changes in taxes or transfers can be less than
1.) Some economists were critical, arguing that
Congress should have insisted on a plan that
yielded more “bang for the buck.”
Both Democratic and Republican economists
working for Congress defended the plan, argu-
ing that the perfect is the enemy of the good—
that it was the best that could be negotiated on
short notice and was likely to be of real help in
fighting the economy’s weakness. But by late
summer 2008, with the U.S. economy still in thedoldrums, there was widespread agreement
that the plan’s results had been disappointing.
And by late 2008, with the economy shrinking
further, policy makers were working on a new,
much larger stimulus plan that relied more
heavily on government purchases. The Ameri-
can Recovery and Reinvestment Act was passed
in February 2009. The bill called for $787 billion
in expenditures on stimulus in three areas: help
for the unemployed and those receiving Medi-
caid and food stamps; investments in infra-
structure, energy, and health care; and tax cuts
for families and small businesses.
Despite controversies over specifics, the gen-
eral consensus about active stabilization policy
is apparent: when at first you don’t succeed, try,
try again.fyi
John Moore/Getty ImagesModule 21 AP Review
Check Your Understanding
- The country of Boldovia has no unemployment insurance
benefits and a tax system using only lump-sum taxes. The
neighboring country of Moldovia has generous unemployment
benefits and a tax system in which residents must pay a
percentage of their income. Which country will experience
greater variation in real GDP in response to demand shocks,
positive and negative? Explain.
Solutions appear at the back of the book.
- Explain why a $500 million increase in government purchases
of goods and services will generate a larger rise in real GDP than
a $500 million increase in government transfers. - Explain why a $500 million reduction in government purchases
of goods and services will generate a larger fall in real GDP than
a $500 million tax increase.