Introduction

President Barack Obama took office in January 2009 facing the country's biggest economic crisis since the Second World War. Obama and Democratic Party leaders have suggested an economic stimulus package to confront the crisis. This package, they say, will save or create over three million U.S. jobs and provide most Americans with tax cuts. In the longer term, Obama says his plan will stimulate vital sectors of the economy such as energy and health care, making U.S. firms more competitive internationally. When Democratic lawmakers first introduced stimulus legislation in early 2009, they presented a bill with a price tag of $825 billion, though many analysts say the total cost of the plan will likely increase as it makes its way through Congress. The package comes amidst a global wave of stimulus spending, and if it succeeds in pulling the U.S. economy from recession, economists say, the positive impact could be felt around the world. Yet experts also see a number of ways the plan could go wrong. Some encourage targeted, temporary spending measures and say lawmakers should take budgetary concerns into consideration. Doing too little to solve the financial crisis could prove calamitous, they say, but legislative overreach could also have serious consequences.

Obama's Stimulus Plan

Obama's plan aims to stimulate employment, certain critical economic sectors, and U.S. consumer spending. It specifies $550 billion in spending on new projects and $275 billion in tax cuts. The initial plan (PDF) includes investments for:

Energy, including $32 billion to transform the U.S. energy grid to make it more efficient; $16 billion to repair public housing and make it more energy efficient; and $6 billion to weatherize low-income homes;

Science and technology, including $10 billion for new scientific facilities and $6 billion to improve broadband Internet access in rural areas;

Infrastructure, including $30 billion for highways; $31 billion to modernize federal buildings and other public infrastructure; $19 billion for clean water, flood control, and other environmental investments; and $10 billion to improve public transit and rail infrastructure;

Education, including $41 billion for local school districts, $79 billion in outlays to states to prevent educational service cutbacks; $15.6 billion to broaden the federal Pell Grant program, which gives need-based grants to fund education; and $6 billion to modernize higher education programs; and

Health care, including $87 billion for Medicaid; $20 billion to improve health information technology; and around $4 billion to improve preventative care.

The plan also includes $140 billion directed toward tax cuts of $500 per worker or $1,000 per family over two years; expanded tax credits for working poor with children; and a $2,500 college tuition credit. The House Ways and Means Committee approved the tax portion of the bill on January 22, though it has yet to pass the entire House of Representatives.

Some analysts say the Obama administration's spending on economic stimulus will be broader than what's included in the stimulus spending plan. "You've got to look at the whole picture," said Adam Posen of the Peterson Institute for International Economics in a January 2009 interview (PDF). Posen and several other analysts have noted that stimulus spending could come in many ways beyond what's in the plan, including:

The Treasury's $700 billion in TARP funds, initially aimed at stabilizing the financial sector, seems likely to be used to provide relief to other industries and "for things that look more like stimulus and less like asset purchases," according to Posen;

Automatic economic stabilizers like extensions of unemployment insurance

Expansions of health insurance;

Some form of "mortgage relief" aimed at helping Americans facing default;

Federal Reserve purchases of mortgage-backed securities and perhaps other types of distressed securities in the future; and

An expanded GI bill for returning veterans.

Posen says the Obama administration, "for understandable political reasons, doesn't want to put it all under the cover of one title called stimulus, in part because these things have their individual merits, but in part because they don't want to have a bill of $1.5 trillion."

How Economic Stimulus Works

Economic or "fiscal" stimulus stands in contrast to monetary stimulus, a process through which the U.S. Federal Reserve Board adjusts interest rates to encourage or discourage lending. By 2009, the Fed had lowered rates to near zero. Because it can't lower rates below zero (which would amount to lenders paying people to take a loan), the Fed had few remaining policy options. Economic stimulus is another means by which a government can seek to boost its economy, either in the short term, by encouraging consumers or companies to consume goods, or in the longer term, by encouraging the growth of businesses and the creation of jobs through investments in infrastructure and research.

There are many different forms of potential economic stimulus and they work in different ways. Tax cuts for individuals generally encourage short-term spending. Tax cuts for companies encourage both spending and investment. Expenditures on public works create contracts for firms and provide short- to medium-term employment opportunities. Investments in research and development take a longer-term approach under the theory that businesses will thrive in the future (and thus provide jobs) if they have the money to make intelligent investments in their operations now.

Finally, some forms of economic stimulus seek to make investments that will pay off in the long run by making consumption cheaper for everybody. An example is investing in the U.S. energy grid. Theoretically, a one-time outlay could make energy costs for both individuals and businesses less expensive for decades to come. Similar arguments are made about health care spending. Critics say an outdated and illogical health care system presents significant costs for U.S. businesses that could be eased through front-end investments. Obama has called attention to both energy and health care as sectors in which infrastructure investments could help make U.S. firms more competitive internationally. Other countries, including China, have similarly focused stimulus spending on infrastructure development.

Analysis

Stimulus as a Strategy

Economists disagree on the wisdom of extensive stimulus spending, as well as the particulars of the current U.S. plan. Given the current economic climate, most mainstream economists now say that the potential downsides of collapse are sufficiently grave that large stimulatory expenditures may be necessary. As the global financial and economic crisis has worsened, this viewpoint has gained international popularity. In a December 2008 paper released by the UN Conference on Trade and Development, leading UN economists call for coordinated stimulus packages across the world's leading economies, above and beyond the money already spent to boost credit market liquidity.

Two scholars from the conservative Heritage Foundation argue in a December 2008 paper that the best medicine for the U.S. economy would be to reduce overall government spending. CFR Senior Fellow Amity Shlaes adds that governments can throw good money after bad if they seek to stimulate unsustainable businesses. "It can be perverse because you stimulate something [i.e. an industry] that's really pretty weak and should maybe fade," Shlaes told CFR.org. In a December 2008 op-ed, Shlaes also argued that huge public works projects often fail to revive national economies, as evidenced by Japan's experience during the 1990s.

Disagreement over Tax Cuts

Some people who support the idea of a stimulus package, including some of those within Obama's Democratic Party, still criticize aspects of the president's plan. Rep. Barney Frank (D-MA), the chairman of the House Financial Services Committee, has criticized the plan for its tax cuts, saying they extend further than he would have wanted. Joseph Stiglitz, the Nobel laureate economist and Columbia professor, supported Frank's position in a Financial Times op-ed.

The chairman of Obama's Council of Economic Advisers, Christina Romer, and another economist, Jared Bernstein, who works for the office of Vice President Joseph R. Biden, Jr., explain the rationale behind the tax cuts in a recent paper (PDF). In the paper, Romer and Bernstein acknowledge that tax cuts and fiscal relief to states will likely create less of an immediate economic boost than direct government investments in infrastructure. But they defend the tax cuts on the grounds that there are limits to the amount of money the government can invest efficiently and quickly in infrastructure; therefore, they conclude that some outlays for states and for tax cuts are merited, given the severity of the current economic climate.

Risks of Large Stimulus Packages

Economists point to several possible risks posed by large stimulus packages and say lawmakers would be well advised to take these risks into consideration as they mould the current package. Most basically, there is a risk that the stimulus package won't work, or won't do enough, and that the economic crisis could continue despite massive government expenditures.

Beyond that basic risk, experts say there are several contingencies under which the stimulus plan could prove problematic, even if its works in many of its goals. A January 2009 paper by two Brookings Institution fellows, one of whom, Jason Furman, was a senior economic adviser to Obama's campaign, argues stimulus spending should be:

Timely, to guarantee that spending affects the economy when it is needed most, and to prevent against capital injections leading to overexpansion or rapid inflation.

Targeted, to make sure each dollar spent creates the maximum possible bump in short-term gross domestic product (GDP), and to make sure that spending benefits the people most adversely affected by the economic slowdown.

Temporary, to prevent unnecessary strain on a country's budget in the long run.

Economists say an important determinant of the long-term success of Obama's plan will be the degree to which he is able to follow these principles and prevent short-term stimulus from turning into massive long-term budgetary obligations. The size of the U.S. budget and current account deficit remain major concerns. The nonpartisan Congressional Budget Office forecast in early January 2009 that the U.S. deficit will tally $1.2 trillion in fiscal year 2009, which would mark the highest U.S. budget deficit as a percentage of the country's GDP since World War II. The Financial Times examines this risk in a January 2009 editorial and concludes that the contours of Obama's plan are "mostly right" in that they seem to acknowledge that some of the fiscal expenditures called for in the bill should be temporary.

Prospects of International Debt Default

Some analysts are concerned that a rapidly expanding U.S. deficit will force Washington to borrow internationally, weakening its geopolitical might and increasing the risk of the United States defaulting on its international debt and facing a true financial meltdown. In a Washington Post op-ed, Gregory Ip, the U.S. economics editor at the Economist, notes that in early 2009, markets pegged the probability of a U.S. default in the next decade at 6 percent, as opposed to a 1 percent risk a year before.

Obama and his advisers have defended the scope of the package, saying the expenditures will boost confidence in the United States by convincing foreign partners that action is being taken to lift the U.S. economy from recession. Tyler Cowen, a respected economics blogger, wrote recently that Obama's plan appears to take into account the very frightening possibility of the United States defaulting on its international debt, and that concerns over default risk probably explain why the package isn't larger.

Finally, and perhaps counterintuitively, some analysts point to potentially frightening risks if the stimulus package works too fast. With the world economy destabilized, foreign governments poured money into the U.S. dollar and U.S. treasuries during the latter half of 2008. If a rapid economic recovery leads to a sudden flight from U.S. debt, some analysts say, the result could be inflationary pressures and an environment in which Washington couldn't borrow as easily internationally. This could potentially press Washington closer to a default scenario.