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ND professors analyze stimulus

Robert Singer | Wednesday, February 11, 2009

The ruptured 2007 housing bubble that has thrown the economy into a tailspin and curbed job prospects in many industries has caused legislators to call for an economic stimulus package.

Economists across the country including those at Notre Dame continue to discuss the best way to find an answer to the problem.

The subprime mortgage crisis created an enormous sum of bad assets and dried up capital, leading to a situation so severe that many economists support a stimulus bill along the lines of the $838 billion package passed Tuesday by the U.S. Senate.

According to Economics Professor James Sullivan, one of the major reasons why legislators are calling for an economic stimulus – a massive increase in government spending – is that widespread uncertainty has caused a decrease in overall demand. Lacking confidence about their job security, people are less willing to make purchases or investments.

“People expect the economy not to recover soon and that has a self-fulfilling prophecy to it,” he said. “If you don’t think the stock market will increase, you won’t invest in the stock market.”

While the economy probably won’t suffer indefinitely without a stimulus, a bill could significantly shorten the downturn, according to Economics Professor Nelson Mark.

“In the long run, it’s not necessary, but who knows if the long run is going to be 10 years or 20 years,” he said. “So I think the question is if the government is capable of lessening the severity of the recession and if what it can do offsets the long-term costs of doing so, then it should do it.”

If people are unwilling to spend money, then the government can do it for them by cutting taxes, sending money to states, making investments or hiring workers for public works.

“The government can jumpstart things and encourage businesses to invest to get out of this sentiment of pessimism,” Sullivan said.

Mark considered the possible effects of a stimulus bill.

“In the short run, the stimulus can only make things better, it can only increase GDP (Gross Domestic Product),” he said. “There are two questions about it, though.”

Mark questioned whether a recovery would endure and whether it would be worth the increase in public debt.

“Will it have a lasting effect?” he said. “Will it shock us out of a recession and onto a growth path?”

Mark said “the second is the added debt the U.S. is taking on to finance the stimulus. “What’s that going to mean for the future structure of taxes? What’s having all that debt out there going to do to interest rates?”

Ideas differ on how best to implement the stimulus, since not all forms of government spending boost demand by the same speed or magnitude.

Sullivan pointed to a reduction in payroll taxes as an effective way to give money to people who would spend it quickly.

“One way to have an effective stimulus is to put money in the hands of people who need it,” he said. “One way is a reduction in the payroll tax. The argument is that those people are more likely to spend it sooner.”

Direct government spending on infrastructure or energy investment would be fail-safe ways to increase overall demand, according to Sullivan, but tax breaks to individuals would allow them to make their own consumption choices.

“If the government spends it right away, then they spend it right away,” he said. “Consumers might choose to hold onto it, so there’s a little bit of a risk there. Ideally you’d like the consumers to spend it, because they could spend it on what they want.”

Economics Professor Martin Wolfson focused on aspects of the bill that call for more direct government spending.

“I think the best parts of the bill are the parts that directly put people to work,” he said. “Infrastructure spending, investing in green technology, those parts of the bill that keep people from losing their jobs and keep people receiving needed public services.”

Mark also mentioned an overlooked way to spur economic activity.

“Something they haven’t talked about is maybe business tax credits,” he said. “You direct that at small businesses and have them invest in capital.”

Raising people’s permanent income through productivity gains – rather than just spending money now to prolong future debt – should be central to the plan, according to Mark.

“I do think that this is a good opportunity for a lot of the investment projects that the stimulus plan has,” he said. “So you can use this as an excuse to do those kinds of projects. Upgrading the infrastructure will enhance productivity.”

Whether the nation’s response to the crisis represents a shift in the way the government manages the economy is an open question.

“I fear that people will use the current recession as an excuse to blame markets,” Sullivan said. “And I don’t think this provides evidence that markets don’t work. It provides evidence that markets don’t always work perfectly.

“This idea that markets unencumbered will always give the best result is putting a little too much faith in markets,” Sullivan added.

Wolfson said there is a need for broader changes to economic policy.

“I think it represents potential for a fundamental shift in our policy. We’ve experienced over the last 25 to 30 years an environment of reliance upon the free market, free trade, deregulation, tax cuts for the relatively wealthy and I think all of this has basically run around,” he said. “We need to dramatically change our approach to the economy.”

Sullivan said the recession has primarily hurt low-skilled workers and that people who are college-educated have less to worry about.

“That doesn’t mean that Notre Dame grads don’t have to be worried,” he said. “They will land on their feet regardless. It just means that it will take them longer to find the right job. “