Commentary | Economic Growth

Recovery Act spurs genuine growth

Share this page:

The American Recovery and Reinvestment Act can’t seem to catch a break. When the economy contracted at a 0.7% rate in the quarter after it was first enacted, critics argued that the contraction was evidence that the recovery act didn’t (or even couldn’t) have any effect at all. Never mind that there was wide agreement among economists that, without it the contraction would’ve been three or four times worse.

Now that it has been reported that the economy expanded at a 3.5% rate in the third quarter of this year, some experts quoted by CNN and the New York Times (among others) are suggesting that precisely because the recovery act was responsible for the lion’s share of growth, it somehow had failed to repair the economy’s deep (usually unspecified) underlying structural problems. In short, the recovery-package-led growth in the third quarter was somehow “artificial.”

In a way, this is progress. At least there’s agreement now that the government’s money is as good as anybody else’s when it comes to spurring economic activity and creating and preserving jobs. Still there is an oddity here. The new Recovery Act skeptics want to argue something like, “without the public spending provided by the Recovery Act, the economy would just crumble. So we should stop this public spending.”

Huh?

Perhaps an analogy will help. Think of the economy as a boat that has sprung a huge leak. Call this leak “the bursting of the housing bubble” if you like. Obviously the leak has to be fixed. Call the job of fixing it “repairing the balance sheet of households and firms that were damaged by the bursting of the housing bubble.” One thing is going to be pretty apparent to anyone in the boat: Just because the leak needs fixing doesn’t mean that there’s no value to bailing out the water that is rushing into the boat (some bailouts are, in fact, useful). Call this bailing operation “making sure jobs are created and saved in the here and now.”

What will help repair household and business balance sheets and plug the underlying leak? First, we need growth in income and jobs that allows households to pay down some of their debt while still providing some spending in the short run. Second, we could use some moderate inflation: as the debt-clogging households and businesses’ balance sheets is fixed in nominal dollars, inflation allows some of this debt overhang to be eroded away over time, in turn allowing recovery to happen that much quicker.

The recovery package is, indeed, helping to plug the leak – by giving people jobs and incomes over the next year, it allows them to dig out of their debt burden. It also helps fight off spiraling disinflation.

The recovery package is also the only thing bailing out the economy in the short run, keeping the economy from entering a downward spiral before households and businesses are ready to pick up the spending slack from the public sector.

It’s true that the economy remains fragile, and will for quite some time. The Congressional Budget Office (CBO) has forecast that the unemployment rate will average 10% in 2010. The recovery act will largely stop boosting the economy by the end of 2010. The economy will still surely need more help from the public sector: more safety net spending, more fiscal relief for states, more direct spending, and even more direct public job-creation and incentives for employers to hire. In short, a second round of recovery spending is needed to keep the economy afloat and finally fix the leak.

The alternative would be just to let the whole boat sink.


See related work on Economic Growth

See more work by Josh Bivens