Myth 1: Government spending doesn't help the economy to grow in the short term.
The Republicans knew that opposing any kind of stimulus just to undermine the Democrats and the president would turn them into villains in front of the voters. They had to accept some kind of stimulus, but they preferred tax cuts to new spending. Tax cuts gave money back to the people who earned it, and they also took money away from the government, which would eventually cause the government to shrink. Their patron saint, Ronald Reagan, put it this way: "People are tired of wasteful government programs and welfare chiselers, and they're angry about the constant spiral of taxes and government regulations, arrogant bureaucrats and public officials who think all of mankind's problems can be solved by throwing the taxpayers' dollars at them."
Faced with the Democrats' proposal for a $900 billion stimulus combining tax cuts and spending, Sen. Jeff Sessions, a Republican from Alabama, said, "we need to resist this package with every strength that we have. Indeed, the financial soul of this country may be at stake." The Republicans called the Democrats' spending wasteful and began to propose alternatives. "We need to make tax cuts permanent, and we need to make a commitment that there'll be no new taxes," said John McCain, the Arizona Republican.
Most first-year students of economics learn about how government spending and tax cuts can affect the economy. When the government spends a dollar, it buys goods or services from a vendor; this is new economic output. The vendor then puts the government's money in the bank, which may in turn lend out a portion of the money. When that portion of the money is spent, it generates more economic output, and so on. This is called the multiplier effect. Tax cuts have a multiplier, too. When people get money back from the government, they may save some and spend the rest. The part that they spend generates new economic output, and the cycle begins again.
Mathematically, the multiplier for a dollar of spending should be higher than the multiplier for tax cuts unless the saving rate is zero, which has often been true in the United States in recent years. But Republicans were essentially arguing that the multiplier for government spending was lower or even zero -- in other words, that the spending was so wasteful that it would just shift economic activity from one area of the economy to another.
Economics textbooks did not agree, and neither did a diverse group of the nation's best economists. At the University of Chicago's Graduate School of Business, the Initiative on Global Markets launched a forum to poll economists on some of the biggest issues in economic policy. It brought together a panel of more than 40 top academics from both sides of the political divide, including members of the Council of Economic Advisers from the presidencies of George H. W. Bush, Bill Clinton, George W. Bush, and Obama. As four panelists wrote in an editorial for Bloomberg News, they wanted to dispel "a common belief that economists can't agree on anything important." The forum, they said, "provides an introduction to the half-century of fact-based research that informs the scholars' opinions."
In 2012, the panel was asked about the stimulus bill that the Democrats pushed through Congress against the Republicans' vocal opposition. Each panelist could agree or disagree with the following statement: "Because of the American Recovery and Reinvestment Act of 2009, the U.S. unemployment rate was lower at the end of 2010 than it would have been without the stimulus bill." Ninety percent of the panel said they agreed or strongly agreed. Then they were asked if the benefits of the stimulus would end up exceeding its costs -- not an essential aspect of a stimulus package, since the goal of stimulus is to borrow growth from the future to smooth out a rough spot in the present. Still, 46 percent agreed or strongly agreed, and most of the rest said the result was uncertain; only 12 percent disagreed or strongly disagreed. Not only did the stimulus successfully lessen the pain and duration of the downturn, which was its main purpose; it also had a decent chance of being a net gainer for the economy in the long term.
How could that be? Looking at data going back to the 1950s, economists from the University of California at Berkeley found that during recessions, every additional dollar spent on goods and services by the government yielded between 1.5 and 2.1 dollars of economic activity. For investments in infrastructure and other forms of public capital, the effects were bigger: 2.8 to 3.4 dollars of economic activity for every dollar spent. The effects were large, the economists wrote, because during recessions the additional spending was very unlikely to crowd out any consumption or investment by the private sector.
When judging the effectiveness of stimulus in the short term, you simply couldn't take the Republicans at their word. One reason was their own hypocrisy. Eric Cantor, who became the House majority leader in 2010, was a case in point. In March 2009, he appeared on ABC News to deny the notion that government spending could bolster the labor market. "It can't create jobs," he said. "It can't create wealth." Yet seven months later, he wrote to the Department of Transportation asking for budget money to do just that. His letters said that a $74.8 million high-speed rail project would "create 281 jobs during each year of construction" and that $60 million in loan guarantees for shipbuilding would generate "thousands of jobs in the shipyard and supplier base for two to three years."
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