Free Custom «Obama’s Stimulus Plan: A Macroeconomic Analysis» Essay Paper

Introduction

The economic stimulus plan enacted a year ago has been viewed by some as a success; nevertheless other people view it as a total failure. The plan has been credited for stabilizing the economy from a great depression and the creation of approximately 2 million jobs. The success has been associated with the provisions in the package such as the tax cuts for citizens, the comprehensive social service benefits, and the massive investments in infrastructure, education, and energy. On the other hand, those opposed to the economic stimulus plan especially the republicans argue that the bill was too costly, financed using debts, and has not fulfilled the promise of creating jobs. This paper aims at analyzing these issues above from a macroeconomic perspective.

The Keynesian problem

The economic stimulus plan worth over $787 billion was put in place one year ago with the aim of returning the economy of the US back on the path of growth. However, from a macroeconomic perspective the plan has failed. The package applies the Keynesianism approach in attempting to reduce recession and this is what has led to the failure of the plan, the idea to use Keynesianism approach seems to have originated from political pragmatism as opposed to historical experience or modern economic theory.

 

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The use of fiscal policy to improve the economy was first used in the 1930s by John Keynes. Keynes proposed that market economies usually get stuck in deep problems which can only be revived by the massive infusion of stimulus by government. He argued that the high rate of unemployment that is experienced in times of great depression was as a result of sticky wages and numerous other market problems that hinder the economy from going back to a state of full employment equilibrium. Nevertheless, Keynes’ approach did not give any evidence to support the idea that sticky wages were a major problem; further research has shown that wages fell considerably in the 1930s. Alternatively, one is required to identify the numerous interventions by the government in elucidating why the downturn took so long (Edwards and Brannon 3)

In spite of the defects in Keynes’ theory, his application of the stimulus plan to increase the level of aggregate demand in times of recession became very popular. He was able to convince governments that by issuing temporary tax breaks and controlling spending, they could be able to eliminate business cycles and scientifically manipulate the economy. A number of economists were of the idea that a trade-off existed between unemployment and inflation, and it could be utilized by policymakers. When there was an increase in unemployment, the government could trigger aggregate demand in attempting to decrease it; however this had the unwanted effect of raising inflation.

In the 1970s, the supremacy of Keynesian theory ended. Government deficits and spending increased, but this resulted in an increase in inflation instead of lowering inflation. The end of Keynesianism was as a result of the rise in Milton Friedman’s monetarism, monetarism refuted the idea that a trade-off between inflation and unemployment exists. Keynes approach was defective and its active fiscal intervention prescriptions were misguided. According to research by Friedman the great depression was as a result of the failure of the monetary policy, as opposed to a failure of private markets.

In as much as the economic stimulus is a good idea, the Obama administration shouldn’t have implemented it in the manner suggested by Keynes. In attempting to take care of a down turn, the Obama administration should have identified the problem early and establish a counter cyclical strategy efficiently and quickly. It is rare nowadays to find books discussing the Keynesian fiscal stimulus without mentioning its serious defects and this is why the economic stimulus plan has not been successful.

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In the recent decades, the Keynesian approach has been improved by integrating ideas from current schools of thought. The Obama administration claims that it has created 2 million jobs over the past year, but how sustainable is this in the future. Today many economists concentrate on the long run growth as opposed to how to manipulate business cycles in the short run. The focus on the long run has enabled economists to advice policy makers on matters such as trade, regulation, and tax reforms. The economic stimulus plan aims at providing a quick fix to recession and the current crisis. Similar to the 2008, $170 billion stimulus act this plan will fail because the overeager economists in the Obama administration are only suggesting dubious proposals aimed providing a quick solution.

The source of money to fund the economic stimulus plan

The aim of economic stimulus plan was to increase its social spending by helping to maintain stability and confidence by giving citizens who are loosing jobs social benefits such as home and health benefits and to support them in getting back their jobs. The other purpose was to introduce tax breaks and invest in the infrastructure of US whether power grid, healthcare, or highways. According to the Obama administration, this would stabilize the economy lower unemployment, and raise output. All this required approximately $800 billion and the main question is, where did government get all this money from?  There are two options to explain how the government was able to raise the money. One is to borrow the money from local markets and this would result in less spending and borrowing by the households in America. This option assumes that banks and individuals have this money, but instead they wish to acquire treasury debts. If the government was to channel this money to individuals who are willing to continue spending it on their daily needs or lending the money to institutions that will direct it on investment goods. This means that the total spending on services and goods could rise, while the total demand for money reduces. In this respect, the stimulus plan is viewed as a way of avoiding the monitory policy. If the demand for money increases with the supply being low, then a deflation and recession arises. For instance, if people were to hold purchases for two months as money as opposed to purchases for a month, and the government fails to raise the supply of money, then the price of services and goods will be forced to fall up to the time the money the public holds is able to cover the expenditure for two months. In this instance people will try to acquire more money by using less on services or goods, until their prices reduce and this result in a recession (Hutchinson 6)

Nevertheless, this is not the current situation. There is high demand for money, but there are no constraints on the supply. The level of excess reserves held by banks has increased considerably and the Federal Reserve can increase the level of excess reserve by creating much more money.

The other explanation of the source of the money is by borrowing funds from overseas, however this is unlikely considering that the global economic down turn has led to the increased rates of interest. Either way, the increased government spending has led to the adverse effect of reducing the amount of private spending and this will affect the economy in a negative way.

Tax cuts.

The economic stimulus has implemented numerous tax actions that are mainly focused on individuals, as well as infrastructure and businesses. The plan introduced a $275 billion cuts on tax, $1000 for the couples and $ 500 for individuals. This is intended to bolster consumer confidence and raise the amount of disposable income. The plan also introduced a provision that allows the termination of indebtedness for companies that modify or reacquire any corporate debt that is outstanding at a discount to postpone the recognition of all taxable income. This provision is estimated at $35 billion in the past year, it is aimed at giving an opportunity for companies with outstanding debts to avert bankruptcy and shore up their balance sheet. The plan has also promoted infrastructure financing that is supported using a comprehensive provision for financing that is tax-exempted. The other provision in the plan is the use of bonus depreciation that is aimed at increasing the rate of recovery of the initial cost of capital used for new investments.

This move to introduce tax breaks contradicts with the provision to increase spending by the government. If spending and borrowing does not work, the lowering of taxes and borrowing will not work either. Borrowing money so as to put it into the pockets of populace is pointless, just as borrowing and spending is. Nevertheless, the reduction of distortions that arise from high rates of tax is effective. However, the most effective plan should be to maintain a predictable and low tax rates for a long period of time. The short term deals under the economic stimulus plan do not encourage individuals to invest, save, and work. From a macroeconomic view, such short term tax breaks increase the marginal rates which will decrease the incentive to invest, save, and work and at the same time will reduce tax revenues. Even if the stimulus plan is borrowing at a lower rate of tax, in future the rates of tax have to be augmented so as to enable government to pay back the debt. Therefore, a reduction in tax that is financed from borrowings should not be permanent as it will not lead to the incentive effects desired. The only solution to this problem is to reduce tax rates, enlarge the base, and address the structural deficits that exist so as to decrease the chances of a higher rate of tax in the future.

The repayment of debt by the government

The economic stimulus package faces a serious problem in terms of repaying the debt used in financing it. The government can use three options but none of these options is considered effective. The first option is that the government might print money since it is considered as mode of transferring payment, however this might be impractical. In actual sense the treasury might borrow money, use it for bailouts, subsidies, and tax rebates and then send the public checks. The Federal Reserve will then buy these debts with the money that has been newly acquired; this will put trillions of dollars in the private hands of individuals. Initially, this will create an increased demand for services and goods and in the end it will lead to inflation.

The second option will be to increase taxes in future, nevertheless if individuals plan for the future, this can lead to zero net effect on the economy. This means that the burden will be borne by young Americans, even though it will only improve the economy merely. This has led to the view that the economic stimulus plan is mortgaging the future further instead of letting the economy to adjust on its own, as it has done during the preceding crises. The Obama administration has not established any clear schedule of future increases in tax or introduction of spending controls that can be utilized in the payment of new debts; in fact the Federal Reserve has augmented the money supply and is announcing its aim to engage in much more. This move will inflate the economy further instead of paying the debts; and it will lead to a maximum inflationary punch (Brandi 5)

The third option would be the government to default the payment of the debt, this will in turn portray the lack of commitment by government to stabilize the economy and at the same time reduce the confidence of the public and private investors.

The success of Obama’ stimulus plan

Those who favor Obama’s economic stimulus plan, argue that the plan is estimated to have created between 1.5 million and 2 million jobs in the past year alone. As

Illustrated by the graph below, the stimulus plan is expected to reduce the number of the unemployed through to 2014.

There have been attacks by republicans that the economic stimulus plan has failed in creating new jobs, but the Obama administration has released a report to refute this claims. Using simple infographs, the Obama administration has been able to illustrate the difference between the job losses during the last year of bush administration and the beginning of the Obama administration. From the infograph below it is evident that President Obama has been able to slow the rate of job loss rapidly. This chart portrays the deep hole that had been created by job losses and how the economy has been able to recover.

The same data can also be presented in a different way so as to represent the situation in an objective and fair manner. This involves the use of another format of infograph that   portrays the number of jobs gained or lost in a cumulative manner as opposed to showing the loss or gain of jobs each month. This chart clearly shows the hole that the Obama administration has dug out the people of America from and the path of recovery that the stimulus plan has put the economy of the US.

Advocates in favor of the package argue that in times of a collapse in the financial markets, the economic stimulus plan is the only effective approach that can be used to counter the decrease in private demand. At the moment, the uncertainty that is being experienced in the financial markets necessitates the increase in the aggregate level of spending. Since the local banks are not in a portion to finance business and household spending, the government needs to contribute to this spending by becoming the source of the finance to be spent. (Gross, 6)

In as much as the package will lead to a massive increase in the spending by governments, advocates argue that this is necessary. Previous financial market downturns have resulted to the rise in the levels of real public debt. This increase in government spending was associated with the extended recessions that came after the financial down turns. Therefore, the stimulus package is required in order to prevent the economy from slowing more and increasing the level of uncertainty, consequently worsening the financial crisis. In addition, governments have the proved to be able to come out of levels of large debt. This was portrayed in World War II where by the gross debt burden of Britain rose to about 200% of the gross domestic product and that of America was at around 120%. However, in both countries there were neither skyrocketing rates of interest nor run away inflation. To wait for the economy to regulate itself will prolong the recession unnecessarily and increase the cost to the tax payer.

Conclusion

From a macroeconomics perspective it is clear that the stimulus plan has its shortcomings. Many macroeconomists including the neo-Keynesians have a number of critical reservations on the effectiveness of the use of fiscal policy to trigger economic growth in the short run. Some economists have proposed that the approach adopted by the administration of Obama is aimed at stimulating confidence in the economy as opposed to initiating spending. The people of America are very worried of the status of the economy, the taxpayers are wondering why their hard earned cash is being misused at the Wall Street. The economic stimulus package may be intended to show the public that the government is trying to act in their interest. The crucial question is whether the stimulus plan is aimed at boosting spending in the short-term or whether it is intended to lead to economic growth in the long run. Only time will tell whether the stimulus plan will flop or whether it will be a success.