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Juicing the economy has a grave cost: Inflation more debt

NEW YORK ( — Within weeks, lawmakers hope to pass a package of measures intended to minimize the effects of a recession. While there’s little agreement on how much such moves would boost the economy, one thing is certain: They will come at a cost.

Initially, President Bush and leading Democrats have indicated they envisioned stimulus measures – cash rebates, business breaks and other proposals – worth roughly $150 billion. Some experts think the final number could be closer to $200 billion.

Even if the stimulus package proves wildly successful, however, it won’t pay for itself in full, at least not in the near term.

The Congressional Budget Office estimated Wednesday that the federal budget deficit this year will increase to $219 billion or 1.5 percent of gross domestic product – and even more if increased military funding is approved. And that doesn’t count the cost of a stimulus plan.

Stimulus will bump that deficit up, but not necessarily dollar for dollar. Here’s why: If the stimulus effort works, the increased economic activity will generate federal tax revenue.

The CBO estimates that every dollar in a well-designed stimulus package could generate a dollar in gross domestic product. For example, if that extra dollar in GDP yields 20 cents in taxes, then only 80 percent of the cost of a stimulus package would be added to the short-term deficit.

Large budget deficits leave the government with less flexibility to pay for its programs without borrowing. But increasing the deficit in the short-term is not the worst thing, some experts say.

“The whole point of fiscal stimulus is to run a deficit [to get the economy going],” said economist Josh Bivens at the liberal Economics Policy Institute.

What’s more important than a given year’s deficit, Bivens said, is that the ratio of debt to GDP remains stable.

In other words, if the target is to have an average deficit that doesn’t run higher than its current level of 1.5 percent of GDP, the deficit could be higher some years when the economy is weak and lower when the economy is strong.

Some lawmakers want the cost of any stimulus measures to be offset by other revenue-raising steps, such as raising taxes. But proponents of the stimulus package note that it would defeat the purpose to spend money to stimulate the economy and at the same time replace it.

Those who oppose adding to the deficit point to the growing burden on federal coffers to pay for Medicare and Social Security, the costs of which will balloon in coming years unless lawmakers reduce the growth in government spending or raise taxes.

Of course, there’s another way to view cost in the stimulus debate: How much will it cost the country if the economy continues to slide and Congress takes no action?

Former Treasury Secretary Larry Summers told lawmakers last week that several hundred thousand jobs could be lost and the average family might see a drop of about $1,000 in income if Congress doesn’t pass stimulus measures.

By contrast, if a stimulus package is successful, Mark Zandi, chief economist of Moody’s, thinks it could add 700,000 jobs and cut the unemployment rate by half a percentage point by mid-2009.

“While a stimulus package will cost us, it’s going to cost us much less than doing nothing,” said Zandi. He estimates that even a mild recession could cost federal coffers $300 billion in lost tax revenue – double the cost of the stimulus package being discussed on the Hill.

What’s not clear is the cost to the economy if a stimulus package that comes too late – a real concern since legislation could get bogged down by politics.

Recessions are hard to detect. They are officially identified based on economic data from past quarters. So there’s a risk that stimulus measures could take effect when the economy is actually in recovery.

And that could increase the risk of inflation. Putting more money into the hands of consumers at a time when the Federal Reserve is making money cheaper to borrow by cutting interest rates can push prices up because it increases demand for goods.

Wages aren’t likely to keep pace with the price increases, demand and productivity would slow and – you guessed it – the economy could swing back into another more | digg story

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