The Deeping Recession

This assessment, written in January 2009, was written by Edith Rasell, a Ph.D. economist, serving as Minister for Workplace Justice, Justice and Witness Ministries.

Layoffs. Business failures. Cuts in workers’ pay or work hours. These are signs of a recession, a slow down in the national economy. As the size of the economic pie shrinks there is less for everyone to purchase and fewer workers are needed to produce it. Unemployment rises. Incomes decline. Some people are unable to pay their bills. Others fail to make payments on their debt. Some lose their home or business.

To halt the downward spiral and get the economy growing again, there must be an increase in purchasing, a rise in spending. This will cause firms to expand production, hire workers, and invest in additional equipment and facilities. But few households or businesses have the extra income to spend. Or uncertainty about the future may lead them to save all they can, not spend. This is where the government must step in. It has two options.

Deficit spending: To boost national spending and end the recessionary cycle, government can run a deficit, that is, spend more than it receives in revenue. Because in recent years the U.S. has already had a deficit, its size must now be increased. To create or enlarge a deficit, the government cuts taxes without cutting spending, or it raises spending without increasing taxes. If new spending is offset by new taxes, or tax cuts are offset by spending cuts, then no additional spending will take place and the recession will not be ameliorated. Because state and local governments are required by law to balance their budgets and prohibited from running deficits, only the federal government can engage in deficit spending to end a recession. 

Lowering interest rates: The second way to increase national spending is for the federal government to lower interest rates. This makes it cheaper to borrow money and encourages households and business to make purchases they might not have made otherwise. But even extremely low interest rates may be ineffective if the uncertain times make households and business unwilling to risk making large purchases or if, as in the U.S., banks are making few loans.

In January, 2009, government-set interest rates were nearly at zero, as low as they can go. But the recession continued to worsen and many considered the U.S. to be in a financial crisis. A package of spending increases and tax cuts that increased the federal government deficit was the only policy tool available. Policymakers called this an economic stimulus.

Characteristics of an Effective Economic Stimulus

Any additional spending will boost the economy. But some types are much more effective than others. Money spent to purchase imports from abroad primarily stimulates job growth and production overseas, not in the U.S. A tax cut that provides extra money to a household which chooses to save it will not help the economy, no matter how beneficial it might be for the household. On the other hand, people in tight financial circumstances often need to spend every penny they get to cover basic necessities. Giving money to people who are hurting  –  such as through expansions of  unemployment insurance and food stamps – is a very effective economic stimulus as well as the right thing to do.

An effective economic stimulus would have the following three characteristics.

• It is big enough to make a noticeable difference, some $2 trillion a year given the current size of the U.S. economy;

• The new spending happens quickly, within months or a year at the most.

• Spending is targeted on items with the largest stimulatory impact, for example, tax cuts for those who will spend the money or public spending for items produced in the U.S. such as roads and other infrastructure projects or services provided by teachers or nurses.