The Obama Stimulus Plan

President-elect Obama, his economic advisors, and many pundits across the country have been proclaiming the need for a large increase in government spending to get us out of the recession. They claim, to my knowledge without any rigorous argument or model to support their claims, that an increase in government spending would generate upwards of 4 million jobs, and that it would be more effective than tax cuts.

The main argument goes along the lines of this: "People are wary of increasing their consumption, so giving them more money will only result in them paying down debt or increasing saving, thereby providing not increasing economic activity." This argument has many holes. First of all, they claim that the increased spending will work by creating jobs, increasing incomes, and hence causing people to spend more. Why would people spend more if the money came from government spending versus from a tax cut? Furthermore, they ignore the fact that any increased government spending must come from increased borrowing, thereby draining money available for private investment.

I cannot say for sure what the effect of all this will be, especially since the details of the plan have nto been released. I can say, though, that in this recent working paper by Professor Harald Uhlig and Andrew Mountford that they find that deficit-financed tax cuts are more effective as economic stimulus than deficit-financed increases in government spending. Here is the link to the paper.