Friday, January 25, 2008

Liquidity constraints, cash and stimulas

Tas at Sugarland is Dreaming raises a good question about the impact of the rebate checks on the general US economy, and this is a combination political and economic question that I want work with for a bit.

there's also the matter of how the government giving us some table scraps of money is going to jump start our economy. While I love money as much as the next person, especially since I'm having trouble paying rent right now, when I get this stimulus check I'm not exactly going to spend it on needless widgets in fancy colors. It's going into my savings account, where it won't have an immediate effect on our economy -- therefore I'm not helping the country out of a recession. I imagine a lot more people will be stashing away their stimulus check, too. So Bush, Reid, and Pelosi: How is this package supposed to help the country avoid a recession?

Tas seems to be operating under normal economic circumstances. He smoothes out his consumption and expenditure pattern over the long term by putting money away in good times, and drawing down his savings or accessing credit in tough times. He'll change his short term patterns only if there is a permanent change in the trend of his income. A $300 or $600 check won't change his spending patterns in a significant way as it is a one-off deal.

However not everyone is able to live on a permanent income hypothesis of consumption. Some people are credit and savings constrained and are currently spending less than they would prefer to, and could support given their expected lifetime earnings due to an inability to access sufficient credit at a reasonable price. In these cases a $300 or $600 or $1,200 check will change their short term spending patterns and increase aggregate economic activity. So this is the economic answer for checks to be issued to individuals who earned less than $75,000 or couples who earned less than $150,000, to get some people to spend more money instead of banking it.

But the political question is why are these refunds being so broadly distributed when most people will be seeing this as a nice one time bump and do next to nothing with it, as TAS believes he will instead of targeting these benefits and refunds to people who have a high probability of being credit and savings constrained? The existing programs that serve this population include long term unemployment benefits such as extending the maximum benefit period from 26 weeks to 39 weeks, food stamps, and Medicaid payments. However the last two programs are perceived as 'welfare' and handouts to potentially undeserving poor and are not politically popular.

The Democratic leadership believes that if they insisted on a stimulas package targeted solely programs that overwhelmingly serve credit constrained individuals, the political costs would be too high as the Republicans might call them names. Furthermore the axiom that programs for the poor are poor programs influences the stakeholder creation process, as the vast majority of the electorate would not mind a check for $300, $600 or $1,200 and therefore they will provide political cover and favor towards the party but enough people would be disgruntled if only the 'underserving' received government assistance.

This is not a good stimulas plan as the bang for a buck is not that high, but it is vastly superior to the initial Republican position of full extention of the Bush tax cuts. The economics could be greatly improved, but as long as there is a Republican veto and a timid Democratic leadership, the political option space is greatly constrained.

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