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Casey Mulligan on Stimulus Spending and Investment

Wednesday January 12th, 2011   •   Posted by Emily Skarbek at 1:54pm PST   •  

Over at Economix, Casey Mulligan has a nice illustration of Austan Goolsbee’s approach to economic planning. In essence, targeted means of stimulating investment (say, with New Homebuyer tax credits) don’t work to increase investment, and thereby employment, in the short-run. Rather these types of subsidies have drive up prices for current asset owners—constituting windfall gains at everyone else’e expense. A related post here.

As Mulligan writes:

“The Home Buyer Tax Credit is just one part of a complicated stimulus law, but it illustrates a general principle of economics…Even when government spending, subsidy or credit is targeted at a highly depressed industry, with plenty of unemployed workers apparently available for hire, the government’s purchases may, in the short run, raise prices and costs without necessarily causing more of those items to be produced.”

The issue Mulligan raises is fundamental. Asserting that government should intervene in the economy presupposes it can effectively accomplish what it sets out to do. The post is a nice example of the failure of targeted economic planning, but it does a fine job of also illustrating political incentives facing economic planners.

Mr. Goolsbee faced mounting pressure to act immediately when he supported increasing these types of targeted stimuli, just as he is facing extreme pressure to increase the debt ceiling now. These strong incentives easily overpowered his better knowledge and judgment in the past and are likely to do so again.

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January 2011