Another Reason Fiscal Stimulus Won't Work: LAGS

WASHINGTON POST -- Less than half the money dedicated to highways, school construction and other infrastructure projects in a massive economic stimulus package unveiled by House Democrats is likely to be spent within the next two years, according to congressional budget analysts, meaning most of the spending would come too late to lift the nation out of recession.

A report by the Congressional Budget Office found that only about $136 billion of the $355 billion that House leaders want to allocate to infrastructure and other so-called discretionary programs would be spent by Oct. 1, 2010. The rest would come in future years, long after the CBO and other economists predict the recession will have ended.

For example, of $30 billion in highway spending, less than $4 billion would occur over the next two years. Of $18.5 billion proposed for renewable energy, less than $3 billion would be spent by 2011. And of $14 billion for school construction, less than $7 billion would be spent in the first two years.

From Bruce Bartlett's Wall Street Journal article "If It Ain't Broke, Don't Fix It" (12/2/1992):

This follows the pattern of postwar countercyclical programs: All were enacted well after the end of the recession. They exacerbated inflation, raised interest rates and made the next recession worse.

Bartlett documents the fiscal stimulus plans that were passed in response to the recessions 1948-49, 1957-58, 1960-91, 1969-70, 1973-75, and 1981-82, and shows that: a) in each of the six recessions, the fiscal stimulus legislation wasn't even signed into law until the end of the recession at the earliest, and in some cases wasn't passed until a year after the recession ended, and b) in all cases the fiscal stimulus plans took effect well after the recessions had ended.

MP: There has been a lot of debate lately about the effectiveness of stimulus plans, and the size of the multipliers, etc., and most of that debate probably assumes that the timing of the stimulus is perfect. But what if the timing isn't perfect, due to the long legislative lags designing the policy and the long lags before the policies actually take effect? In that case, even if some of the multiplier effects work as intended, it's still possible the policy will fail, and will actually destabilize an economy that has already recovered from a recession.

In other words, unless fiscal stimulus is timed perfectly, it will fail to stimulate the economy. Given the reality of legislative and effectiveness lags, perfect timing is impossible. Given that reality, fiscal stimulus policy won't work due to the problem of lags, regardless of any multiplier effects.

See Greg Mankiw's related post about fiscal policy lags here.