Macroeconomic Effects of the Senate Stimulus Legislation

February 4, 2009

Ina letter sent today to Senators Grassley and Gregg, CBO analyzed the macroeconomic effects ofan initial Senateversion of thestimulus legislation (the Inouye-Baucus amendment in the nature of a substitute to H.R.1, which is the House stimulus bill). CBO estimates that the Senate legislation would raise outputby between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislationwould raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011.

Those estimated effects are slightly greater than those of H.R. 1 (as introduced) in2009 and 2010(particularly in 2009), but lower in 2011, because more of the overall rise in spending and fall in revenues occurs in the first two yearsunder the Senate legislation.

Most of the budgetary effects of the Senate legislation would occur over the next few years. Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to "crowd out" private investment---thus reducing the stock of private capital and the long-term potentialoutput of the economy.

The negative effect of crowding outcould beoffset somewhat bya positive long-term effect on the economy ofsome provsions---such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislations budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.