Economic stimulus options

January 15, 2008

CBO released a report today, written at the request of the House and Senate Budget Committees, on the current economic situation and options for fiscal stimulus to boost short-term aggregate demand. CBO will release more information about economic and budget conditions in its Budget and Economic Outlook on January 23.

The report's key points are that:

  • Strong indications suggest that economic growth is slowing and will remain sluggish for much of this year. Most professional forecasters are continuing to project very slow growth, as opposed to an outright recession, this year. The risk of recession is elevated, however, and some respected economists believe that the probability of a recession has now risen to 50 percent or greater.
  • Fiscal policy stimulus may not be necessary to avoid an outright recession, if most current forecasts are correct. Nonetheless, policymakers may choose to proceed with a stimulus package to bolster a weak economy and as insurance against the elevated risk of a recession. Some economists advocating a stimulus also believe that a recession, if it occurs, could prove to be unexpectedly deep; a fiscal stimulus would help to reduce the severity of a recession should one occur.
  • Fiscal stimulus aims to boost economic activity during periods of economic weakness by increasing short-term aggregate demand. This approach is in contrast to policies aimed designed to improve long-term economic growth: such policies work by increasing the economys capacity to produce. Because short-term stimulus is focused on demand, its efficacy depends on a different set of principles than long-term supply-based policies, and it is often in tension with those principles. Some of the most effective forms of short-run stimulus provide little aid to, and may even retard, long-run economic growth if made permanent. At the same time, many options that promote long-term growth provide little short-term stimulus.
  • Effective stimulus does not necessarily require addressing the source of economic weakness directly; instead, it requires strengthening aggregate demand.Although much of the current economic weakness can be traced to the housing and mortgage markets, other factors, such as the high price of oil, have played an important role. If policymakers choose to address problems in the housing and mortgage markets, possible actions should therefore be evaluated primarily with regard to their effectiveness in correcting identifiable failures in those markets---and not necessarily with regard to their value in counteracting economic weakness. Such policies may nonetheless help to reduce the severity of a possible recession.
  • The most effective types of short-term fiscal stimulus (delivered either through tax cuts or increased spending on transfer payments) are those that direct money to people who are most likely to quickly spend the bulk of any additional funds provided to them. The report includes a summary table assessing various types of tax and spending options from the perspective of short-term fiscal stimulus effects.

The report was written by a team of analysts primarily from our Macroeconomic Analysis and Tax Analysis Divisions.