(Bloomberg Opinion) -- If the U.S. economy falls into recession, it is going to take more than the Federal Reserve to revive it. That means Congress — specifically, Republican members of Congress — should start thinking now about what kind of economic stimulus plan they favor.
This will require a change of mindset. Some conservatives oppose any fiscal stimulus at all, either because they think monetary policy alone is sufficient to stabilize the economy or because they believe the government should simply let the recession “play out.” Both of these views are fundamentally misguided.
President Donald Trump has done a lot to repress if not extinguish the latter line of thinking; he is clearly not indifferent about the prospect of a recession. Yet there are some conservative economists who say that downturns have “cleansing effects” that help make the economy more efficient. This is a rare case when the president has it right and the economists have it wrong. Far from cleansing the economy, recessions leave permanent scars not only on the economy but also on the generation that experiences them.
Trump is back to being wrong, however, with his belief that the Federal Reserve alone can guarantee that the U.S. avoids a recession. In the current low-interest environment, the Fed faces significant challenges.
In theory, the Fed could provide sufficient stimulus to offset a recession. For example, the Fed could lower interest rates to zero, then promise not to raise them again until the economy has not only recovered but overheated. The bank could allow inflation to run above its target for at least as long as it ran below its target. Yet such a commitment would be difficult to keep. There would be public outcry over high inflation, and there is no way for the Fed of today to hold the Fed of the future to its promise.
These constraints mean that, if and when a recession comes, fiscal stimulus will be necessary. Democrats have their wish list ready, featuring such proposals as increases in Medicaid support and an expansion of Temporary Aid to Needy Families — not to mention the Green New Deal, which is as much fiscal policy as environmental policy. Republicans hardly ever mention the word stimulus, even though it could apply to 2017’s Tax Cut and Jobs Act.
So how should they talk about it now? If they’re smart, Republicans will favor across-the-board cuts for all taxpayers, affluent and not; tax relief and investment incentives for businesses; and well-considered infrastructure spending. They will almost certainly face Democratic opposition, and they should have arguments at the ready.
Tax cuts for wealthier Americans, for example, may have a more simulative effect than Democrats think. As affluent consumers age, they are becoming more sensitive to the fall in asset prices that usually accompany a recession. Indeed, high-income spending is already weakening as a result of the trade war’s effect on stock prices. Allowing affluent Americans to quickly rebuild their nest eggs could help get them spending again sooner.
Another argument is that tax cuts are inferior to government spending as a stimulus, even if the spending is on projects with a poor rate of return. It’s true that government spending may have more impact, but that benefit is counteracted by the fact that poorly considered government spending may have a negative return. Low rates of return are less of a concern in a recession, but they are not irrelevant.
In contrast, tax relief for households and businesses will be spent or invested by actors who are looking to get the most for their money. And larger amounts of stimulus can be provided to business and households without worrying about the crowding-out issues associated with federal spending.
One Democratic argument Republicans should embrace is the need for government spending to focus on the suffering of the least among us. Stimulus should certainly include that type of relief. But popular support for it is more easily achieved as part of an overall plan that includes every sector of society.
None of this is to suggest that Republicans should dig in their heels and insist on stimulus programs that reflect only conservative principles. They should be ready and willing to negotiate with Democrats about tax cuts and spending programs that will help return the economy to full employment. If there is a recession, an effective fiscal stimulus may be the best way — it may be the only way — for the government to avoid the slow recoveries that have plagued the U.S. after the last two recessions.
To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior.
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