You probably know that we are in a recession. Unemployment is at 7.2%, the highest in 15 years. As my macro students will learn later this semester, increasing aggregate demand (AD) through government spending can help the economy in recessions. But only if that spending hits the economy at the right time.
To read about the problems that Obama's policies might have, go to Much in Obama stimulus bill won't hit economy soon. Here are some key exerpts:
"It will take years before an infrastructure spending program proposed by President-elect Barack Obama will boost the economy, according to congressional economists.
Less than half of the $30 billion in highway construction funds detailed by House Democrats would be released into the economy over the next four years, concludes the analysis by the Congressional Budget Office. Less than $4 billion in highway construction money would reach the economy by September 2010.
The economy has been in recession for more than a year, but many economists believe a recovery may begin by the end of 2009. That would mean that most of the infrastructure money wouldn't hit the economy until it's already on the mend.
Overall, only $26 billion out of $274 billion in infrastructure spending would be delivered into the economy by the Sept. 30 end of the budget year, just 7 percent. Just one in seven dollars of a huge $18.5 billion investment in energy efficiency and renewable energy programs would be spent within a year and a half.
And other pieces, such as efforts to bring broadband Internet service to rural and underserved areas won't get started in earnest for years, while just one-fourth of clean drinking water projects can be completed by October of next year."
The parts that will hit the economy quickly are the tax cuts and aid to states, who are facing budget problems due to lower tax revenue, which always happens in recessions. Later in the semester, we will also learn about something called the "policy lag problem."
A group of economists called the Monetarists believe that when a recession occurs, it takes too long for the government to recognize it and take action to end it. The action will probably cause AD to increase when the economy is already back to the full-employment GDP. This is called the Policy Lag Problem. Here is how it works:
A recession begins (the economy produces less and workers are laid off) and at least 6 months later, the government finally recognizes that we are in a recession, so there is a Recognition Lag.
A few months later (maybe more), the government finally decides to do something about the recession (it can take time for Congress to pass a spending bill), so there is a Decision Making Lag.
A few months later (maybe more), the government implements the spending plan (maybe Congress passed a spending bill for highways and companies have to be found, bids taken and so on), so there is an Implementation Lag.
A few months later (maybe more), the government spending finally has an effect on the economy (AD increases), so there is a Effectiveness Lag. By this time, the economy is normal or back to full-employment. Then alot of spending hits the economy. This could cause inflation. Inflation is too many dollars chasing too few goods. If there is too much money in the economy, prices rise.