CBO: Stimulus Shrinks Economy

The Congressional Budget Office director's blog posted a surprising bit on its blog last week. The CBO writes that the economic stimulus plan now in Congress would actually shrink the economy — come 2019, the office says, "by 0.1 percent to 0.3 percent on net." Why?

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 potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some 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 legislation's 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) . . .

The CBO says the stimulus will help in the short run — big quote after the jump. I'm hoping to look at this more over the next couple of days. Simon Johnson talked us through some of this on Friday. (Thanks to listener Waciuma Wanjohi and NPR's Maria Godoy for the link._

The CBO writes:

In a letter sent . . . to Senators Grassley and Gregg, CBO analyzed the macroeconomic effects of an initial Senate version of the stimulus 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 output by 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 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would 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.

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