Serious mistake to believe the stimulus failed

Mark Zandi

is chief economist

of Moody's Analytics

No one is happy with the economy's current performance. Granted, conditions are much better than they were not long ago: Remember the dark days of 2008, when major financial institutions were evaporating, layoffs were surging, and house and stock prices were plummeting? But with unemployment still stuck near 10 percent, and household nest eggs significantly diminished, Americans remain understandably on edge.

Not surprising, many blame government's response to the financial panic and recession for our current problems. Yet no one knows what the world would look like today if policymakers had not acted as they did.

It's certainly not difficult to find fault with various aspects of the government's response. Were bailouts for the banking and auto industries really necessary? Do extra unemployment-insurance benefits discourage the unemployed from seeking work? Shouldn't bloated state and local governments be forced to cut wasteful budgets? Was the housing tax credit a giveaway to buyers who would have bought homes anyway? Are the government's efforts to mitigate foreclosure as effective as they can be? The questions go on and on.

The government's response also has been very expensive. Total direct costs - including the bailouts, the fiscal stimulus, and the mortgage-related losses of Fannie Mae and Freddie Mac - are expected to reach a whopping $1.4 trillion, equal to about 10 percent of gross domestic product. This explains the current year's entire federal budget deficit.

Given where the economy is today, were these massive expenses worthwhile?

It's a reasonable question, but the answer is a clear yes.

If government had not reacted as aggressively or as quickly as it did, the financial system would still be unsettled, the economy would still be shrinking, and the cost to U.S. taxpayers would be vastly higher. In sum, the government's unprecedented response stabilized the financial system and ended the recession.

The most criticized part of the policy response was the bank bailouts, led by the Troubled Asset Relief Program, or TARP. Congress at first voted to reject the program in October 2008, a decision that fueled the panic that was already roiling financial markets. Under pressure, lawmakers reversed their vote days later - just in time to prevent a catastrophe.

The TARP saved not only the nation's major banks (and their shareholders and creditors), but also the broader economy. If more banks had been allowed to fail, many large U.S. companies would have followed, destroying many millions of jobs in the process.

As things have turned out, taxpayers will end up making money on the TARP. The banks have been quickly repaying the government with interest.

Critics have also objected to the fiscal stimulus as a case of government overreach and ineptitude. They could not be more wrong.

It is no coincidence that the recession ended when it did - about a year ago - just as the stimulus was providing its maximum economic benefit. Emergency unemployment-insurance benefits and tax cuts put cash into Americans' pockets that they have largely spent, supporting sales and employment. And without help from the federal government, state and local governments would have slashed payrolls and raised taxes at just the wrong time. (Even with the stimulus, state and local governments have been cutting, and they will cut much more.)

Stimulus infrastructure spending is now kicking into high gear, and it will be a significant source of jobs through at least this time next year. And business-tax cuts have contributed to more investment and hiring.

Setting the record straight on the stimulus question is important because it will shape the current debate about how government should manage the still-fragile economic recovery. Last week, partly because of the misconception that the stimulus didn't work, Congress was barely able to muster enough votes to pass another extension of emergency unemployment benefits. Not doing so would have been a serious error, putting the recovery in jeopardy.

The mistaken view that the stimulus failed also threatens to short-circuit federal assistance to hard-pressed state governments. That, too, would be a mistake.

Yes, the economy is still struggling, but not because the policy response failed. Our troubles persist, rather, because the problems at the root of the financial panic and the Great Recession ran so deep.

There have been missteps for sure, but government has served us well. We must not lose sight of that now, because the economy still needs help.