Why don't we pay food stamps and unemployment benefits indefinitely to stimulate the economy?

Question

A Moody's Analytics study found that expanding unemployment benefits stimulated the economy by 1.64 times the amount spent on the program.

In findings echoed by other economists and studies, he said the study shows the fastest way to infuse money into the economy is through expanding the food-stamp program. For every dollar spent on that program $1.73 is generated throughout the economy, he said. [...]

The report pointed to expanding unemployment benefits as the program that gets the next biggest bang for the buck. That's because, although the unemployed are already getting checks, they need to spend the money. For every dollar spent here, the economy would see a return of $1.64, Zandi said.

A similar study found (quite possibly the same one) a much smaller multiplier in regard to a federal minimum wage increase. (Full Text)

An analysis of the stimulative impact of raising the minimum wage draws on the macroeconomic multipliers calculated by Moody’s Analytics Chief Economist Mark Zandi (2011), [...] gives a reasonable fiscal stimulus multiplier for the spending increase due to the increase in compensation of low-wage workers. This value is 1.2, which means that a $1 increase in compensation to low-wage workers leads to a $1.20 increase in economic activity.

The calculation of the stimulative impact of the minimum wage, however, must also account for the offsetting shift from employers. [...] The minimum-wage multiplier is between [...] (.53 to .74)

In a weak economy since food stamps and unemployment benefits have the best multiplier effects on the economy, why don't we encourage 100% participation in food stamps, and expand unemployment benefits indefinitely (or until the economy improves)?

Answer 1

Why don't we? Welfare system exists in Germany and many other North-European countries. The unemployed is provided not only food, but also accommodation and clothes (not directly, but he receives the money calculated to be enough for that commodities). But no one is speaking about stimulating economy through that, it's the general welfare ideology.

When it comes to such models, all models are simplifications of the reality. In social sciences, where it's very hard to measure or even list all factors, the models are even more imprecise. An imprecise model can be adjusted to match the data from some period of time, but there's no guarantee it will work with any other data from any other period or any other part of the world.

Second, such models are usually static. They are made to prove some point, they don't consider the way the rule of the game are changing through the actions of the players. It is possible that giving money to the poor will stimulate the economy for the short period, but in the longer period people living from benefits are less interested in finding a job. Many people work because they find work interesting, many want to have higher social status, but many want simply have money to survive. The last group would completely lost motivation for work when you give they high unemployment benefits.

Those models also doesn't deal with one factor. They say, if you give $1 to unemployed, it will generate $1.x income. But before, you must take that dollar away from someone else. That person would also spent that dollar, and it would generate $1.y income. Or he/she would put it in bank, and bank would invest that dollar, generating $1.z income to the economy. Is really x > y or x > z ?

Answer 2

The multiplier effect

Because the concept is hooey. If the government gives a poor person $10, the government has to get it from one of

• Printing money, which causes inflation.
• Borrowing money, which takes money out of circulation somewhere else.
• Taxes, which take money out of circulation somewhere else.

So yes, there is a way that it can be claimed that the $10 turns into $26.40 of economic activity. But what that claim misses is that the $10 of taxes or borrowing also would have caused $26.40 of economic activity if it had been left where it was. I.e. we're adding $10 plus $16.40 of economic activity over here at the cost of subtracting it over there.

Printing money doesn't take money from one location, but it dilutes the value of the existing money. It effectively takes value from all the money. In small amounts, that's only moderately harmful, but in large enough amounts, it can lead to hyperinflation, which does more damage than the original dilution.

Keynes

There was an economist named John Maynard Keynes who has often been misquoted. He said that during recessions national governments should run fiscal deficits so as to avoid an investment deficit. He was concerned that during recessions, people would put their money in safe investments (e.g. national bonds) rather than investing in things like new machines or buildings. So he wanted governments to engage in countercyclical investment during recessions.

He believed in things like new roads and bridges. Big capital projects that would give benefits long after being completed. Things that people would use to generate economic activity later. He was worried that during recessions, people would stop investing and simply save for the purpose of saving. Meanwhile, during booms, people would be investing because everyone was.

Keynes idea was that governments should run deficits during recessions and then run surpluses during the boom periods that followed. Under his system, the net effect would a balanced budget. It's just that the investment spending would be concentrated in the recession years while the taxes to pay for it would be concentrated in the boom years. Keynes believe in cutting taxes and increasing spending during a recession and then increasing taxes and cutting spending during the rest of the cycle.

Consumption vs. saving

Another problem is with the formulation that giving money to poor people is better than giving it to rich or middle class money. This is only true if the goal is to increase consumption. But there are few circumstances where increasing short term consumption is a valid economic goal. More generally, we try to increase savings because that increases the funds available for investment. Investment is the good thing to do with money.

Investment creates capital, which magnifies the effects of labor. So the more capital, the more effective labor is. It makes sense to pay more for labor when it creates more value. So increased wages come from increased capital, which may be physical capital like a building or a welder or it may be human capital, like an engineering class (or even just work experience).

Neither food stamps nor unemployment increase capital. You start with a living person with food stamps or unemployment benefits (or both) and finish with a living person without those. People eat the food or spend the unemployment check on rent. In the past, that gave them stuff, but it's gone now. They've consumed it. Their $10 is gone, leaving only the $16.40.

Now let's consider what happens during a normal economy when someone saves $10. The $10 goes to a bank, which then bundles it with money from a lot of other people and loans the money out to someone, perhaps to buy a new house. There, the $10 contributes to the construction of the house. It gets paid to the company that builds the house. They use that money to pay their bills, creating the same $16.40 multiplier as they money gets spent again and again.

Now we have a $10 deposit in a bank and $10 of mortgage debt. The borrower goes to work, earns $10.02 and pays $10.02. The $10 deposit is now a $10.01 deposit after the bank takes their $.01. So let's see how much economic activity we have:

• $.01 to the bank.
• $.01 in interest to the original depositor.
• $10 in house constructed.
• $10 in income to the builder.
• $16.40 in multiplier effect.
• $10.02 in income to the borrower to pay off the loan.

That's a whopping $46.44 in economic activity, and the original depositor still has the $10 which can be used again.

Even if we use a more realistic $9 loan with a $1 reserve fraction, that's still $41.80 in economic activity created without consuming the original $10. That dwarfs the $26.40 from the consumer.

Minimum wage

It's worth noting that the reason why they said the minimum wage has a lower multiplier effect is that that study is including the lost wages as well. So if there are ten people working forty hours a week at $7.25 an hour, that's $2900 a week for a multiplier of $4756. Now, we raise the minimum wage 20%. If the employer has the same money as before, they now pay $2900 for 320 hours a week, either only employing eight people or cutting back to thirty-two hours per person.

The more general belief is that this only happens partially. So rather than cutting back to 320 hours, they might cut back to 360 hours. The equivalent of paying nine full-time workers. If the ten workers instead go to part-time, they lose about half their raise. Thus only half the multiplier effect.

What's missing though is that also happens with welfare payments. The welfare payments can substitute for wages. When they do that, they reduce the multiplier effect.

The welfare trap

Welfare can be a trap. Say you have $200 in weekly welfare benefits. If you get a job making $225 a week, you pay $25 in taxes and have essentially the same income as the $200 welfare. So your fiscal incentive to get a job is zero. If you had a $250 a week job, you might pay $30 in taxes and net $20. Is it worth working twenty hours to make $20? Or would you rather just chill? Can you afford the commuting costs on $20? Or are you still losing money at the nominally higher wage?

Of course, after six months at $250, they might give you $500 for forty hours a week. Maybe $500 a week is enough to make your new expenses and still feel like you're making something.

Even if we agree that $200 in welfare has a $328 multiplier effect, we still have to account for the lost economic activity from the $250 wage that person can't afford to earn. And don't forget the $410 multiplier effect from that.

Answer 3

I'll give it a shot...

Simple answer: Politics. Social welfare programs have always been heavily debated and somewhat partisan.

Specific to extending unemployment benefits, that was intertwined with the Fiscal Cliff debates late last year (2012). An agreement was reached in December. The main argument against extending the benefits was that it costs a lot of money.

As for Food Stamps, I think that's a harder one to answer. But, like unemployment benefits, the intent is to make sure that those that have incomes below a certain threshold are given an amount to 'cover the gap' between what they earn and what they need to spend.

Giving those particular people that money does directly help the economy as they end up spending nearly 100% of what they are given.

Super simple example: If a loaf of bread costs $1, and I only earn 50 cents, if given another 50 cents in benefits, I will then be able to spend that entire dollar and have my loaf of bread. 100% of the benefit went back into the economy.

However, if I already earn $2, giving me the extra 50 cents may not equate into instant spending. I may choose to spend it on some other food. But I may just as likely choose to save it. So we can't reliable assume 100% of the benefit will go back into the economy.

As such, extending unemployment and food stamps beyond those that are eligible likely won't have the same level of ROI in terms of economic stimulus.

This article points out that the benefit is seen with the 'paycheck to paycheck' consumer

"If someone who is literally living paycheck to paycheck gets an extra dollar, it's very likely that they will spend that dollar immediately on whatever they need - groceries, to pay the telephone bill, to pay the electric bill" [-- economist Mark Zandi]

All that said, I don't believe that's the direct reason why we don't do that...it really just comes back to politics. Those programs are seen as safety nets for those that need it and were not intended to be universal benefits for everyone. To argue that they should be extended to everyone is likely not a political argument that will get very far.

Answer 4

I think it is a very good idea to give stimulus money directly to consumers, as you suggest, and it doesn't need to have anything to do with welfare (which can be construed as giving money specifically to the lazy).

The alternatives are channeling stimulus either through banks or through government spending.

Fiscal stimulus takes the form of either cheap loans given to banks (something of a bit temporary/limited nature) or of freshly printed money given to those who want to sell their government bonds. The theoretical appeal of this system lies with what I call the fundamental idea of Capitalism: the economy wants to grow and the way this is done is to have banks coalesce and invest capital (saved-up money). However, the past decade has really shown how mistaken this idea is. Neither low interest rates nor quantitative easing (money printing) have had the expected effect. Why? Because economic growth is as much about having robust demand as supply of investment capital. In fact, the rich are happy to use their capital for gambling with eachother in the markets as doing real investing. Giving the money directly to the gamblers has made it less effective, because it immediately enters and gets "stuck" in the casino. Even if it is invested, the financial system still gets first cut at the profits.

Government spending focuses on demand and is more effective, in my opinion, today than the supply-side approach. With government spending you can do one of two things 1) do useful, interesting things with science, technology, and infrastructure that wouldn't have gotten done otherwise 2) steal or spend wastefully. Most often, we end up with the latter (primarily through the military-industrial complex and the healthcare system, but also many other ways).

Sometimes it does make sense to stimulate the supply side with cheaper credit or additional capital, and in an ideal world we would stimulate demand with efficient, unique government spending. However, in today's world, directly stimulating demand by handing out money to ordinary people is more effective because they will spend it immediately (not let it get stuck) and try to spend it effectively (on products with a high value/price ratio that are found on the competitive market). We can avoid disagreements regarding welfare by giving the money to everyone somewhat equally (eg, through a negative sales tax).

The reason this is not done as often as it should is a combination of (to a small extent) stale academic thought and (overwhelmingly) greed/corruption.

I want to point out, however, that there is a fourth, absolutely brilliant, and even more effective way to stimulate the economy. This is for the government to exchange their currency for foreign currency and invest the foreign currency in foreign assets. Because the domestic money needs to be spent by the foreigners who bought it, this creates (foreign) import demand. Importers are similar to consumers in that they spend effectively, although not as immediately. In fact, an importer can devote more effort to finding the most efficient (cheap, high-quality) producers. This creates a great stimulus. But the most incredible thing is that the government hasn't actually spent the money. The money still exists as investment assets. This was China's strategy. This strategy faces the same problem as a negative sales tax because it's less amenable to corruption, decreases the spending power of the country's rich, but it also becomes less effective the more developed the economy is and can upset other countries.