08/08/2009 05:12 am ET | Updated May 25, 2011

Is The Third Time The Charm?

The dismal unemployment report released last week showing 9.5% unemployment -- and a decline in both work hours and weekly wages -- inspired renewed interest in a second economic stimulus. While Vice President Biden downplayed the idea on the Sunday talk shows, the administration has warmed slightly to the notion.

Economists -- from Krugman to Feldstein -- have led the charge for another stimulus since just after Obama signed the American Recovery and Reinvestment Act into law. Unsurprisingly, though, economic and political realities are at odds and most members of Congress, both Democratic and Republican, are unwilling to consider additional stimulus. That is, except for House Minority Whip Eric Cantor who has called for additional stimulus that includes an income tax cut for small businesses and their employees.

Though it is somewhat heartening to hear that Rep. Cantor is willing to distance himself from the fiscal austerity crowd, there at least two major reasons to reject his proposed version of additional stimulus. First, the very premise of Republican complaints about President Obama's American Recovery and Reinvestment Act is that it has not acted quickly enough to stimulate job creation. Yet, the very spending that has occurred from ARRA has come in the form of tax cuts (and expanded unemployment benefits), not from spending on infrastructure and other public investments. If any piece of the stimulus has actually failed, it has been the "fast-acting", low "bang-for-the-buck" tax cuts forced into the package by Republicans and centrist Democrats.

Second, most commentators seem to forget that an additional stimulus package in the summer or fall would, in fact, be our third stimulus, not our second. Recall that in February of 2008, President Bush worked with Speaker Pelosi to pass a stimulus that included $600 tax rebates and business tax cuts at a cost of about $150 billion. At the time, economic prognosticators were overly optimistic about the economy's prospects, just as the Obama administration was when it predicted peak unemployment of about 9.0%. Indeed, at the beginning of 2005, the Congressional Budget Office, while obviously concerned about the prospect of recession, was open to the consensus view of economists that a "resilient" American economy would "keep the economy from going into recession this year."

There is little evidence that the tax cuts that President Bush signed into law had a significant effect on the economy. Not only has the unemployment rate increased in every month since the legislation was enacted, but only an estimated 20% of households that received a tax rebate increased their spending as a result. Though consumption increased in the second and third quarters of 2008, the stimulus actually decreased consumption by 1.0% in the fourth quarter. In other words, the stimulative effects of the tax rebate were not only inefficient, but the overall economic picture did not improve.

Still, the dismal state of the economy suggests that a third stimulus will be necessary. Mohamed El-Erian, CEO of the giant bond firm PIMCO, worries that policymakers have not yet realized that this dismal economic state is actually a "new normal". When they do, he writes:

They will have to recalibrate fiscal and monetary stimulus to recognize the fact that "temporary and targeted" stimulus will be less potent than anticipated.

The real muscle behind President Obama's economic stimulus package has not yet been flexed. The weakness of tax rebates of the sort Rep. Cantor is calling for, on the other hand, has been exposed. Perhaps now it is time to rethink our definition of what temporary and targeted stimulus looks like. Perhaps now we can consider how best to help struggling households deal with a new normal of persistent high unemployment.