CREDIT: <a href="">Tinou Bao</a> (<a href="">CC</a>).
CREDIT: Tinou Bao (CC).

Policy Innovations Digital Magazine (2006-2016): Innovations: Green Stimulus

Jan 17, 2008

According to the business press, a near majority of economists are now predicting recessions. Economists don't predict recessions. Almost all of them missed both the 2001 and the 1990–1991 recessions. Economists' predictions of a recession are a lagging indicator showing that we are in fact in a recession. The economists' predictions go along with a large collection of other data—rising unemployment rates, crashing house sales and slumping retail sales—all of which indicate that the economy has likely entered a recession. The fact that even economists now recognize the economy's dire straights just seals the case.

Recessions, especially in election years, bring calls for stimulus, and we are hearing those calls now. The crew that managed to somehow overlook an $8 trillion housing bubble is running around calling for a "timely, targeted and temporary" stimulus package. The frequency with which this mantra is being repeated demonstrates that the collapse of the housing bubble has not yet increased the demand for original thinking in Washington policy circles.

But, those of us who keep a safe distance from these circles can still indulge. First, there should be no doubt that stimulus is needed, and almost certainly more than the $70–100 billion figure being tossed around. A reasonable target would be 1 percent of GDP, which would be almost $150 billion in 2008. While any stimulus figure is somewhat arbitrary, the question is the relative risk of erring on the low or the high side. If we err on the low side, then we are not doing enough to support the economy and create jobs. If we err on the high side, ostensibly we would be creating too much demand and risking inflation.

House prices are currently falling at a rate that will destroy $2.2 trillion in value over the next year. This will not only wreak further havoc on the housing and mortgage market; it will also put a huge damper on consumer spending. Does anyone who knows the numbers believe that a stimulus equal to 1 percent of GDP will create excess demand in today's economy?

The second question is where to direct the stimulus. Some items are no-brainers. This list includes extending unemployment benefits to cover longer stretches of unemployment, aid to state and local governments to cover budget shortfalls and general tax rebates comparable to $300 per taxpayer check that was mailed out in the last recession.

However, we can also see the stimulus as a chance to get a foot in the door on advancing a green agenda designed to reduce greenhouse gas emissions. At the top of this list would be a generous tax credit for installing energy efficient improvements to homes or businesses. This one should also be a no-brainer since it could directly re-employ many of the workers laid off in the construction sector. While a similar programme had limited impact in 2004–2006, contractors will be far more energetic in pursuing this business now that the housing bubble has left them with few alternatives.

A second effective form of green stimulus would be to subsidize mass transit ridership. There are approximately 10 billion trips a year on buses, light rail, or commuter rail trains. If the federal government gave transit agencies $10 billion to reduce the average fare on these trips by $1, this would be a very quick way to get an additional $10 billion into the hands of mass transit users. This would be a very progressive tax cut, which would also have the lasting benefit of promoting public transportation.

If we really want to think outside of the box, we can use some of the stimulus to promote pay-by-the-mile insurance policies. These insurance policies are green because they give drivers a strong disincentive to drive. If insurance were paid on a per mile basis, it would provide roughly the same disincentive to drive as a $2-per-gallon gas tax.

Suppose that the federal government paid a $300 subsidy for every pay-by-the-mile policy. This would give insurers a strong incentive to offer these policies and effectively put $300 in the pocket of every driver who switches to paying by the mile. While this policy would take somewhat longer to implement than the other two, the good news is that the recession is likely to be long enough that we could still benefit from the stimulus a year or two down the road.

There are many other ways to structure a stimulus so that it can help to reduce greenhouse gas emissions. If we just accept the idea that it is possible to walk and chew gum at the same time, we can structure a stimulus package that also produces real gains for the environment.

Dean Baker is co-director of the Centre for Economic and Policy Research.

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