4
H ow to C ombat R ecession
was government debt in the era when the government promised gold to any holder of government paper money who requested it. But when the government nearly a century ago removed its promise to provide gold or anything else to the holders of paper money, the paper money ceased to be government debt. By contrast, government bonds are government debt because the government promises to pay government paper money—principal plus interest—on schedule to all holders of government bonds. Another question arises: Does fiscal stimulus really work? Most empirical studies find that the answer is yes. Moreover, just think about it using common sense. Suppose Congress decides, as it should, that the main component of the fiscal stimulus package will be tax rebates to each household. Suppose that the US Treasury mails out two rebate checks to each household— one in June, one in December—each check for $6,000. Is there anyone who seriously believes that households, in a severe recession when most employees haven’t received a raise and some have been laid off, would save the $12,000? In a recession, doesn’t it seem more likely that hard-pressed households would spend a substantial portion within six months? The best empirical studies support common sense: in a recession households do indeed spend about two thirds of their tax rebates within six months. Similarly, does anyone seriously think that in a severe recession, when state and local tax revenues plunge, that cash grants from the federal government would be saved instead of used to maintain normal state and local government expenditures? If you managed these governments during a recession, would you really save the grants, and then do lots of borrowing or slashing of expenditures? Most empirical studies of state and local government behavior in a recession support common sense: federal grants are mainly used to keep state and local governments from
