I believe your analysis is flawed because it leaves out crucial factors relevant to the effectiveness of a stimulus and contains some flawed assumptions.

I’d prefer to start with the premise of your argument by can’t because the chair producer you describe couldn’t be in business, recession or no. A producer with a cost of $10 a chair could not survive in a market where consumers place a $5 value on the chair.

But let me proceed in the spirit of your analysis:

In good times, we have a chair producer whose cost is $12/chair, which he sells for $13 because that’s what the market will bear and consumers value the chairs at $13 (or more).

A severe recession hits and demand for chairs at $13 collapses. Prices throughout the economy,, including wood supplies, drop due to the widespread fall in demand. The chair producer negotiates a lower price for wood, finds other ways to increase efficiency, cuts his profit margin and reduces prices by 20% to $10.

Consumers, also affected by the recession, reduce the value placed on chairs by 30% to $9 or more, but less than $10. Chairs still don’t sell.

The govt steps in with a program that gives consumers a $1 rebate on chairs purchased within 6 months. 1,000 chairs are sold.

Here are the results:

* The govt. spends $1,000.

* Consumers are induced to buy chairs they value at $9. They’re no worse off, and if they value the chairs at more than $9, they’re better off. (Note that this calculation is very different from yours.)

* The chair producer covers both his fixed and incremental costs, makes a small margin (i.e., whatever he retained at $10) and stays in business. He’s better off by the amount of his fixed costs and small profit margin, and he lives to fight another day.

* Employees of the chair producer keep their jobs or are rehired, as are employees up the producer’s supply chain.

* Employees use their income to continue spending, boosting the economy above where it otherwise would be without a stimulus.

With a broad stimulus package, this happens across multiple sectors of the economy, reducing fear and pessimism. As the precipitous fall in the economy eases, consumer and business confidence stabilizes and private spending gradually increases.

If, instead of rebates, the govt sent checks to the chair producer or to consumers, there’s no reason to believe all, most or any of it would go toward buying chairs (or anything else for that matter). Consumers might be just as likely to save the windfall to increase their financial reserves in the face of a recession of uncertain duration. I certainly would. Hell, I’ll buy the chairs later if the recession ends soon.

If there’s no stimulus, the recession deepens, and instead of triggering the positive feedback we seek to induce, the negative feedback generated by a severe recession is sustained. In fact, it may be worsened because people lose confidence that the govt knows what its doing in economic policy making.

I can address Steve’s point about pecuiary externalities, if you’re interested, but I’ve taken enough space already.

Thanks for the link. Good article.

“If the government buys a chair from the chair manufacturer, then the chair manufacturer passes on some of that money to the wood supplier, and that benefits the wood supplier, fair enough.

“But if the government had just given cash to the chair maker (as I was advocating), then he probably wouldn’t have spent it on wood from the wood supplier, but he would have spent the money *somewhere* (what good is money if you don’t spend it eventually), and now that money recipient is better off too.”

But if the government buys the chair, the manufacturer must produce the chair now and therefore must hire the workers and buy the materials, exactly the response you want in a recession.

If the govt gives the manufacturer a check with no requirement to make chairs, why wouldn’t the manufacturer simply save the check in order to build his reserves to better ride out a recession of uncertain duration? Sure, “he’ll spend it eventually”, but the purpose of the stimulus expenditure is to have it spent immediately, not saved.

If the government buys a chair from the chair manufacturer, then the chair manufacturer passes on some of that money to the wood supplier, and that benefits the wood supplier, fair enough.

But if the government had just given cash to the chair maker (as I was advocating), then he probably wouldn’t have spent it on wood from the wood supplier, but he would have spent the money *somewhere* (what good is money if you don’t spend it eventually), and now that money recipient is better off too.

Therefore this, by itself, does not seem to weigh in favor of government spending as opposed to government stimulus checks.

“The wood supplier is better off for making the sale; this slightly pushes up the price of wood, which damages everyone else who’s trying to buy wood.”

Does this assume there is no excess supply of wood as you’d expect in a recession? If supply and demand are balanced or if demand exceeds supply, I can see how the pecuniary externalities would cancel each other out. But when supply exceeds demand, it’s not so clear.

Does this analysis also assume that the negative and positive pecuniary externalities are both internal to the domestic economy? If so, wouldn’t the “export” of any part of the negative externality leave the US economy with a net gain?

“Government stimulus incentives do not induce consumers to buy products they don’t want. They lower the costs of products consumers want or need and are “less likely to buy” because of the recession, making them more affordable and making consumers “more likely to buy” them.”

The trouble is that my argument applies just as much to subsidized products as it does to free products — the government subsidies are still less efficient than if they had just handed out cash.

Suppose 1,000 chair makers are willing to make chairs and sell them for any price above $10 (that’s their cost to make the chair). And 1,000 chair buyers are willing to buy chairs for any cost below $5 (that’s exactly how much they value the chairs). No trades take place.

So the government steps in, buys 1,000 chairs from the chair makers for, say, $12 apiece, and resells them to the chair buyers at a price of, say, $2. Government spent $12,000 and made back $2,000, so spent $10,000.

The chair sellers, who made the chairs at a cost of $10 each and sold them to Uncle Sam for $12 for a $2 profit, are better off by 1000 x $2 = $2000. The chair buyers, who valued the chairs at $5 and got them for $2, are better off by 1000 x $3 = $3000. So the total improvement in everyone’s lives is $5000.

Thus the government spent $10,000 to make people better off by a total of $5000. Fail! It would have been more efficient just to hand out cash.

No matter what numbers you use, there’s a simple proof that the government subsidies are always going to be less efficient than just handing out cash: When an exchange only takes place with the aid of a government subsidy, that means the cost to the producers was greater than the benefit to the consumer, so you’re getting less benefit than your costs, and the exchange is wasteful. A government subsidy (of a purchase that otherwise would not have happened) is equivalent to handing out cash and then mandating a wasteful exchange. This is always less efficient than the handout of cash would have been by itself.