Do we know enough to give stimulus packages?

The US government is clearly under some pressure to take action in an attempt to stabilize the economy, and as a consequence, recently announced a $150 billion (more or less) stimulus packages that is supposed to rejuvenate the economy and stabilize the market (H.R. 5140 — the Economic Stimulus Act of 2008).

Will the current plan achieve the government’s goals?

The field of behavioral economics has rather convincingly shown that money given in different forms can have different effects. Paying for dinner in cash feels very different than paying the same amount with a credit card, giving your hosts a gift when you arrive at their place for a dinner party is not the same as giving them cash, and giving employees a monthly increase in their salary has different effects on their spending compared to an equivalent yearly bonus.

In the domain of the stimulus packages, these results suggest that the method of delivering them (individual tax relief in the form of tax rebates, money toward retirement saving, gift certificates, pre-paid debit cards, etc.) could have large consequences on its effectiveness.

The next question, of course, is which delivery method to select. Here behavioral economics has been instructive as well. In particular, years of research have demonstrated over and over that our intuitions about the relative effectiveness of different approaches are often wrong.

Given that the method of delivery could make a large difference, and given that our intuitions about their relative effectiveness could be wrong, what should we do?

One answer is to conduct an experiment, as this is the only method we have for testing what really works and what is likely to fail. In the same way that we force drug companies to test the efficacy of their drugs before rolling them onto the market, shouldn’t we ask the government to first test their ideas before they invest billions of dollars of our tax money on some stimulus packages?

Doing such experiments is clearly not simple, but in order to learn what is truly effective, we must select a few leading candidates, try them out in different markets or market sectors and compare their effectiveness over time. The value of such an investment in learning about the effectiveness of different policies is not only useful for helping us spend the immediate stimulus package but, more importantly, it can help us with market problems that we are certain to encounter in the future.

We all have some complaints about the FDA, yet we also realize that without the FDA medicine could have been nothing but leeches and placebo–isn’t it time to take the same systematic approach to policies that are so central to our society?

Maybe the Fed should hire some experimentalists and start investing in learning about these hugely important decisions?

Some related links,1,7830253.story