Sunday, January 11, 2009

What Are The Expected Values Of the Stimulus Plans?

Every government stimulus spending or tax reduction plan has its own risks associated with it and probabilities that measure that risk. There is obviously a political risk as to whether Congress will pass the plan, will substantially modify it, or will fail to pass it. Likewise, there is an implementation risk as to whether the plan can be and will be set up as envisioned. Lastly, there is also obviously a results risk as to whether the plan will achieve its intended effect with the expected impact without negative unintended economic consequences. For example, a plan double the size of that proposed may have no additional impact on the economy in a reasonable time because the government will be unable to spend the extra funds sufficiently quickly to have a positive economic result. Additionally, there can be other economic risks to the proposed plan not discussed here, such as geopolitical risks from trade effects, military budget effects, etc.

Evaluation of different stimulus packages just by the final modeled effect on the economy, GDP and unemployment is misleading because it does not incorporate the chance of the success or failure of the different proposed plans. It would be like playing poker and assuming the odds of getting two of a kind are the same as getting four of a kind.

A much more meaningful and relevant discussion of the comparison of different stimulus packages, whether the packages are government spending, tax reduction or a blend, is to compute the expected value of each plan based on each plan's risk profile. Under economic theory, the plan with the highest expected value is the one to choose for the greatest economic impact. Without a computed expected value for the different plans, the discussions about the various economic plans in news articles, or in blogs shed no real light on what plan to choose.

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